Gold Stocks Are Up 35%. Now What?

by Daniel Putnam | March 14, 2014 9:01 am

Gold Stocks Are Up 35%. Now What?

After enduring a brutal stretch of underperformance through most of 2012 and 2013, gold stocks have finally begun to reward investors. The Market Vectors Gold Miners ETF (GDX[1]) has surged 35.5% from its mid-December low, while the smaller Market Vectors Junior Gold Miners ETF (GDXJ[2]) has rocketed 55.4%. The Direxion Daily Gold Miners Bull 3x Shares (NUGT[3]), for its part, has risen 131% off of its low.

This incredible run seems to have finally validated the views of those who have long held that the sector is unloved, inexpensive and due to close the performance gap with physical gold. But with gains like this already in the rear-view mirror, is it still possible to make money in gold stocks?

Positive Technical Signals Support Gold Stocks’ Outlook

Even after a rally of this magnitude, there are still plenty of signs that the gains can continue. Three, in particular, stand out:

Gold stocks finally beating gold: GDX’s year-to-date return of 31% has vastly exceeded the 14% gain for physical gold, as gauged by the SPDR Gold Trust ETF (GLD[4]). This stands in distinct contrast to gold stocks’ underperformance in both 2012 (-8% vs. 8%) and 2013 (-54% vs. -28). Gold-stock bulls had been calling for this type of mean reversion throughout 2013, but with little success. The fact that the performance gap has been closing for over two months now indicates that a sustainable move may finally be underway. And, given the extent of gold stocks’ shortfall in 2012-13, the mean-reversion trade still could have a lot further to run.

A favorable GDX chart: GDX has printed a strong chart formation, breaking above recent resistance and holding above its 200-day moving average. Notably, the 200-day has flattened out and is on the verge of turning upward. If this occurs, it will be the first time GDX has had its 200-day MA heading north in almost three years. This move is confirmed by GLD, which is further above its 200-day than by the widest margin since the fourth quarter of 2012.

gdx2 Gold Stocks Are Up 35%. Now What?

Juniors are outperforming: Much like gold stocks are outperforming the physical metal, so too are junior miners outpacing the returns of their larger peers. This reverses a long-standing trend of underperformance for the juniors. GDXJ returned -61% in 2013, behind the -54% of GDX, and its 14% loss in 2012 also lagged the -8% return of GDX. The recent shift in favor of the juniors indicates that investors are feeling confident enough to venture out the risk curve in the gold miners — a positive sign for the sector as a whole.

These recent performance trends are underpinned by important fundamental developments. The sector has benefited from the weaker U.S. dollar, analysts’ ratings upgrades, and expectations for improved capital discipline among mining companies. If gold miners indeed focus more on profitability and less on expansion, earnings could move higher even without a substantial increase in the price of gold. It certainly doesn’t hurt that gold’s safe-haven status has received a boost from concerns about developments in China and Ukraine.

All of this being said, investors still need to be cautious with gold stocks. While the bear market indeed appears to be over, this sector has seen more than its share of false dawns in recent years — making it essential to control for this risk via stops and careful position management.

At this point, however, the recent signs of improving health for the gold-mining sector indicate that it’s finally safe to buy the dips.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. GDX: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDX
  2. GDXJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDXJ
  3. NUGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=NUGT
  4. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD

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