Gold-Stock Record Highs by Adam Hamilton

Posted on October 11, 2010

Inspired by gold’s relentless momentum, investors drove the flagship HUI gold-stock index to new all-time highs this week.  While great fun for all of us with capital deployed in this sector, seeing the best levels in history often spawns anxiety in those with a contrarian bent.  Following gold stocks’ run into record territory, are they in danger of an imminent correction?

Interestingly, the history of today’s secular gold-stock bull suggests the answer is they’re not.  The manner in which the HUI achieved its new record highs this week has always led to big surges historically.  And if today’s upleg holds true to this extensive precedent, the gold stocks have a lot farther to run yet before a healthy correction arrives to rebalance sentiment.

Since mainstreamers are largely just starting to discover gold stocks, a lot of people assume this bull is fairly new.  This couldn’t be farther from the truth.  The HUI bottomed in November 2000, a whopping 10 years ago, at 36.  As of this Wednesday, this index has enjoyed a stupendous 1375% bull run since those humble beginnings!  For comparison, the benchmark S&P 500 lost 16% over this exact span.  Gold stocks have easily been one of the best-performing sectors, if not the top one, of this entire past decade.

Now 10 years is a great deal of time to observe the behavior of anything.  Whether you’re watching your kids, prairie dogs, or the financial markets over such a long span, definite patterns and tendencies emerge.  And in gold stocks’ case, these can be traded with great success.  In our popular Zeal Intelligence monthly newsletter, we realized our first gold-stock trade in March 2001.  Nearly 100 gold-stock trades later in this publication alone, ZI’s average annualized realized gold-stock gain (including all losing trades) is +58.8%.

One of the HUI’s patterns that helped us achieve such stellar returns over the past decade is its drift-surge tendency.  Periodically gold stocks rocket higher in massive new uplegs, leading to enormous gains for investors and speculators.  But these mighty runs leave this sector super-overextended.  So gold stocks need to drift sideways and consolidate for a year or two after these surges, giving traders time to digest and ultimately accept the new prevailing price levels.

New record highs in the HUI are seen at a couple distinct times in these drift-surge cycles.  The first is during a surge, within the gigantic uplegs.  The second is after a drift, a year or more into a high consolidation.  When record highs are seen late in surges, it is definitely a warning sign of an approaching top that traders should heed.  But when they’re seen late in drifts, they herald the birth of major new uplegs.  Thankfully this week’s HUI records fall into the latter category.

As a good chart is worth far more than a thousand words, all of this is much easier to understand visually.  This first chart superimposes the HUI (blue) and some of its key technicals over the gold price (red).  This sector’s drift-surge tendency that is so incredibly profitable to exploit is crystal-clear from this long-term perspective.  And provocatively we are finally exiting the biggest and longest drift of this entire bull.

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