Getting Technical

Gold Stocks Undervalued and Set to Spring Higher

After a sharp August pullback, gold stocks look refreshed and set to shine once again, charts say.

By Michael Kahn             


 
After a strong seven-month performance to start the year, gold stocks and exchange-traded funds ran into a buzz saw in August. Using the standard, and quite frankly lazy definition, the group fell into “bear market territory” by falling 20%.

It is very interesting that the decline erased exactly one third of the prior 2016 gain for the VanEck Vectors Gold Miners ETF. That is a textbook correction in my book (see Chart 1).

Chart 1

Last week, after the tepid August jobs report was released, the ETF scored a bullish one-day reversal bar by falling to a new low for the decline and then closing well into the green for the day. That tells us there was a sudden change of heart in the market, and what was once shunned was now back in favor.

To be sure, there are contrary technical factors that should be on everyone’s minds. First, the bounce so far has not been able to take the ETF back above its 50-day moving average.

And second, there is the double-edged sword of gold itself. The metal held quite steady for the past two months yet gold mining stocks fell with ferocity. Stocks tend to lead their commodity so this could be a negative for both. But on the other hand, the rising trends for gold, silver and platinum remain intact.

I will give the benefit of the doubt to the trend any time.

Plus, there are many other bits of bullish technical evidence to be found. For example, the VanEck Vectors Junior Gold Miners ETF, which tracks smaller capitalization stocks in the sector, sports on-balance, or cumulative volume levels on par with its July and August price peaks.

That suggests that all the money that flowed out during the August decline already flowed back in, even though prices remain depressed. Put another way, volume traded during the recovery was greater than volume during the decline telling us that bulls were more aggressive than bears. That’s demand.

Many component stocks of these ETFs echo the chart patterns above. Coeur Mining, for example, shows the sharp 2016 rally and equally as sharp August pullback (see Chart 2). It also shows two types of short-term reversal patterns that suggest a bottom was already reached.

Chart 2

                   
First, it shows the familiar double bottom, or “W” pattern, so named for its look of that capital letter.

In a nutshell, downside power waned as the bears could not press their case. And it is further confirmed by rising momentum and cumulative volume indicators from the first price low to the second.

Next, another pattern familiar to investors is the head-and-shoulders, defined by a high – the head -- surrounded by two lower but equal highs – the shoulders. Normally, this is a sign that the major rally leading into the pattern was transitioning into a decline of comparable size.
When the stock dips below the bottom of the pattern, the sell signal is triggered and the bears win.

However, with this pattern the failure to break down tells us that the bulls win and prices normally head back higher. We can see variations on all of this in familiar names such as Newmont Mining and others.

Of course, there are gold stocks that do not fit this mold, including Kinross Gold and Goldcorp ( GG ). The former, for example, did not show strong performance starting in May as it traced out a triangle pattern (see Chart 3). That pattern broke to the downside last month and indicators such as on-balance volume and momentum did not show any positive signs as they did in Coeur and Newmont.

Chart 3

The major difference between stocks that look ready to resume their rallies and stocks that seem to have problems is the trend leading into the August decline. Those stocks with clear and strong rallies seem refreshed and ready to resume their advance. Those stocks with sideways patterns leading into August have much more work ahead just to get through the congestion zones set up by their floundering performances.

The wild card remains the uncertainty over the timing of the Federal Reserve’s next rate hike.
However, given that it seems inevitable and gold still trades near 52-week highs perhaps the market has already factored that in.

Don’t let the “bear market territory” comments used by the media turn you off. After all, every bull market starts after a significant price decline.

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