Pater Tenebrarum

About the Author Pater Tenebrarum

I'm an independent analyst and have been involved with financial markets for 31 years. I write economic and market analyses for independent research organizations and a European hedge fund consultancy. I'm the main author of the blog 'Acting Man', which presents articles on the markets and the economy, a mixture of commentary on current events as well as economic theory and history from an Austrian school of economics viewpoint.

Gold Stocks: Update on a Tricky Situation

Readers may recall that in one of our recent updates on the gold sector – which we believe is at an interesting juncture that may at the very least provide a good trading opportunity – we presented the chart of the 1992-1993 low in order to illustrate how extremely tricky the sector can be in the vicinity of turning points.

Specifically, the sector made every imaginable move in late 1992 to convince market participants that a durable rally was nigh impossible. Early recovery attempts were abruptly aborted, giving way to merciless and sharp declines. By the time the real recovery started, very few market participants still found it credible. We remember the high degree of skepticism that prevailed in the early stages of this rally quite well actually.

The sector is once again making things difficult, but from a trading perspective there is the advantage that the most recent lows can be used as a stop. The recent mini-crash in the stock market has complicated things – at first, it was seen as a positive factor for gold and gold stocks, but after gold could not hold on to its initial advance, gold stocks began to correlate with the broader market again in the short term and quickly surrendered their gains.

However, in the process a number of divergence have been established, specifically with momentum oscillators. Such divergences often signal impending trend changes, which is why we always pay close attention to them. Below is a chart of the GDX (gold miners ETF) and the HUI Index that shows the divergence between prices and RSI:

1-GDXGDX and HUI – another price/RSI divergence – click to enlarge.

This isn’t the only remarkable technical signal though. Another one is the state of the “bullish percent” index of the broad gold mining index GDM. This index shows the percentage of stocks in the sector that is currently on a “point and figure” buy signal. The interesting things is that this percentage currently stands at a big fat zero – i.e., it cannot possibly become more “oversold”:

2-Bullish percentBullish percent index of the broad gold stock index GDM: at zero, i.e., the maximum oversold level – click to enlarge.

As you can see above, the last time this happened in late 2014, a playable rally promptly ensued (in the course of this rally, many individual gold stocks rose by 100% and more, so these short term rallies are nothing to be sneezed at). Naturally, there is no guarantee whatsoever that the same thing will happen again, but history is actually on our side here – in the past, a zero on the bullish percent index has fairly regularly been followed by sizable short term rallies.

Lastly, here is a chart comparing the HUI to the HUI-gold ratio. There is also a divergence in evidence, with the ratio recently falling to a new all time low. This seems hardly justifiable to us, even though the gold mining business is obviously not exactly in great shape at present. But is it in worse shape than ever before? We seriously doubt that.

3-HUI-Gold ratioThe HUI-gold ratio vs. the HUI – another divergence, with the ratio actually falling to a new all time low – click to enlarge.

A few Interesting Anecdotal Data Points

In late August an article appeared at Reuters that really got our attention as a “textbook” contrarian marker. It is entitled “Junior miners jump into medical marijuana, food service amid slump”. Some of our readers may recall that something similar happened in 1999-2000. At the time, many “junior miners” became internet companies overnight. It was a strong sign that the tech boom was soon going to be over and that a gold boom was about to begin. From the Reuters article (which even mentions the “defections to the tech industry” in the late 90s!):

“Many of the world’s junior miners are laying down their picks and shovels to start new ventures ranging from egg exporting to medical marijuana farming, as they as try to survive a crash in metals prices by shifting away from exploration.

Prices for copper, gold, iron ore, coal and almost every other metal have collapsed, stalling exploration work and hitting early stage miners particularly hard. These firms typically find the deposits that larger miners often then go on to acquire and develop into mines. But there’s scant demand for new sources of metal now.

Pivoting into other businesses has happened during mining funks in the past, including a spate of defections into the tech sector during the dotcom boom in the late 1990s. But now the concern is that when prices eventually do rebound, there will be fewer junior miners, and a reduced pool of new mine prospects.

“No one has any interest in a grassroots exploration project right now,” said Yari Nieken, chief executive of Chlormet Technologies (PUF.CD), which has bought an e-cigarette company and has a license to grow medical marijuana pending.

Canada made it legal to buy marijuana from licensed producers with a doctor’s prescription in 2014. Regulator Health Canada estimates that the Canadian medical marijuana industry will reach C$1.3 billion (US$987 million) in a decade. Canada’s Century Iron Mines, whose mining projects are backed by two major Chinese companies, Minmetals and Wuhan Iron and Steel Corp, owns development stage iron ore assets in eastern Canada. In July, Century started a new independent venture to distribute Australian eggs in Hong Kong, Macau, and potentially mainland China.Century aims to piggyback on Australia’s move from a reliance on mineral exports to shipping food and agricultural products to a growing Asian middle class.

“Due to the downturn in commodity prices, Australia’s moving its focus from mining to dining,” said Century CEO Sandy Chim.


This is really quite funny – from mining to marihuana and eggs? Of course, alert entrepreneurs have switched to different businesses long ago, but there were no articles about them in the press, because these alert entrepreneurs are a tiny minority. Only now, when a great many “miners” are laying down their shovels and drills is the press reporting on the phenomenon. This is why it is a contrary indicator: by the time everybody notices the trend, the trend is usually over.
The seven acre medical marihuana growing facility owned by Supreme Pharmaceuticals, a former copper exploration company! Note that the facility is still empty – no plants are growing there as of yet.

Moreover, it seems to us that a few gold mining companies are actually not doing as badly as one might think. This is especially true of companies that have most of their mining assets in jurisdictions the currencies of which have been weak. The gold price in local currency terms is often quite high, or putting it differently: for a while the fact that their input costs are paid in local currency while their revenues are denominated in dollars enhances the margins of these companies in spite of a falling dollar gold price.

Only when domestic prices and wages have fully adjusted to the situation will this advantage disappear. A good example is South Africa – here is a weekly chart of the gold price in South African Rand – try to spot the “gold bear market” on this chart:

4-Gold in RandGold in terms of the Rand, weekly. What bear market? Gold in Rand is almost at a new all time high actually … click to enlarge.

While there has been no net progress in the Rand gold price since 2012, it is definitely not in a bear market. So we should perhaps not be too surprised that DRD Gold came out with this press release today. We show a few excerpts below, with the salient points highlighted:

“Johannesburg, South Africa. 1 September 2015. DRDGOLD Limited (DRDGOLD; JSE, NYSE: DRD) has declared a final dividend of 10 South African cents per share for the year ended 30 June 2015, the eighth consecutive final dividend declared and a five-fold increase on the final dividend declared in FY2014. The improved dividend flows from what CEO Niël Pretorius describes as “very satisfactory results” for the 2015 financial year. A 13% increase in gold production to 150 145oz boosted operating profit for the year which increased by 48% to R384.3 million, assisted also by a 4% rise in the average Rand gold price received.


Strong quarter-on-quarter improvements: The company ended the 2015 financial year strongly, with substantially improved final quarter-on-quarter comparisons. Gold production was 9% higher at 40 253oz, due mainly to a 9% rise in throughput to 6 333 000 tonnes. This resulted from delivery on previously-announced plans to improve the availability of infrastructure, the commissioning of new reclamation sites, and drier winter weather conditions.

Operating profit was 26% higher at R122.6 million, a result of the higher gold production, the lower cash operating cost performance, and a slightly higher Rand gold price received.”

Proving that the market often “knows” very little, the stock of DRD Gold has been totally crushed along with all other gold stocks prior to this information becoming public. If the gold price rises a bit, we would expect this company to do quite well.


Even though the most recent action in the gold sector was once again disappointing, there is actually no reason yet to abandon a constructive stance (not least in view of heavy buying by Canadian gold company insiders). Traders can now use the recently tested interim low as a “stop” for trading positions, which limits risk considerably.

Investors should simply continue to be patient in our opinion. Just keep in mind that similar opportunities – almost regardless of the market in which they emerged – have often required great patience and a willingness to absorb losses in the short to medium term. While the short term fundamentals of the gold market remain mixed overall (some of them are improving lately), there is little doubt in our mind that it has excellent long term potential (besides, as Keith Weiner reports, there is now fundamental upside potential in the gold market even in the short term).


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