Put gold miners on radar screen

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Ever since I started my investment career as a mining analyst in 1984, I have taken a keen interest in gold stocks. The behavior of the miners in recent times warrants special attention.

I always keep a close eye on the relative strength of the miners versus the metal as stocks often lead bullion. The chart below was constructed by dividing the MarketVectors Gold Miners ETF (GDX) by the SPDR Gold Trust (GLD). A rising trendline indicates outperformance by gold stocks against bullion, whereas a declining line shows the metal having the upper hand. After a period of outperformance until the beginning of 2011, the miners have been drifting lower until finding a possible bottom (in relative terms) over the past few weeks. Based purely on this chart, more evidence is required that the curve of mining stocks has in fact turned upwards.

Source: StockCharts.com

In addition to the nascent outperformance by gold stocks, the Gold Miners Bullish Percent Index (BPGDM) shows only 23% of the 32 stocks in the Gold Miners Index are now in point and figure uptrends. The sentiment indicator is used like all bullish percent indices: readings over 70 are overbought while drops below 30 are oversold.

Importantly, the last two times an oversold condition existed were at the end of 2008 and during the first quarter of 2010. The late 2008 upturn signaled a major rally in gold shares. While the BPGDM has just turned up, the “all clear” for the group will only be signaled when more than half of its stocks are in new uptrends (i.e. above 50). However, given the very low level of the indicator, and buy signals being given by short-term indicators such as MACD and ROC, it would not be surprising if better tidings for gold and silver shares lie ahead.

Source: StockCharts.com

The fact that most gold mines are situated in developing countries contributed significantly to their underperformance as the currencies of these countries tend to come under pressure during crisis times as investors shy away from high-risk assets.

Source: Plexus Asset Management (based on data from I-Net Bridge).

Furthermore, the gold stocks are included in the main stock indices of the respective emerging markets and are therefore vulnerable when foreign investors hedge their exposure to the developing countries.

Source: Plexus Asset Management (based on data from I-Net Bridge).

Although the gold miners (GDX and its younger brother GDXJ) have more work to do before confirming the stocks are back in secondary uptrends, I doubt one could go too far wrong by starting to nibble on this neglected sector.

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