Bullish HUI Technicals 4

By: Adam Hamilton | Fri, Feb 5, 2010
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Over the last couple weeks, gold and silver stocks have been clobbered. The flagship index that tracks this sector, the HUI, hemorrhaged nearly a sixth of its value in just 8 trading days! Frightened traders have been scrambling for the exits, dumping their PM stocks at any price to rush their capital out of harm's way.

While such a freefall sounds very bearish, it is actually incredibly bullish. The mission of investment and speculation is to buy low and sell high, and the best times to buy low are when prices are plunging and traders are practically soiling themselves in fear. If you want to multiply your capital in the markets, the surest way to do it is to buy aggressively when nearly everyone else is rushing to abandon ship.

The infamous 2008 stock panic is a perfect illustration of this truth. Over just 5 weeks ending in late October 2008, the HUI plummeted a mind-blowing 57.2%. PM-stock traders were so caught up in the popular fear that they failed to realize that stock panics are not the Apocalypse. Markets perpetually flow and ebb, yet life goes on. We were buying aggressively near those panic lows, and were richly rewarded. Over the next 9 weeks, the HUI doubled!

While the recent sharp HUI selloff is trivial compared to that once-in-a-century stock panic, these same principles apply at a smaller scale. When a sentiment storm slams into a sector with strong fundamentals and leads to a blitzkrieg of selling, the new lows never persist. Extreme fear never lasts long, and as soon as the storm clouds of emotion start clearing the beaten-down stocks quickly rally back up to big gains.

Thus the recent precious-metals-stock selloff has created awesome buying opportunities. Far from portending an endless death spiral lower as most traders seem to assume, today's deeply-oversold HUI technicals are extremely bullish. For disciplined contrarian traders with the fortitude and wisdom to ignore the herd's irrational hysteria, the HUI's incredibly bullish near-term prospects are readily evident in these charts.

Precious-metals stocks have never been for the faint of heart. They are very volatile and unforgiving, but that's their charm too as these wild moves create great opportunities. In the pre-panic years between 2000 and 2007, the average HUI upleg surged 94.4% higher over 8 months while the subsequent average HUI correction fell 28.3% over 3 months. Big and steep selloffs are nothing new for PM stocks, merely par for the course.

Since its latest interim high in early December, the HUI has fallen 26.7% in just under 8 weeks. As is often the case in PM stocks, this correction has been two-staged. There was an initial 17.6% leg down in early December that paralleled gold's own. Gold has always been the PM stocks' primary driver, traders buy PM stocks when gold is strong and sell PM stocks when gold is weak.

This initial December correction in PM stocks was sharp, but it only lasted a couple weeks. Then the HUI actually bounced at its upleg support line that was established throughout last year. A few days before gold itself bounced, the selling in PM stocks had been so aggressive that everyone interested in selling soon had already sold. And once gold started heading higher again in late December, the HUI followed.

While we sold some PM stocks at 100%+ gains in Zeal Speculator in early December, we weren't buying that late-December bounce literally or metaphorically. Given PM stocks' volatile history, they hadn't corrected long enough or deep enough to properly rebalance sentiment by eradicating the early-December greed. And as the 21.4% HUI correction in June and early July of last year reinforced, major HUI corrections often encompass two separate and distinct legs down.

And a couple weeks ago when today's second leg down commenced, it was fast and furious as you can see in the chart. The HUI not only shattered its uptrend's support, which officially signaled it was in full-blown-correction mode as opposed to mid-upleg-pullback mode, it plunged to its 200-day moving average. 200dmas are incredibly important technical lines in trending markets. Within secular bulls the 200dma is the highest-probability point for corrections to run out of steam and tradable interim bottoms to be carved.

Many years ago I developed a trading system based on these 200dma approaches, Relativity. Over time in any given bull market, prices tend to advance and contract within a fairly constant multiple-range of their trailing 200dma. When they advance to the top of this range they are temporarily overbought, it is time to sell or go short. And when they subsequently retreat to the bottom they are temporarily oversold, the time to buy.

The latest relative trading range for the HUI is rendered above, between 0.95x and 1.40x its 200dma. Our subscribers have unlimited access to large long-term Relativity charts updated weekly on our website that show these ranges being established. Once you wrap your mind around these Relativity concepts, your trading will improve tremendously as you'll have early warning of excessively overbought and oversold conditions that are not sustainable.

In this chart the red line tracks this relative HUI, or rHUI. It is simply the HUI divided by its 200dma, which renders all the percentages in perfectly-comparable terms across time. In effect the 200dma is flattened at the 1.00x line and the rHUI bounces along it in a horizontal trading range. This construct illuminates the HUI's endless advances beyond and contractions back to this critical support zone in constant-multiple terms. Consider how this powerful trading tool has worked in the past year.

Back in April, the rHUI was running 0.933x since the HUI was well under its 200dma. This was deeply-oversold territory, which happened to be just before the last time I wrote a bullish HUI technicals essay. And indeed coming out of such oversold conditions the HUI soon rallied rapidly, blasting 44.6% higher in just 6 weeks ending in early June. Why did the spring rally die then? Mostly because this sector had become seriously overbought, pushing the top of the rHUI trading range at 1.40x this index's 200dma.

Once the HUI nears the top of this relative trading range, the probabilities balloon for an imminent sharp correction. So back in early June when the rHUI hit 1.397x, it was a big warning sign for traders. After this relative resistance approach, the HUI soon fell sharply in that June-and-July correction. But once sentiment was rebalanced again by mid-July, the HUI's strong uptrend resumed.

This strength gradually accelerated until November, when the PM stocks shot up with gold. After soaring 32.9% higher in only 5 weeks though, once again the rHUI hit 1.397x indicating the HUI was seriously overbought. And that's when today's correction started. While no tool can call exact tops and bottoms, Relativity offers excellent insight into when conditions are so extreme that a major interim high or low is exceedingly likely. This is a powerful edge in trading, which is itself the ultimate probabilities game.

After plunging in the second stage of its latest correction, last week the HUI knifed under its 200dma for the first time since April. On Friday the 29th the rHUI hit 0.955x, deeply-oversold territory. Being down near the bottom of its relative range, this was a screaming buy signal. Again 200dmas are the highest-probability bounce points within ongoing secular bulls, and 200dma approaches are fairly rare. Since deeply-oversold lows never persist for long, traders must be quick to jump on the opportunity to buy low.

Remember how excited people were about gold and silver stocks back in late November when they were soaring? Being in the newsletter business, I get deluged by e-mails from folks excited about buying PM stocks when they look the hottest. But this is exactly the wrong time to buy, when they have run fast and far and look exciting. The best time to buy is in conditions of extreme technical weakness and mushrooming fear just like today. In order to buy low, you have to pull the trigger when you least want to buy!

While this first chart alone easily drives home the awesome buying opportunities in gold stocks today, I'm throwing in another one to further buttress this bullish case. This is the HUI/Gold Ratio, or HGR. The HGR simply divides the HUI close by the gold close. When PM stocks are outperforming gold, the HGR rises. And when they are underperforming gold, usually by falling faster than gold in a correction, the HGR falls. Today's HGR reveals incredibly-oversold gold stocks, a phenomenal buying opportunity.

Until the second stage of today's HUI correction, the HGR was advancing nicely over this past year. It had carved the solid support line rendered here. Each time the HGR fell to lows near this support, a sharp rally immediately followed. And all these sharp HGR rallies were driven by sharp HUI rallies. When they finally get excited, the manic-depressive PM-stock traders buy with almost as much zeal as they show in their periodic intense-selling episodes!

But over the last few weeks, this HGR uptrend's support decisively failed. Soon after that, the HGR's 200dma failed as well. The HGR has now plummeted so far that it is back to early-July levels. In other words, relative to gold the PM stocks are now just as cheap as they were last July just before the launch of their strong 63.1% upleg climaxing in early December. Buying opportunities like this don't come around very often.

This HGR work since the 2008 stock panic has led to enormous realized and unrealized trading gains for our subscribers. The whole story of gold and silver stocks since that panic is the normalization of the HGR, its gradual return to pre-panic levels. In the 5 years prior to the stock panic, the HUI averaged 0.511x the price of gold. The yellow line above shows where the HUI would be trading if it returned to this long-term pre-panic-average level.

Meanwhile the red line shows the actual HUI itself. Note that back in March around the general-stock-market lows, the HUI was only running about 57% of where the long-term average HUI/Gold Ratio suggested it should be. By early December, this gap had closed to 82%. Make no mistake, over time the gold stocks are gradually normalizing relative to today's higher prevailing gold prices. Unfortunately this critical truth is usually forgotten in the day-to-day chaos of this volatile sector.

But since its early-December interim high, the HUI has stumbled far more steeply than gold. Thus last Friday the actual HUI was only at about 68% of where the pre-panic average HGR suggests it ought to be. This is also the lowest level seen since the exact mid-July bottom before the last strong HUI upleg was born. From a variety of perspectives, HGR analysis corroborates and amplifies the message of this strong PM-stock buy signal.

Shifting gears briefly, the fundamentals also support this bullish stance. Stock prices ultimately follow long-term profits, and the higher the prevailing gold price the greater gold-mining profits grow. Averaging $1115 so far this year, this is the best gold-mining environment ever seen. In 2009 the average gold price was around $975, 14% lower. Gold miners are going to make more and more money, which is going to attract more and more capital into this still-tiny sector.

The recent selloff, as is true in almost all sharp corrections within ongoing secular bulls, had nothing at all to do with fundamentals. Gold itself has largely been consolidating around an average price near $1110 since mid-December, its mining outlook hasn't changed a bit. Corrections are always driven by sentiment, emotions. Unlike fundamentals which are very slow to change, sentiment turns on a dime.

Today's bullish HUI technicals couldn't be clearer, it really looks like an incredible buying opportunity for gold and silver stocks. In basic technical terms, the HUI has shattered its upleg's support line and is even sojourning under its 200dma, the best time within ongoing secular bulls to buy aggressively. It is the HUI's first sub-200dma episode since April. On top of that, the rHUI is flashing a deeply-oversold strong-buy signal for the first time since April as well. PM-stock traders should be salivating at this!

And when you layer in the HGR analysis on top of this, the buy signal flares even brighter. Relative to gold the PM stocks are now at their worst levels since last July right before a major upleg launched. You really couldn't ask for a better convergence of bullish HUI technicals. If you want to buy low and can steel your emotions for the challenge, I don't know what more you could hope for today.

At Zeal we are absolutely seizing the moment. In our hot-off-the-presses new monthly newsletter we added a couple new PM-stock positions likely to thrive in the near future. And in our weekly newsletter more geared towards active traders, we've deployed 7 new PM-stock trades in recent weeks. All these trades are likely to witness excellent gains as the HUI recovers over the coming months as gold and silver enter their seasonally-strong springs. It should be a very lucrative run.

And we certainly aren't done, we'll continue to buy aggressively as long as PM stocks remain ridiculously cheap. If you act quickly, you too can capitalize on this rare buying opportunity before it vanishes. Subscribe today and harness our hard-won market knowledge and wisdom for your own advantage! In each newsletter I explain what is going on in the markets, what is driving it, how various markets are influencing each other, and how this translates into specific trading opportunities. This elite level of applied analysis is one heck of deal for just $10 per month!

The bottom line is the HUI technicals look exceedingly bullish today. The recent sharp selling that has sparked such widespread fear among PM-stock traders is actually creating phenomenal buying opportunities. Though gold remains strong which means mining it will be more profitable than ever, the stocks of its miners have been driven to silly levels by emotional selling.

But as always, this sentiment storm too will pass. Soon all the weak hands will be out and the PM stocks will resume their long post-panic normalization with gold and silver prices. Investors and speculators tough enough to buy now when few others want to will reap the largest gains as this secular PM-stock bull resumes. But such deeply-oversold buying opportunities seldom last long, so carpe diem!

 


 

Adam Hamilton

Author: Adam Hamilton

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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