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Why Gold Stocks Are in a Rebound that Should Continue Into June

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Renowned gold investor breaks down the technical and sentiment data in tandem with the positive and negative catalysts.

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Two weeks ago, I proclaimed a major bottom could be imminent in the precious metals sector. (See What Is the Real Price of Gold Signaling?)

My basis for making the prediction was that the metals and shares were extremely oversold, breadth indicators were at 2008 levels, sentiment was contrarian bullish, and markets were nearing areas of strong support. In this article, I review the compelling evidence for this important bottom and discuss the potential fundamental driving forces for the start of the next cyclical bull market in this sector.

Two weeks ago Market Vectors Gold Miners (GDX) formed a bullish reversal at the 50% retracement (2008-2011) amid an all-time high in weekly volume. The market showed excellent follow-through last week as it gained 7.9% on substantial volume. Also note that the four-week moving average of the bullish percent index (a breadth indicator) reached the 2008 low.



Market Vectors Junior Gold Miners (GDXJ) (larger juniors and mid-tier companies) also formed a major reversal on massive volume and would gain 7.5% last week.



Also encouraging is the relative strength of the shares that usually lead the metals at key turning points. In the chart below, I plot gold, GDX, and GDXJ. Note the positive divergence in favor of the shares.



The length of the current cyclical bear market (because that is more apt than "correction") implies that the sector should soon begin a new cyclical bull. The Gold Bugs Index (^HUI) (large caps) has endured three primary corrections or cyclical bear market downturns. The 2004-2005 consolidation lasted 18 months and declined by 37%, while the 2008 downturn lasted six months but declined by 71%. The recent cyclical bear has lasted 18 months and declined by 42%. Corrections or bear markets are a function of price and time. Typically, less severe downturns will be spread out over a period of many months, while the most severe downturns tend to culminate quickly (2008).



Though the HUI was only in a bear market for six months in 2008, most gold shares peaked some time in 2007. Some peaked at the end of 2007, while some peaked in April 2007. Below we show an index that consists of 20 companies (most of which are producers too small for the HUI) and has a median market cap of $900 million. It peaked in April 2007 and would bottom 16 months later. Each countertrend move has lasted 16 to 18 months. This bear market has lasted nearly 18 months and at the recent low was 50% off the high.



Clearly, I have presented some compelling evidence that the gold shares have completed an important bottom. A rebound is under way and should continue well into June. However, until we see a successful retest of this low, I have no way to confirm if this is the start of the next cyclical bull market. We technicans sometime feel that we can call every tick and turn of the market. We must remember that fundamentals drive markets and trends. Technicals are a context, not a catalyst. That being said, technicals lead fundamentals and reflect fundamental themes as they develop under the surface.

Positive fundamental catalysts include the likelihood of a new rate cutting cycle in China, the inevitable monetization of European debts by the European Central Bank, and the potential for a shift in Federal Reserve intentions given global economic uncertainty amid falling inflation and weak commodity prices. Our job is to weigh the technical and sentiment data in tandem with the potential positive and negative catalysts. Should these aforementioned catalysts emerge in tandem with favorable technicals, then we'll have stronger confirmation of a new cyclical bull market. In the meantime, my firm and I continue to focus on the companies best positioned for and most likely to take advantage of the inevitable next leg up in this bull market in precious metals.

Editor's Note: See more from Jordan Roy-Byrne at The Daily Gold.
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No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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