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Indicator Suggests Precious Metals Stocks Are Due for a Big Rally

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Each time an indicator reached this level in the past, precious metals stocks went up 33% to 131%.

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While the rest of the stock market has been hitting multi-year highs, precious metals stocks have been in a bear market. On Thursday, March 22, precious metals stocks closed at their lowest levels since before Fed Chairman Bernanke's infamous late August 2010 QE2 speech. However, there may be light at the end of the tunnel. Gold stocks' dramatic underperformance has caused an indicator to reach levels that have always preceded large rallies in precious metals stocks.

The indicator we will be taking a look at today is the 21-day RSI of the $XAU/$SPX ratio. The $XAU is a gold/silver stock index. The $SPX is the S&P 500. The reason we are looking at the $XAU is it is a precious metals stock index that has daily data and goes back to December 20, 1983. In short, we are looking at times when precious metals stocks did poorly relative to the S&P over a one-month period.

Here is the chart:


Click to enlarge

You may have to enlarge the chart as there is a lot going on there. The top part of the chart is the RSI (21) indicator. The middle chart is the ratio between precious metals stocks and the stock market. It really isn't the main focus of this article. The chart on the bottom is precious metals stocks. It is also quite helpful to have a CrossHair program so you can more easily see how gold stocks fared once the RSI indicator dropped so low. What we want to know is how the bottom chart (gold/silver stocks) fared when the indicator in the top chart got this low.

Here are all the other times when the indicator went below 27.64:



These were in four groups. To avoid redundancy, we will take a look at the first date in each group (designated in bold).

  • July 22, 1986 to April 14, 1987 -- gold/silver stocks up 131% in 8.7 months
  • November 25, 1992 to January 18, 1994 -- gold/silver stocks up 121% in 13.7 months
  • December 1, 1997 to April 23, 1998 -- gold/silver stocks up 33% in 4.7 months
  • April 28, 2004 to November 17, 2004 -- gold/silver stocks up 37% in 6.6 months

There were also three other times the indicator got close to the recent reading but did not quite get that low.



Let's take a look at how these fared.

The September 12, 1988 signal was a bit complicated. Here are the prices of ^XAU after the signal:



As you can see, gold stocks entered a multi-month trading range. The downside was 6% which isn't all that bad. This instance was, by far, the worst of the low RSI readings as it did not produce a sustainable rally. However, you did have a couple of opportunities to get out with a double-digit gain. Then there was yet another drop to the 80s.

On the third bottom it set off another low RSI reading. This second RSI reading set the stage for a 59.9% rally in gold stocks for 7.7 months. If you could have managed to hold from the first low RSI reading for 16 months you would have made 54.9%, which is equates to a 38.82% annualized return.

This leaves us to the final signal which was May 16, 2005. Precious metals stocks went up 112% in a little less than a year.

All seven times the $XAU/$SPX RSI (21) went below 28.14, gold stocks rallied 33%-131% for 4-16 months.

The earnings yield of the ^XAU is 5.83% compared to the S&P's 6.22%. However, the earnings' yields for 2012 and 2013 are 9.14% and 10.91% for gold stocks and 7.2% and 7.6% for the S&P. How accurate and sustainable those estimates are is another debate, but it does at least offer some rationale in buying gold stocks for a mutli-month rally which should be sold in the next four to 16 months.

One of the more interesting aspects of the chart in this article is five out of seven signals were in a midst of a 19/20 year bear market in gold/precious metals stocks. Despite this, four of the five "bear" signals were outstanding and the other one had limited downside. One note of caution however: This study doesn't cover 1980-1983, and that was a very rough time for gold and silver stocks. However, at the very least, the $XAU:$SPX RSI (21) indicator suggests that this is not the optimal time to be shorting precious metals stocks. While the long-term outlook looks poor for gold and silver prices, somewhat paradoxically, over the next four to 16 months precious metals stocks should participate in the stock bull.

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No positions in stocks mentioned.
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