Justin Smyth's Blog

Gold stocks have had a nice bounce over the past couple weeks and gold investors are likely wondering if this long period of underperformance by the miners is finally drawing to an end. Even though gold is more than $150 higher than it was in November 2010, gold stocks are still at the same level as they were last November.

The oversold bounce continued to start the week with a strong move higher in the market today. Over the last 3 months the last 5 trading days of the month, often cited as window dressing time, have been strong.

The market bounced late in the session on Thursday on the heels of yet another band-aid attempt on the Greek debt crisis. This was also coupled with an attempt by the government to alleviate some pain at the gas pump by releasing oil from the strategic petroleum reserve.

Gold stocks continued to lose ground last week and have now hit the same level they were at in September 2010. Gold however was marginally higher last week and is still holding above its May 2011 lows. The divergence between gold and gold stocks is clearly visible on the next chart:

When investing in the gold sector one of the most frustrating experiences you can have is watching gold outperform the gold stocks in your portfolio. Investors flock to gold stocks to leverage the returns in gold, not underperform gold. The idea is that a rising gold price produces bigger profits for gold producers, and the market rewards increased profits with higher share prices. So when gold investors take on the elevated risk of buying gold stocks, they want to see their gold stocks outperform the price of gold when gold is rising.

May was the worst month for the S&P 500 since August 2010, but the percentage loss for the month only ended up being about 1.5%. The four day rally at the end of May, including the big up day on Tuesday, served to soften some of the damage done in May. But the market reversed all of that bounce in one day to start June with a massive selloff.

It’s usually constructive to go over the landscape of the market and get a feel for where things are at. Since the end of April we’ve seen the market undergo a definitive change of character. Instead of seeing most of the market in one big rally mode that we’ve become used to since September 2010, we’re seeing corrections, non-confirmations, and trend changes across different parts of the market.

Silver’s destiny with its 200-day moving average appears to be sealed this week as a brief bounce earlier in the week failed at the 50-day moving average. From peak to trough so far this correction has run about 35%, which is still less than the 37% correction silver underwent from its parabolic peak in 2006. And the rally in 2005-2006 for silver was dwarfed by this recent run. In 2005-2006 silver went from $6.64 to $15.21 for a 129% gain. The 2010-2011 rally took silver from $17.22 to $49.75 for a 189% gain. So if this recent silver parabola follows the “higher they rise, harder they fall” rule then we should see a bigger correction than 37% peak to trough.

Silver has sold off hard the first 3 days of this week and is down over 17% for the week. If silver falls more this week it will be the worst weekly loss for silver during this silver bull market. The next chart shows the weely and biweekly rate of change in the silver price and only a weekly correction in 2008 was worse than this correction so far.

The stock market had a very strong week last week with the major indexes all up close to 2% or more. The Transports were the big winner for the week up 4.24%. In the commodities complex gold actually outperformed silver last week, which hasn’t occurred since March. Money is likely flowing into gold instead of silver since gold is much less overbought than silver. Industrials, Health Care, and Utilities were among the best performing sectors for the week.