Gold Miners Signaling Trouble

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Includes: ASA, DUST, GDX, GDXS, GDXX, GGN, GLD, GOEX, GTU, IAU, MELT, NUGT, OUNZ, PHYS, PSAU, QGLDX, RING, SGDM, SGOL, TGLDX
by: Brad Zigler

Trends in bullion and stocks diverging.

"WOLF!"

There, I've said it. Or cried it, as the fable goes. You know Aesop's story, surely, about the shepherd who repeatedly tricks nearby villagers into thinking wolves are attacking his sheep?

A lot of gold aficionados have felt I've cried "Wolf!" in past columns when I've warned of metal selloffs. Some of the more vehement objections arise when I point to indicators which show diminishing conviction among gold investors.

Take the relative strength of gold mining stocks as an example. Obviously, investing in gold stocks is not the same as investing in gold itself. Typically, gold miners are more volatile than bullion. Three times as volatile over the past three years as you can see from the chart below:

The annualized standard deviation in the price of the VanEck Vectors Gold Miners ETF (NYSEARCA:GDX), a tracker of more than four dozen global gold producers, is 46 percent. The volatility in the spot price of Comex bullion is only 14 percent. Even so, GDX is well correlated, at 93 percent, to Comex gold. Obviously, gold mining stock investors get more bang for their bucks. That's good when gold is favored, bad when it isn't. It should be no surprise then that mining stock investors are exquisitely sensitive to bullion's shifting fortunes.

You can get a sense of how sensitive they are by measuring the mining stocks' relative strength against gold's proxy, the SPDR Gold Trust ETF (NYSEARCA:GLD). Relative strength measures the vitality in one stock's trend by comparing it to another stock's.

Historically, gold miners' strength mirrors that of gold itself - or gold's proxies mostly. There are times, however, when miners diverge from the bullion trend. These are the fabled times when miners are said to lead gold higher or lower. Back in 2011, for instance, miners' relative strength started to wane even as bullion - and GLD - rallied to historic highs. By the time GLD peaked in August 2011, GDX's relative strength had been in a four-month free fall (see the blue oval on the left). And that led to a four-year downtrend in which GLD shed more than 40 percent of its value.

Recently, we've seen a rally in gold prices but that hasn't been accompanied by strength in the miners. In fact, miners are diverging. See the blue oval on the right?

Is the wolf stalking the golden sheep? History says it might. Gold investors should assess their risk exposures here, just to be safe.