Bullish Gold-Stock Volume

Even before this week’s latest Fed-tapering scare, gold stocks remained firmly entrenched as the most-hated sector in all the markets.  They are as deeply out of favor as they’ve been in their entire dozen-year secular bull, hyper-oversold and radically undervalued.  Given such epic antipathy, I figured they were also suffering from low trading volume.  Turns out they are, with some surprises, which is a bullish omen.

It’s been several years since I’ve studied gold-stock volume in any depth, and I’ve been growing more curious about it as this year’s massive gold-stock rout wore on.  Trading volume is pretty ambiguous as far as technical indicators go.  While most indicators clearly flag excessive greed or fear, high volume can show both.  Volume tends to surge when traders get excited, when either kind of emotion is running high.

And prior to gold stocks’ latest Fed-sparked plunge this week, the dominant emotion in this sector was certainly despair.  After a brutal 2013, investors and speculators have pretty much universally abandoned all hope in this sector.  With the sparing exceptions of abnormal days like this week’s Fed aftermath, gold stocks are generally way past fear.  In a left-for-dead sector, trading volume ought to be dismally low.

In years past I used the flagship HUI gold-stock index in my volume studies.  But sadly I fear the HUI is dying.  The last time its custodian (NYSE Amex) reported this index’s component stocks was way back in December 2011.  We’re even now seeing divergent component listings on major financial websites, they don’t agree which stocks are even in the HUI!  This isn’t a good sign, the benchmark HUI is fading away.

Of course the universal loathing for gold stocks is a big factor.  If investors don’t care about an obscure sector, index custodians also neglect it.  But a bigger reason is probably the rise of ETFs.  The HUI is never mentioned on CNBC, instead whenever analysts talk about gold stocks they use GDX as their sector metric of choice.  That of course is Van Eck’s widely-known Market Vectors Gold Miners ETF.

GDX is indeed a fine gold-stock ETF, and worthy of being a sector benchmark.  Born in May 2006, I started studying it in depth in late 2007.  And its component stocks and their weightings mirrored the HUI’s very closely.  While GDX’s annual 0.5% expense ratio makes it less clean than a pure index for long-term measuring, GDX is still increasingly replacing the HUI as the gold-stock metric of choice.

While the large majority of gold-stock trading doesn’t happen through GDX, its volume is still very representative of this sector as a whole.  When traders are buying and selling gold stocks, they are also buying and selling GDX proportionally.  And GDX’s enormous trading range in recent years reflects gold stocks’ huge volatility.  This ETF traded from the mid-$60s in September 2011 to the mid-$20s this week!

This means raw volume isn’t particularly comparable over time thanks to GDX’s broad range.  A 20m-share day now represents far less capital changing hands than the same volume a couple years ago when gold stocks weren’t despised.  A concept calledcapital volume bridges this disconnect and restores comparability.  It simply multiplies raw GDX shares traded each day by this ETF’s intraday average price.

The result is how much money is moving in and out of gold stocks daily.  Ignoring inflation, there’s no difference between a billion dollars moving through gold stocks today or a couple years ago.  This first chart looks at GDX capital volume over the past several years or so.  The raw capital volume is in red, and is super-volatile.  So I applied a yellow 21-day (average trading days per month) moving average to smooth it.

As always with Zeal weekly essays, the data cutoff for getting them researched, charted, written, proofed, and published on time is Wednesday’s close.  So Thursday’s wild Fed-tapering-scare action isn’t reflected here.  Nevertheless, it isn’t relevant to this study of the gold-stock capital-volume trend in place so far this year as gold stocks spiraled ever lower.  As I expected, widespread despair led to low GDX capital volume.

This past Monday, the money changing hands in GDX trading fell to a paltry $244m per day.  This is exceptionally low.  The collective market capitalization of the old HUI component gold stocks that day was around $116,347m.  So in GDX alone, only about 0.2% of major gold stocks were being traded.  Once again GDX is not the majority of gold-stock trading, but it is certainly representative of this whole sector.

When investors and speculators have abandoned a sector and walked away, low capital volume is the natural result.  With fewer traders left, and virtually no enthusiasm, there’s neither a large-enough remaining constituency nor any motivation to buy or sell rapidly. Thus after a long selloff, when stocks are exceptionally oversold and deeply out of favor, low volume is a very bullish contrarian buying indicator.

In a truly literal sense, stock prices are a popularity contest.  When stocks are in favor traders love them and flood into them, bidding up their prices to new highs.  Eventually the greed this sparks balloons to unsustainable levels, and a major top occurs. Conversely when stocks are out of favor traders hate them and steer clear, so their prices fall to new lows.  Major bottoms happen after fear and despair finally peak.

And with GDX already plummeting 41% year-to-date even before the Fed scare, there is no arguing it was in a brutal selloff.  And everyone knows gold stocks are despised, the vast majority of traders have convinced themselves that markets move in one direction forever so gold stocks will never materially rally again.  So the sub-$250m-per-day GDX capital volume earlier this week was a major bottoming indicator.

Major new uplegs in any sector are always born in fear or despair.  When the majority of traders are the most bearish, everyone susceptible to being spooked into selling low has already fled.  That leaves only buyers, who stealthily start bidding up the battered sector in an effective volume vacuum.  Nearly every major upleg and even significant rally in gold stocks was born in low volume, as you can see in this chart.

Pick virtually any low point in GDX before a multi-month rally, and then look at its red capital-volume line.  It is always low as post-selloff pre-upleg despair reigns, and often near that $250m-per-day line which has effectively proven a hard floor in recent years. Most of these times the yellow 21dma of GDX daily capital volume is low too.  Very low volume after major selloffs is a harbinger of an imminent new rally.

I was well aware of this low-volume and major-bottoming connection after decades of intensely studying the financial markets.  I expected to see volume very low given the universal antipathy towards gold stocks these days.  But what I didn’t expect at all was the surprising uptrend in GDX capital volume in recent years!  That is highlighted above bracketing the 21-day moving average of this volume metric.

Traders naturally get excited during both steep rallies and steep selloffs, stoking highly-motivating greed and fear respectively.  So the huge capital-volume spike into GDX’s September 2011 highs makes perfect sense.  It’s hard to believe now, but gold stocks were actually on the verge of being exciting back then!  Fortunes were being won as they rallied higher.  But volume changes dramatically in corrections.

We all remember the outsized down days that punctuate corrections from time to time, like the carnage this Thursday.  During these big selloffs fear flares dramatically, and volume spikes accordingly as traders rush for the exits to end the pain.  But the great majority of corrections are not dramatic down days, but slow, demoralizing grinds lower. This eventually breeds despair, leading to declining volume.

And indeed between GDX’s September 2011 peak and its May 2012 trough, a more normal 8-month correction span, capital volume fell off dramatically.  This is particularly evident in its 21dma line.  With the exception of those occasional big down days that ignited fear-driven selling, volume faded with traders’ interest in gold stocks.  It didn’t recover again until gold stocks started surging in the middle of last year.

As GDX rallied rapidly, capital volume rocketed higher.  These high-volume rallies were a very encouraging and bullish sign for gold stocks.  High volume reflects high interest and strong conviction.  Incidentally one of the biggest complaints about 2013’s general-stock-market melt-up was it happened on low volume.  Low-volume rallies are suspect with a weak foundation, while high-volume ones are strong.

Gold stocks as represented by GDX indeed started climbing higher, carving the nice support line shown above that would normally announce a major new upleg.  But then 2013 arrived, with a super-low-probability event that short-circuited gold stocks’ advance.  American stock traders started to dump their shares in the flagship GLD gold ETF to use that capital to chase the levitating general stock markets.

I can’t emphasize enough how anomalous, unprecedented, and unsustainable this GLD mass exodus has been.  As explained in depth in our current monthly newsletter, the entire reason gold has been weak in 2013 was capital rotating out of gold ETFs utterly dominated by the US GLD.  The extreme differential selling pressure in their shares dumped too much gold supply onto the markets too fast to be absorbed.

Not even big physical demand out of Asia could overcome it.  And as gold prices ground ever lower, gold-stock traders fled.  The levitating stock markets sucked capital out of GLD, gold was hit on GLD bullion flooding the market, and the gold stocks were crushed on falling gold.  This dynamic is slowing and reversing, and the totally anomalous carnage it wreaked in gold stocks will reverse along with it.

One of the biggest mistakes investors and speculators make in markets is to assume hyper-overbought or hyper-oversold markets are at fundamentally-righteous levels.  As Iwarned aggressively back in mid-May as the general stock markets were euphoric, they were far too high and due for a major selloff.  And I continue to pound the table on theincredible bullishness of gold stocks, the ultimate contrarian trade.

As this sector drifted and sometimes plunged lower in 2013, I expected capital volume to continue to fade as despair set in.  And indeed we saw raw GDX capital volume fall near or slightly below that $250m-per-day floor several times this year.  But what really surprised me is the continuing uptrend in the 21dma of GDX’s capital volume.  That flies in the face of all my expectations, and has intriguing implications.

This uptrend began back in mid-2010, as GDX was slowly climbing towards new all-time highs in a strong upleg.  It should have failed as GDX corrected, and indeed if you draw a resistance line from the tops of 21dma spikes between GDX’s September 2011 peak and early 2013, average capital volume was declining.  But it has actually picked up again in 2013 despite the worst gold-stock action since 2008’s stock panic.

Why is the cash changing hands in gold stocks still growing on balance despite the universal despair plaguing this hyper-oversold sector?  I don’t know.  It could be a massive distribution, the remaining gold-stock investors dumping shares low en masse to forever spurn this sector that has been so miserable in 2013.  It could also simply be a GDX-specific thing not representative of this sector, as this ETF grows more popular.

It’s hard to believe, but hedge-fund managers have increasingly been buying sizable long positions in GDX in recent months.  These professionals recognize excessive greed and fear, and know when a sector is too overbought or too oversold.  And since researching individual gold stocks is so challenging, time-consuming, and expertise-dependent, many have decided to let GDX’s custodians do it for them.

But there is a third possibility that intrigues me.  As a newsletter writer, I receive a never-ending stream of countless e-mails from individual investors, speculators, and money managers all over the world.  While the vast majority have naturally been very down on gold stocks this year, there is a small minority that are getting really excited.  They see the extreme oversoldness and are buying for the inevitable mean-reversion rally.

If there is indeed a lurking remnant of hardcore contrarians now out there stealthily buying, the moment gold turns decisively higher gold stocks are likely to explode higher. GDX’s own capital volume shows huge spikes higher on rallies since last spring, a bullish sign.  This continuing capital-volume uptrend in 2013 despite unbelievable pain may show far more underlying psychological strength than most imagine.

Since I was looking at GDX capital volume, I decided to check out its smaller cousin too.  GDXJ is Van Eck’s Market Vectors Junior Gold Miners ETF.  It has become the benchmark way to track gold’s explorers and small producers.  Using the same methodology as above, this GDXJ chart is exactly what I expected to see in GDX.  As prices tumbled and despair mounted, volume dried up and trended considerably lower.

GDXJ is far smaller than GDX, so note the different scales here.  While the first GDX capital-volume chart showed daily trading up to $2250m, that same axis on this GDXJ chart merely goes to $300m.  Unlike GDX which is mentioned and shown anytime gold stocks are discussed in the major financial media like CNBC, GDXJ is relatively unknown.  The junior-gold-stock total abandonment makes gold stocks look popular!

While these charts again go to Wednesday, as of Thursday after this latest Fed scare GDXJ was down an astounding 78.8% since its December 2010 peak!  This comparesto “merely” 63.2% for GDX.  So junior gold stocks have suffered far more than major gold stocks as this entire sector fell deeply out of favor.  This makes sense, since juniors are far riskier in general than larger established gold miners with multiple mines.

GDXJ’s capital volume reflects what the gold-stock sector feels like in terms of universal despair.  Volume has shriveled to virtually nothing, levels so low they’ve only been seen in recent years right as major gold-stock rallies have started.  Low volume after long selloffs reflects widespread despair.  And once that peaks and all susceptible sellers have exited, only buyers remain.  So that’s when new uplegs are born.

The 21dma of GDXJ’s capital volume is also down considerably, with a downtrend that has lasted for gold stocks’ entire correction (or probably severe cyclical bear market is a better label now).  As prices grind ever lower, more and more investors and speculators capitulate and sell low.  With fewer traders left, and less excitement among these remaining contrarians, there is simply lower trading volume in general.

But this GDXJ read on junior volume and interest also has bullish components.  The downtrend in junior-gold-stock capital volume is actually relatively modest considering the sheer magnitude of their losses.  And just like in larger gold stocks as represented by GDX, we’ve seen high junior trading volumes during rallies.  This implies there is plenty of capital waiting on the sidelines ready to flood in when gold decisively turns.

So despite the horrendous carnage in gold and gold stocks this year, the volume profiles in the leading gold-stock and junior-gold-stock ETFs show lots of bullishness. And it is incredibly hard psychologically to be bullish on gold stocks these days.  Wall Street has somehow convinced itself that record global central-bank inflation, with no unwinding (just slowing), is bearish for gold!  This has crushed gold stocks.

They’ve become the most hated sector in the world, plunging to hyper-oversold deeply-undervalued levels reflecting gold prices radically below current levels.  But gold isn’t going anywhere, and neither are its miners.  This metal has been an essential asset class for all portfolios for millennia, and it absolutely will recover from its extreme anomalous 2013 selloff.  This mean-reversion rally is going to be huge.

So as hardcore contrarians, we continue to be bullish on this hated sector.  There isblood in the streets in gold stocks, they are trading below panic levels.  Mocked, ridiculed, and despised, they are the ultimate contrarian play.  And compared to the larger miners, the juniors are seriously contrarian within this sector.  The greatest gains by far as gold and gold stocks inevitably recover will absolutely be in elite junior golds.

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The bottom line is gold-stock volume as represented by the popular GDX ETF is very bullish.  Low volume after long selloffs flags peak despair, the sentiment extreme right before major new uplegs are born.  And despite horrendous pain in 2013, gold stocks are still enjoying high-volume rallies and their average capital volume is still rising.  This suggests lots of traders waiting on the sidelines eager to buy when gold turns.

And turn gold will, its 2013 selloff was a total anomaly driven by stock traders aggressively dumping GLD shares and super-leveraged futures traders suffering a couple forced liquidations.  These are temporary events having nothing to do with bullish underlying global gold supply-and-demand fundamentals.  As they pass, strong world physical demand will retake the gold driver’s seat.  And it and its miners will soar.

Adam Hamilton, CPA

June 21, 2013

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