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Investors in mining stocks have taken a major beating with Market Vectors Gold Miners ETF (NYSEARCA:GDX) trading back to where it was in late 2009, but the extended consolidation appears to be about over. The miners are forming a major bottom, and will likely outperform both gold and silver in the next bull market phase.

Gold vs. Gold Miners:

Source: stockcharts.com

The Gold:GDM ratio recently hit a high that was three standard deviations from the 200 day moving average. The probability of a three standard deviation event is only approximately .25%. This has only happened a few times before, and has historically been a great indicator that mining shares will outperform the physical metal.

GDX:

GDX recently had a major reversal on record volume, which is often an indicator of a bottom. Although there remains strong near-term economic headwinds and upside technical resistance, GDX looks likely to finish consolidating soon, and may have already bottomed. I would not be surprised to see one more drawdown in the near-term, but believe mining stocks will offer investors significant upside in the next bull market cycle.

Gold:

SPDR Gold Shares (NYSEARCA:GLD) bounced off support at the $150 level, and looks like it may soon break out to the upside. A long consolidation after the spike to nearly $185 is healthy for GLD in the long-term. If gold is able to break out of its trading range the miners will follow, but with even great force.

GLD vs. GDX:

The disparity between gold and mining stocks is too great, and will result in the miners outperforming the physical metal in the next major up move.

Source: Yahoo Finance

The miners often lead the physical metal and are showing signs that they may continue the recent outperformance. GDX is back to where it was in late 2009, and ready to move upward as the market obtains a resolution from Europe. Although stocks had their worst day in 2012 on Friday, GDX was up 6.4%. Even Freeport-McMoRan (NYSE:FCX) was able to close slightly up, despite its large exposure to copper, and has strong support at $30.

PHYS Premiums:

Source: sprottphysicalgoldtrust.com

Sprott Physical Gold Trust (NYSEARCA:PHYS) premiums are at 1.60%, which is well below the average since inception. The low premiums are indicative of a bottom being formed.

US Dollar Index:

Source: Stockcharts.com

The U.S. Dollar Index has increased dramatically since its low a year ago, but the rally is getting overextended, and likely to resume its downward trend once Europe settles on a temporary solution for Greece. After the recent run, investors should prepare to switch back to dollar bearish. Although I expect another euro scare to push the dollar higher in the near term, the long dollar trade is nearing the end of its run.

Commercial Shorts Covering:

The commercial shorts have been unwinding their position, which are at multi-year lows. Their reduced short position indicates they are preparing for a powerful move to the upside in gold.

Investment Thesis:

  1. The unsustainable performance disparity between precious metals and mining stocks will result in a major upswing for precious metal miners.
  2. GDX recently had a major reversal on record volume, and has strong support at $40 per share.
  3. Gold miners recently started outperforming the physical metal, and often lead the metal at peaks and troughs.
  4. The commercials have dramatically decreased their short positions, and are positioned for a powerful move up in gold.
  5. After such a long and trying consolidation, only the strongest hands are left, while everyone else will play be playing catch-up.
  6. The U.S. Dollar Index has had a powerful run that has been fueled by European concerns, but likely to reverse as investors get a resolution out of Europe.
  7. Commodity position limits as part of the Dodd-Frank Act could help reduce the short selling in the gold market.
  8. Many investor expectations for additional QE have come down since the end of QE2.
  9. Weak economic data, a stronger dollar, and lower bond yields will eventually enable the Fed to provide additional stimulus.
  10. The Fed is typically accommodative in an election year.
  11. Easy money policy coming out of China.
  12. Historically low premiums to purchase PHYS.
  13. Precious metals provide a better opportunity over the next 3-5 years than broad market stocks, bonds, or real estate as detailed in my article here.

Major Risks:

  1. India's tax on gold imports, and a weak rupee could cause gold and miners to suffer.
  2. A major economic shock (i.e. Greece exiting the euro) would probably result in significant near-term downward pressure on every asset class except the dollar and government bonds.
  3. Continued currency turmoil could keep the dollar rising longer than expected, and continue to exert downward pressure on precious metals and miners.

Commentary:

The next major bull market in the miners and precious metals is approaching. In the next major cycle I believe silver will outperform gold, but the miners will outperform both gold and silver by a significant margin.

My previous article on the bottom being formed in silver can be found here.

Disclosure: I am long GDX, GLD.

Source: The Miners Are Forming A Major Bottom