Gold mining stocks represented by the Market Vectors Gold Miners ETF (NYSEARCA:GDX) have lost 35% since September last year. Over the same period of time gold prices have shed 'only' 13%. Is that price divergence bullish or bearish for GDX and gold?
Gold Mining Basics & Disadvantages
Gold mining (and mining in general) is a tough business for several reasons. The mining business is capital intensive. It takes expensive equipment to replace 'inventory.'
In fact, the goal and business model of every mining company is to sell the most valuable asset on its balance sheet - gold. It's hard to create consistent value that way.
Unlike brewers (think of your favorite beer) for example, miners don't get any excess return from branding. It's not that gold mined by Barrick Gold fetches more than gold mined by Newmont. Gold is gold and commodities are anonymous.
No Progress in the Best Environment Ever
Gold miners have enjoyed the best possible environment for mining and selling gold. Political and financial uncertainty have sent gold prices soaring from $250 to well over $1,500/oz, but Barrick Gold shares trade at their 1996 level today and shares of Newmont Mining (NYSE:NEM) are at the same level as in 1987.
Barrick Gold and Newmont Mining are well-managed companies. They are industry titans and combined account for over 20% of the Market Vectors Gold Miners ETF, but mining is a tough sector to create shareholder value in.
The first chart illustrates gold miners' struggle to keep up with gold prices. Newmont Mining is trading below its 1997 peak. Gold prices on the other hand have soared more than 600% since the early 1990s.
Obviously, it is possible to make money with miners. From 1998 (or 2000) - 2011 Newmont Mining shares gained over 460%. However, it took a frenzy drop into the 1998 low and a frenzy rally to the 2011 high to deliver such handsome gains.
Short-Term Gold/GDX Correlation
The second chart below plots the percentage change of gold prices since the September 2011 high against the percentage change of GDX.
Again, GDX has been hit much harder. Gold is down 17%, GDX lost 37%.
Is that performance discrepancy bullish or bearish for gold prices and GDX?
Now is not the time to join the sell gold/GDX crowd. The decline accelerated back on February 10, when the Profit Radar Report predicted that: "A break for gold below 1,663 will result in a move to 1,635, and a drop to at least 1,620 - 1,600 would be welcome to shake out some of the weak bulls."
Much of the damage has already been done and the recent drop no doubt spooked goldbugs. It also catapulted many fair weather SPDR Gold Shares (NYSEARCA:GLD) and iShares Gold Trust (NYSEARCA:IAU) investors back to the sidelines.
I would view a more deliberate test of gold support around 1,530 accompanied by a bullish RSI divergence as a buy signal (with a stop-loss below support).