Trade Of The Decade: An Update On The Gold And Silver Mining Sector

Tuesday, March 1, 2016

In a recent article, we made the case that the most recent lows seen across the gold mining sector were likely generational lows, and because of the extreme nature of the undervaluation in the sector, investors should consider this setup as our Trade of the Decade. Our recommendation was to short the broad S&P 500, and to go long on a basket of the highest quality gold and silver mining equities.

Four weeks have passed, so let us tune into the market action to see how this trade has materialized thus far, and what we might expect moving forward.

Our chart of reference was the XAU Gold & Silver Mining Index compared to the S&P 500, shown in ratio form. In other words, how many shares of each company in the broad US stock market are required to purchase one share in each of the largest precious metals miners.

Four weeks ago we alerted readers that the ratio, standing at 0.02, was the lowest it had ever been in modern history, with data dating back through the 1970's. In our view, the valuation had become too extreme, and as ratios between real asset classes cannot go to zero, it was time to start looking to position for a reversion to historic norms. Additionally, our technical analysis revealed a pending break of a multi-year primary downtrend channel, as shown by the royal blue color above.

Updating our chart below, we can see that the breakout in the mining sector has materialized, as the ratio has broken through the multi-year downtrend and fully cleared the 6-month resistance level at 0.029. This break higher has closed the month at 0.033, a full 65% higher in four weeks. Such would represent an annualized gain of 780%!

At this time, we see many investors nervous that they have missed the move higher in the precious metals after such a strong rise.

Of course, it is unlikely that the ratio will keep moving 65% higher per month. However, to ease those fears, it is important to put this move into historical perspective.

The Majority Of Gains Still To Come

You have not missed this opportunity; it is only just beginning.

Now standing at 0.033, our ratio still has years of gains ahead and over a 3,000% relative-percentage gain to reach our expected precious metals peak of a 1.00 ratio with the S&P 500, as shown on the generational chart below.

Truly, the valuation metrics are almost beyond belief, but that is the state in which we find the precious metals sector at present. The numbers are in plain sight for everyone to see. If there is one thing we can say for certain, its that the opportunity ahead of us is not small.

Also note that the XAU tends to be the weakest of the sector averages compared to the HUI or GDX (which is why we use it to identify lows). The strongest mining companies may double or triple these average sector gains.

Stock Market Failing To Regain Broken Support

Turning our attention to the stock market itself, we note the important break of the multi-year uptrend, which was seen in January.

Zooming this chart into the 1.5-year perspective, we can see the importance of that broken multi-year trend line. Note how once broken in January, the stock market has made two attempts to recover the trend, only to fail each time. This is a major red-flag warning that the trend in the stock market from 2009-2016 is, indeed, in the process of changing. And while we are not predicting an imminent crash, we are saying the easy gains of the last seven years in the stock market have been made.

Investors would be wise to turn their attention toward the sector now likely to be ready for years of gains - the gold and silver miners.

Near Term Considerations In The Gold & Silver Sector

Turning to the GDX fund for a look at price and volume, we note the impulsive 65% move higher in the sector, clearly breaking our multi-year bottoming wedge pattern from 2013-2016.

The challenge for investors, now, is deciding how to enter the sector. While clearly the moves have already been significant, often during the early stages of new trends higher markets will not give us a proper pullback. Many investors are left waiting on the sidelines during these early stages as gains run away from them.

The potential for a pullback would currently be in the 15-20% range, into the vicinity labeled "Strong Support" on our chart below. This would correspond to 16-17 on the GDX fund.

Of course, such a pullback may not happen. Instead, we may simply see a period of consolidation before a trending move higher develops.

Do Not Miss The Forest Through The Trees

Again, we want to remind readers to look again at the first chart in this article. There are valuation precedents for hundreds or thousands of percent gains across this sector in the decade to come. We have seen an immense bottoming signal on record high volume, the clearest that such a signal could be. So while there could be a 15-20% correction at any time, the risk at this point is to the upside.

Thus, long-term investors may want to consider a partial strategy of some gold and silver sector purchases at this time, with the hope of making further additions on the first meaningful correction.

Christopher Aaron

Christopher Aaron began his career as an intelligence analyst for the CIA and Department of Defense. He served two tours to Afghanistan and Iraq between 2006 - 2009, conducting pattern-of-life mapping for military leaders.

Mapping shares similarities with technical analysis of the financial markets because both involve the interpretation of repeating patterns found in human nature. He is the founder of iGold Advisor, providing research on the precious metals, and iGlobal Analytics, featuring technical analysis of the global capital markets.

Christopher speaks regularly on the cyclical patterns found within the financial markets and on international policy. He has been featured in the New York Times and NPR news amongst other publications.