In this article, I want to examine the move in miners and consider whether this is simply a counter-trend move or the beginning of a change in trend. A change in trend would dictate a new pattern of higher highs and higher lows, rewarding a "buy the dip" mentality.
As of Friday's close, GDX was up 15% in the last eight trading days. I wrote in this article one set-up to take advantage of a potential "snap-back" rally in the miners. In this article, I made the case that the ratio of gold to gold miners indicated gold miners were undervalued.
I have been able to take advantage of this move higher in the miners, mainly via the Triple Bull Gold Miners ETF (NYSEARCA:NUGT). I wanted to give my reasons for why this is an apt time to take some risk out of the trade by raising stops, taking profits, or hedging.
The first chart above shows the inverse relationship between gold miners and the U.S. dollar over the long term. The second chart shows that currently both are moving higher together. I consider this divergence atypical, and don't think it will persist. A sustained move higher in the miners requires a weakening dollar. If the dollar remains strong, the miners will be susceptible to a nasty reversal as a strong dollar will pressure gold and silver.
Gold and Silver
Another puzzling development in this recent bounce for the miners has been the stark underperformance of the underlying metals. The first chart shows the SPDR Gold Trust (NYSEMKT:ETF) (NYSEARCA:GLD) against the Market Vectors Etf Trust (NYSEARCA:GDX). The second chart depicts the iShares Silver Trust against the Global X Silver Miners (NYSEARCA:SIL).
Both charts show that the move in the miners has been quite robust, however the same cannot be said for the precious metals. A sustained uptrend in the gold and silver miners cannot happen without participation from gold and silver.
As I explained in this article, the junior miners (NYSEARCA:GDXJ) lead sustained moves higher, since they are the most leveraged to gold. In this rally, the Market Vectors Junior Gold Miners ETF has actually underperformed GDX, which is not consistent with the notion of a major trend change. This is another warning sign, and another signal indicating caution toward longs in this sector.
Of course, no one can be 100% certain whether or not this upmove indicates the bottom is in for the sector or this is merely a respite in the downtrend. However, I think we have to remain objective and consider evidence even if it contradicts our bias. I stated some reasons that this move should be treated with skepticism. The next sell-off in the sector bears watching, an orderly sell-off forming a higher low would be constructive and a good entry point, especially with confirmation from currencies, metals and junior miners.
Shorter term, after such a strong move, prices could continue drifting up. However, I don't think aggressively buying will be rewarded at these levels. It's important to remember that there is a considerable amount of supply at these levels. The risk/reward is no longer on the side of buyers and given the lack of confirmation from the measures above, traders should keep an open mind that this was a counter-trend move higher.
Given the favorable fundamentals in the sector, I remain optimistic about the prospects for the miners. Longer term, however, I think there is some reason to doubt whether the trend has changed despite the recent, impressive price action.
Disclosure: I am long NUGT.