Gold-Stock Red October


Summary

  • Gold stocks' setup leading into their October seasonal plunge is quite bearish this year. They recently enjoyed a major upleg, leaving them very overbought technically and laden with greedy enthusiasm.
  • That makes a healthy rebalancing correction necessary. Gold stocks have avoided that so far, generally consolidating high. But very-weak seasonals will add to mounting downside pressure.
  • October is gold stocks' weakest month seasonally by far. When gold itself rolls over, it will drag the gold stocks with it. It has been very overbought recently as well.

The gold miners' stocks have largely ground sideways in the last couple months, consolidating their big mid-summer gains. That drift is slowly bleeding away greedy sentiment, but this sector remains really overbought. Gold stocks' dominant driver, gold, is even more overbought, and still facing a massive gold-futures-selling overhang. This makes October gold stocks' weakest month seasonally by far, particularly risky.

The gold stocks have enjoyed a big run since late May. Their leading benchmark and trading vehicle is the VanEck Vectors Gold Miners ETF (GDX). Birthed way back in May 2006, its first-mover advantage has proven insurmountable. This week, GDX's $12.0b in net assets were a colossal 36.4x, larger than its next-biggest 1x-long major-gold-miners-ETF competitor! GDX is the most popular metric to track sector performance.

The past five months' gold-stock action is a case study in the value of contrarian trading. Back in early May, GDX slumped to $20.17. That was down 4.4% year-to-date, and you couldn't even give away gold stocks. I was pretty lonely beating the contrarian drum on them, arguing about their major upside potential when their temporarily stalled young upleg resumed. But the vast majority of traders couldn't care less.

That's the time to buy low, when sectors are out of favor and apathy reigns. Multiplying your fortune in high-potential gold stocks requires deploying capital when it feels bad, and nearly everyone else is bearish. If the gold miners have already rallied far enough with strong inertia to stoke excitement, it's too late to buy low. Buying high to chase momentum sometimes works, but it is much riskier with smaller gains.

Gold-stock prices are totally dependent on gold's fortunes, with miners' profits amplifying underlying gold moves by at least 2x to 3x. As usual it was a series of gold surges starting in late May that catapulted gold stocks much higher. At the end of May gold surged after Trump threatened Mexico with tariffs to pressure it to greatly slow illegal immigration across the US southern border. That woke the miners' stocks.

Their initial strong upside momentum was fading a couple weeks later until the mid-June meeting of the Fed's Federal Open Market Committee. The top Fed officials' collective outlook for the future interest-rate trajectory reversed from hiking to cutting, a sea-change shift. That dovishness unleashed huge gold-futures buying, propelling gold to its first decisive breakout to new bull-market highs in several years!

Gold stocks exploded higher on all that newfound excitement and interest in gold, with GDX rocketing to $28.25 by mid-July. That made for huge 40.1% gains in just 2.5 months! This first chart showing GDX's technicals highlights how violent that mid-summer gold-stock surge was. GDX had been trapped under vexing $25 upper resistance for almost several years, but that was shattered with gold finally breaking out.

Such a big-and-fast move left the gold miners' stocks very overbought. GDX had stretched way up to 1.313x its 200 dma. When prices run too far too fast, the excitement they generate sucks in all available near-term buying power. When those pulled-forward capital inflows are exhausted, the sector rolls over into a pullback or correction. So gold stocks weakened, leading into an ugly 4.8% GDX plunge on July 31st.

That was the next FOMC decision following that hiking-to-cutting-shift one that lit a fire under gold and its miners' stocks. Though the Fed cut rates for the first time in 10.6 years, the Fed chairman disappointed by reining in traders' hyper-dovish expectations. In his post-decision press conference, he declared that cut was not "the beginning of a lengthy cutting cycle", but a "midcycle adjustment". Gold fell 1.2% on that.

Gold stocks are essentially leveraged plays on gold, so you have to follow the metal if you are interested in the miners. And unfortunately FOMC decisions and Fed officials' collective outlooks on the future rate trajectory can really bully gold around. They also really affect the US dollar, which gold-futures speculators look to for trading cues. I analyzed the Fed's big impact on this gold bull in-depth in last week's essay.

Gold and gold stocks were rolling over hard as August dawned until they were savagely whipsawed back up on another Trump tariff surprise. He more than doubled the amount of annual Chinese imports subject to US taxes. GDX soared a neck-snapping 7.4% from intraday lows before Trump's tariff tweet, and closed 5.1% higher! This gold-stock upleg was back to the races again, flagging momentum reversed.

About a week later GDX crested at $29.77, up a massive 47.6% in just 3.2 months. But the serious overboughtness in this sector worsened, with GDX hitting a lofty 1.343x multiple of its 200dma. These 200-day moving averages offer a slow-moving baseline from which to gauge technical overboughtness and oversoldness. The higher gold stocks stretch above their 200 dmas, the more near-term downside risk exists.

GDX started rolling over again as gold's latest tariff-hike-sparked surge stalled out. By mid-August, GDX had slumped 6.2%, but much residual excitement remained after such a powerful upleg. Gold was still mostly holding the psychologically heavy $1,500 level after finally regaining it in early August for the first time since April 2013. Gold-stock traders were rightfully anticipating far-higher profits going forward.

With interest and excitement high, gold-stock buying ignited again on a minor gold up-day. That built into another 10.8% GDX rally over the next couple weeks or so into early September. The resulting upleg high of $30.95 was this ETF's best level in 3.1 years. But as you can see above, gold stocks were still really stretched relative to GDX's 200 dma. GDX was way up at 1.338x its own, showing a very-far very-fast run.

That proved this gold-stock upleg's high-water mark, extending GDX's total gains to 76.2% in 11.8 months! The smaller mid-tier and junior gold miners' stocks with superior fundamentals to the majors did much better, with plenty enjoying huge gains way over 100%! That is where we focus our gold-stock trading to ride these major uplegs. But gold stocks can't and won't rally forever, and eventually major corrections follow.

The writing has been on the wall on this for some time. Despite GDX's surges to higher highs in both early August and early September, it has generally been grinding sideways on balance. This Wednesday GDX was trading at $28.43, not much over mid-July's $28.25. GDX's average price since then has only been $28.57. This sector's strong upside momentum in June and July largely stalled in August and September.

GDX's 76.2% upleg gain was right in line with historical precedent. The last secular gold-stock bull ran from November 2000 to September 2011. GDX wasn't around for the first half of that bull, so we have to revert to an older metric to study it. Before GDX, the HUI NYSE Arca Gold BUGS Index was the leading sector benchmark for decades. It closely mirrors GDX now, as it holds most of the same major miners.

The HUI skyrocketed a stupendous 1,664.4% higher over those 10.8 years, the best-performing sector in all the stock markets that decade! The wealth generated riding that bull was epic, showing why contrarian traders put up with gold stocks' outsized volatility. During that bull the gold stocks saw 11 major uplegs excluding the anomalous post-2008-stock-panic rebound one. They averaged 80.7% gains over 7.9 months.

So by early September, GDX's 76.2% upleg was right back up in that past range. Major gold-stock uplegs are always followed by major corrections, which are necessary to rebalance sentiment. During that last secular gold-stock bull, these averaged 26.1% losses over 2.8 months. That's the magnitude of downside the major gold stocks are facing. The fact red October is nearly upon us really ramps selloff risks.

The primary short-term drivers of gold and its miners' stocks are technicals and sentiment. They are both stretched, surging to really-overbought levels by historical standards spawning serious exuberance and greed. So a rebalancing selloff is highly likely soon regardless of seasonality. Seasonals add additional pressure on top of technicals and sentiment, acting like retarding headwinds or spurring tailwinds for prices.

So an inevitable and essential gold-stock selloff after a major upleg is likely to be bigger and sharper when it lines up with weak seasonals. Enter October, the weakest month of the year for gold stocks! This next chart distills out gold-stock bull seasonals in all modern gold-bull-market years. Those ran from 2001 to 2012 before a subsequent bear, then resumed in 2016 to 2018. 2019 is excluded, as it's still a work in progress.

Again the HUI has to be used for this long-term data-crunching, as GDX is way too young. Each calendar year's gold-stock price action is individually indexed to its final close of the preceding year, which is set at 100. Then all gold-stock price action that following year is recalculated off that common baseline. This is necessary to normalize all years in percentage terms regardless of prevailing price levels, which vary widely.

Then all years' individual indexes are averaged together into the blue line. If you want more background on gold-stock seasonals which are driven by gold's own, I wrote my latest essay on that thread in early August. For our purposes today, note the sharp seasonal plunge gold stocks have tended to suffer in red October. This is the only time when prices fall from above seasonal resistance to below seasonal support!

Gold stocks' sharpest seasonal plunge of the year technically isn't October proper, but runs from late September to late October. On average in these modern bull-market years, the major gold stocks peak on September's 14th trading day. That happened to be last Friday the 20th this year, when GDX was rebounding out of a sharp 13.9% September correction. This seasonal plunge divides autumn and winter rallies.

On average it has lasted until October's 19th trading day, which is Friday the 25th this year. During that span, the HUI has averaged 6.9% seasonal pullbacks in these modern gold-bull-market years. That may not sound bad, but remember it smoothes out 15 years of data. Of those 15 years, gold stocks bucked this seasonal plunge to rally in 5. Those averaged modest 5.1% gains, usually related to their October lead-ins.

Going forward here, I'm going to use "October" to reference that late-September to late-October gold-stock swoon. The gold miners tended to buck this seasonal selloff a minority of the times when they were flattish or weaker heading into it. When gold stocks are down leading into October, some of their selling momentum has been expended. That leaves technicals and sentiment less supportive of more weakness.

In the other 10 years or 2/3rds of the time, gold stocks plunged 12.5% on average in Octobers which is serious. This seasonal selloff killing the gold stocks' autumn rally before paving the way for the winter one is only five weeks long. So average corrections of that magnitude compressed into such a short span of time hammer sentiment. They eradicate preceding greed much more effectively than slow selloffs.

The biggest seasonal drops tend to come after gold stocks have powered higher leading into Octobers, when technicals grew overbought and sentiment exuberant with relatively-high gold-stock prices. 2016 was a recent case in point. Somewhat like this year, the gold stocks had soared heading into the market summer. Though peaking earlier, after an initial selloff, they generally consolidated fairly high into October.

Yet, through that whole seasonal-plunge span, GDX fell 14.9%. At worst in mid-October, GDX was down 19.1% in just a few weeks from late September's seasonal peak! It wouldn't surprise me at all to again see the major gold stocks drop 20%ish sometime in the next month here. Based on gold stocks' latest upleg peak in early September, that translates into $24.76 in GDX terms. The rationale behind this is simple.

Remember gold almost exclusively drives gold-stock fortunes. A couple weeks ago, I wrote about its ominous massive gold-futures-selling overhang. The extreme-leveraged gold-futures speculators utterly dominate gold's short-term price action. But their capital is finite, as that is a crazy-risky game to play. Their collective bets were and have stayed excessively bullish, nearly all-in longs and all-out shorts.

That leaves them little room to buy more gold futures, but vast room to sell big on the right catalyst. And because the leverage in gold-futures trading is so extreme, selloffs soon cascade and take on lives of their own. Thus a 6% to 12% selloff in gold is highly likely. Based off its latest upleg high of $1,554 back in early September, that implies a bottoming level of $1,367 to $1,460 also likely in this red-October time frame.

Normally gold slumps around October because there's a gap between outsized seasonal drivers. That's when Asian buying including for Indian wedding season winds down, but before Western holiday buying spins up. This year gold has been heavily influenced by trade-war and Fed-rate-cut news. On the former front, high-level US-China trade talks are coming in mid-October. Like usual those will spawn happy talk.

Even though little or no progress has been made on the tough issues between the US and China for a year and a half, after all high-level meetings officials wax optimistic. That breeds bullish headlines for stocks, which are bearish for gold. And on the Fed-rate-cut front, top Fed officials need to rein in traders' crazy expectations for more cutting before the FOMC's next meeting in late October. They must talk hawkish.

So the coming few weeks are likely to see major catalytic news motivating gold-futures speculators to unwind their excessively-bullish bets. If that selling snowballs as usual, it will slam gold. The major gold stocks tend to leverage gold's moves by 2x to 3x. So GDX is looking at 12% to 36% downside on a 6% to 12% gold selloff. The middle of that range is 24%, in line with the last secular gold-stock bull's 26.1% mean.

While the actual gold and gold-stock selloffs could prove smaller or larger based on other developments in the markets, like how the S&P 500 fares, the odds definitely favor imminent selloffs. That coupled with still-overbought gold stocks and general enthusiasm for this sector is a big warning sign. It isn't prudent to add material gold-stock positions heading into red October's sharp seasonal plunge. Why risk tempting fate?

Gold-stock traders need to stay wary. Any current positions should be protected with relatively-tight stop losses to maximize gains in the event of a major selloff. And cash from trades already stopped out or sold should be held, not plowed right back in. Buying high with stretched technicals and popular excitement is risky any time, but even more so when stiff seasonal headwinds can hasten and intensify any selling.

If this seasonal selloff comes to pass, late October should prove an excellent time to redeploy at much-lower gold-stock price levels. GDX should be much closer to its 200 dma, and that is just before the bulk of gold miners' Q3'19 results are released. Gold-stock earnings should rocket higher, with gold averaging $1,473 so far in Q3, which is up an amazing 12.5% quarter-on-quarter! We just have to weather a selloff first.

The bottom line is gold stocks' setup leading into their October seasonal plunge is quite bearish this year. They recently enjoyed a major upleg, which left this sector very overbought technically and laden with greedy enthusiasm. That makes a healthy rebalancing correction necessary. Gold stocks have avoided that so far, generally consolidating high. But very-weak seasonals will add to mounting downside pressure.

When gold itself rolls over, it will drag the gold stocks with it. It has been very overbought heading into its own seasonal drop between its autumn and winter rallies. And with gold-futures speculators' bets remaining excessively bullish, they have little capital firepower left to buy more but vast room to sell. That selling will ignite and likely snowball on the right catalyst, like positive US-China trade-war talk or Fed hawkishness.

Copyright 2000-2019 Zeal LLC (www.ZealLLC.com)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Adam Hamilton

Adam Hamilton

Contributing Editor

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A lifelong student of the markets, speculator, and investor, decades of experience have forged Adam into a hardcore contrarian. He believes in buying low when others are afraid, then later selling high when others are brave. He founded the financial-market research company Zeal LLC in early 2000, when he made an epic contrarian bet on a commodities secular bull and stock secular bear. Adam continues to write acclaimed weekly and monthly subscription newsletters, which have helped countless traders all over the world deepen their understanding of the markets and multiply their fortunes. Zeal also publishes comprehensive reports on our fundamental favorite stocks in specific sectors.

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