The Hallmark of a Gold Bottom

The Hallmark of a Gold Bottom

Precious metals had another great day at the office today as gold (NYSEARCA:GLD) pushed another full percent higher with silver (NYSEARCA:SLV) up 1.2%. The gold bugs index (^HUI) rocketed up another 5.2%, and this is perhaps the more important move indicating a possible final bear market bottom in gold and the entire metals complex.

From gold’s intermediate bottom in late October 2008 until bull market top in September 2011, the HUI went up an astonishing 274%, nearly tripling. The metal itself “only” went up 154%, meaning the stocks led the metal decidedly out of the bottom. Contrast that with the current 4 year bear market in gold, and for every brief rally, gold stocks vastly underperformed the underlying metal during every leg down.

In terms of the way up, the first week of gold’s climb out of the intermediate bottom of late October 2008 looks very much like the rally happening now. Back then, gold rallied 7.5% from its lows on October 22 until the October 31 close. The HUI had rallied 35% over the same timeframe. Now, gold has rallied 6.2% off its bottom on August 5. The HUI has rallied 25% since then. Both initial climbs out of the bottom saw mining stocks outperform gold by over a factor of 4.

More important than the way up though, is the way down. The hallmark of a major bottom in the gold market is relatively strong gold stocks especially on the way down. If, during the coming inevitable pullbacks in gold, the HUI and its associated stocks retain relative strength on a day to day basis, then that is a strong sign that we have seen the final bottom. Relative strength does not necessarily mean that gold stock ETFs (NYSEARCA:GDX) need to decline less than the underlying metal on any given down day. Since gold stocks generally outperform gold on good days, all we really need to see is the stocks more or less keeping pace with gold itself on down days.

So if we see gold go down, say, 1% tomorrow on a technical pullback and gold stocks go down only 1% with it, that would still be relative outperformance by the stocks over the metal. An interesting technical experiment over the next two months could help clarify the issue significantly. Keep track of the down days until the end of the year, to pick a round date. If on the majority of those down days, the majors and the juniors (NYSEARCA:GDXJ) tend to keep pace with gold, then it would seem the bottom was printed in gold in early August already. A few days of underperformance are still allowed.

If, however, on the down days the stocks tank hard consistently, then this may just be another bear market rally. In any case, it will be the down days that are much more telling than the up days like the one we had today.

Disclosure: At the time of writing, the author was long gold and mining stocks.