Another Extreme Historical Inflection Point Upon Us

Over the past year, the gamut of various indicators/studies that have shown gold stocks to be “generational buys” have been numerous. Another very rare feat that we are in the process of accomplishing is the Y-O-Y (Year over year) 52 week rate of change of < -50%. Having an individual security decline by such an amount is not uncommon but for an entire sector to be down that much is indeed rare. Of course, there are no guarantees that history will repeat itself but investing is all about probabilities that are in your favor. Most certainly such an approach does not provide with the adrenalin rush  of momentum trading, however if one steps back and looks at the entire picture (fundamental/sentiment/technical) the probabilities clearly show that we are VERY CLOSE to another advance of relevance.

HUI Gold Bugs Index 1997-2004

HUI Gold Bugs Index 2005-2013

(Click images to enlarge)

The HUI index has been in existence since 1994 and this is the 4th time that such an event has transpired (Yes, we are only on Tuesday and by Friday this study may be for naught, but it is worth noting at the current time given the host of variables arguing for a favorable outcome here, including the current models’ buy signal). The other three times were as follows:

Week of August 24, 1998:

This was the lowest weekly close. Prices advanced quickly, in 5 weeks’ time we recorded an advance of 53% and after a 6 month period prices had settled back to only a 4% gain from the inception of the -50% reading in the ROC. As is evident in the chart above the lows did hold for over a year before succumbing to more downside.

Week of October 2, 2000:

At the onset, prices continued to retreat, with a maximum drawdown on a weekly close basis of 15%. Within the 6 month window, prices recorded their maximum gain after 22 weeks for the first -50% reading with a gain of 36%.  Of course this period also marked the secular low and was followed by multiyear advances of several hundred percentage points.

Week of October 20, 2008:

The second chart speaks for itself as you will note this marked the low for gold stocks following the financial crisis of 2008. There was no drawdown from a weekly close basis and prices recorded a 94% advance after 21 weeks, with significant more gains after the 6 month window.

Going back in history, the uniqueness of this phenomenon within the gold stock sector also exhibited similar results. Using the Barron’s Gold Mining Index as a proxy, from 1938 until 1994 (when the HUI took over the analysis), the 52 week rate of change recording a reading of < -50% had taken place on 4 different occasions. A brief synopsis of the four occasions follows:

Week of May 21, 1940:

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At the onset, prices experienced a 4% drawdown and then proceeded to gain 40% over the next 25 weeks. Similarly to the 1998-1999 period, prices went on to break the lows about a year and a half later where they formed a final bottom. Although the ensuing 10-20 year period produced reasonable gains for gold stock investors, the “play” was still the general equity market since we had begun a secular bull market unlike 1999/2000 where the opposite held true.

Week of December 16, 1969:

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Another major low signaled by the extreme reading in the 52 week ROC. The weekly closing level was the lowest in the decline and thus produced no drawdown. Prices advanced by 52% within the first 26 weeks.

Week of August 3, 1976:

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This was the period that led to the final low following the devastating bear market of 1974/1976. The -50 reading was a couple of weeks too early (similarly to OCT 2000) and produced a drawdown of 16% (again a similar amount to 2000). The ensuing advance was rather slow  with a 29% advance after 18 weeks and was followed by a lengthy period of sideways action (once again, very similar to 2001). Unlike the 2000/2001 period where prices did catapult higher after the 9/11 bottom, the 1976/1979 period was one characterized by a very slow advance until of course the parabolic rise of late 1979 and into 1980.

Week of June 15, 1982:

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Once again the -50% reading was recorded at the absolute low week of the preceding decline. Of all the signals before and after this one, the 1982 example produced the fastest and best gain in the shortest period of time; a 138% gain in 26 weeks. Those highs of 1983 however were not to be seen again until 2006 as the secular bear market took hold. Nevertheless, the rally of the June low was one for the ages.

SO WHAT CAN WE DEDUCE?

Based on our sample study, if we assume the HUI closes the week around current levels (240), a 15% drawdown will take us down to the June lows. Even a muted advance (25-30%) from current levels takes us up to 300 and above the August highs which should bring in technical buying. Longer term, if my assessment of a secular advance still being in the picture holds true, more than superior gains lie ahead.

Chart courtesy of StockCharts.com

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