Stock Up on Gold Miners

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"Keep a close eye on the relative strength of miners vs. the metal."

Ever since I started my investment career as a mining analyst in 1984, I have taken a keen interest in gold stocks. In particular, I always keep a close eye on the relative strength of the miners vs. the metal as stocks often lead bullion.

The chart below has been constructed by dividing the Market Vectors Gold Miners ETF (GDX) by the streetTRACKS Gold Trust (GLD). A rising trendline indicates outperformance by gold stocks against bullion, whereas a declining line shows the metal having the upper hand. After a period of underperformance until October 2008, the miners outperformed bullion for about 12 months before drifting lower until January this year. The curve for mining stocks then turned upwards and led the metal higher.

GDX:GLD 8/27/10

In addition to the nascent outperformance by gold stocks, the Gold Miners Bullish Percent Index (BPGDM) shows almost 60% of the 32 stocks in the Gold Miners Index are now in point and figure uptrends. The sentiment indicator is used like all bullish percent indices: readings over 70 are overbought while drops below 30 are oversold. Importantly, the last two times that an oversold condition existed were the end of 2008 and during the first quarter of 2010. The late 2008 upturn signaled a major rally in gold shares. The latest upturn this year similarly appears to be signaling better tidings for gold and silver shares. While the BPGDM (below) is no longer oversold, it's generally a positive sign for a group when more than half of its stocks are in new uptrends.

$BPGDM 8/27/10

I remain bullish on gold bullion and gold miners (GDX and its younger brother GDXJ), but repeat my usual advice that the yellow metal and gold-related instruments should only be bought at times of pullbacks.

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