Gold, Silver, Mining Stocks: 'Capitulicious'?

Includes: AGQ, GDX, GLD, NUGT, SLV
by: Dave Kranzler

Everyone involved in the stock market has heard the old adage, "Buy when there's blood in the streets." Supposedly the quote comes from one of the 18th century members of the Rothschild banking family. My own little twist on that statement is: "The amount of pain being felt by precious metals sector investors today is proportionate to the size of the gains we will experience in the next leg up."

Certainly everyone involved in the precious metals and mining stock sector feels as if the there's investor blood splattered all over the place after this last week of a price correction that started Sept. 21, 2012, for mining stocks and two weeks later for gold and silver. Is this correction in the sector over? I can't say definitively, but judging by the sentiment indicators, right now is a great time for contrarian/value investors to close their eyes and plunge into the water.

The numbers are ugly. Since the correction commenced, the Amex Gold Bugs mining stock index (HUI) is down 30.8%, gold is down 12.2%, and silver is down 17.6%. Some individual mining stocks are down well over 50% in that time period. I can say with certainty that currently the investor sentiment with regard to the sector is the worst I've seen it in 12 years of researching, investing, and trading this sector.

In terms of mining stock investor sentiment, I like to look at the Gold Miners Bullish Percent Index (BPGDM). The Bullish Percent indexes are momentum-based indicators that indicate the percentage of stocks in a sector that have bullish technical patterns. BPIs can range between 0 and 100 are typically considered overbought above 80 and oversold below 20:

Click to enlarge images.

This chart shows the BPGDM for the last three years. The only time I've seen it lower than the current reading of 6.67 was back in October 2008, when it hit zero. At that time the HUI index had dropped from 485 to 150 in six months. You can see from the black lines connecting the BPGM chart to the corresponding HUI chart that readings this low can be successfully traded by getting long the HUI index (see below).

While the BPGDM is one good sentiment indicator, I wanted to post a chart that I "hypothecated" from Jim Sinclair's Mineset blog that shows daily market sentiment for gold:

The actual source of the chart is the Daily Market Summary, for which the proprietor offers a 15-day free trial (I just signed up). I modified this chart with the vertical yellow lines to highlight the fact that extremely low sentiment readings in gold correspond with market bottoms. This chart goes back to 2001 and the current daily sentiment for gold is the lowest it's ever been over that time period.

Certainly judging by the sentiment readings in the mining stocks and for gold, it would appear as if the precious metals sector is bottoming out. Let's look at a few other statistics. MarketVane's Bullish Consensus for gold lost to 2 points yesterday to 49% (silver's went down to 46%). The last time this sentiment reading for gold was this low was Nov. 13, 2008. Back then, gold had just finished dropping from a new bull market high of $1,020 down to $681. On the day the sentiment indicator hit 49%, gold had closed at $704. Again, based on sentiment, it sure looks and feels like a bottom.

Just a couple more statistics. The Hulbert Gold Newsletter Sentiment Index is at -12.5 and has been there for a few weeks. When this indicator is below zero, it means that investment letters that issue recommendations on gold are net short the market. My observation has been that whenever this indicator registers an extreme reading either negative or positive, it is almost a 100% contrarian signal.

Was yesterday "capitulative" (ergo, my title)? Yesterday, the trading volumes for NUGT (3x the rate of return on the HUI), GLD, GDX, and AGQ were all 3 times higher than the 90-day average volume for each of the respective ETFs -- SLV's volume was 2.5 times higher. Certainly any technical analyst who uses volume in his analysis will tell you that kind of volume on a big down day like yesterday is "capitulative."

Based on the above analysis, my view is that the precious metals and mining stock sector is forming a big bottom and is getting ready to start a move that ultimately will culminate with new highs for gold, silver, and the mining stock indices. I would be so bold as to say that next to October 2008 and early 2001, this is probably the single best entry point that investors will get during the course of the precious metals bull market.

My strategy is to start accumulating AGQ and NUGT in order to capitalize on the leverage offered by those two ETFs (2x silver and 3x HUI). I am also selectively adding to the mining stocks owned by my fund. Because some of the names are illiquid, I'd prefer to keep the names I added yesterday proprietary for now. But I did add recently to EXK, HL, Osisko (OSKFF.PK), and Rye Patch Gold (OTCQX:RPMGF). My best advice if you want to aggressively make a contrarian play is to "leg in" to AGQ and NUGT.

Disclosure: I am long OTCQX:RPMGF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The fund I manage is long AGQ, OTCQX:RPMGF, OSKFF.PK, EXK, and HL.

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