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Gold-Stock Volume Divergence

Adam Hamilton
Feb 17, 2017

The gold miners' stocks have blasted higher in this young new year, far outpacing the broader markets. But surprisingly gold stocks' trading volume has diverged from their powerful rally. Volume has actually been waning on balance since gold stocks' newest upleg was born in mid-December. While volume is a complex nuanced indicator, this bullishly suggests that major gold-stock buying hasn't even started yet.

Naturally price action is the most-important technical indicator, exposing underlying supply-and-demand trends for anything. The shares of precious-metals miners and explorers have surged this year because investor demand exceeds supply. The capital flowing into this beaten-down sector is overwhelming the numbers of shares sellers are willing to part with, bidding up stock prices and driving their sharp rally.

But the strength of rallies isn't fully apparent through their price moves alone. Trading volume, how many shares change hands daily, is a critical secondary indicator. The strongest rallies advance on big high-volume buying, showing growing investor interest and broadening capital inflows. The more volume that drives any rally, the greater its momentum, staying power, and ultimate gains. Volume reflects vigor.

One of the many problems plaguing today's radically-overvalued Fed-levitated stock markets is the low-volume buying driving recent years' gains. Low volume reveals low conviction, traders begrudgingly buying shares in moderation since they doubt a rally's durability. Low-volume rallies are often more the result of a lack of sellers than any meaningful buying. That's what's happening in gold stocks so far in 2017.

This is readily apparent in the leading gold-stock trading vehicle, the GDX VanEck Vectors Gold Miners ETF. In this increasingly ETF-dominated stock-trading world, GDX commands an insurmountable lead over its competitors. This week, GDX's net assets of $11.9b were a staggering 63x larger than those of the second-largest normal 1x-long major-gold-miners ETF! GDX is truly this category's only ETF that matters.

GDX pioneered gold-stock ETFs when it was launched way back in May 2006, giving it a big first-mover advantage. This ETF's slowly-growing popularity leading to total ascendency has made it one of the most-important gold-stock benchmarks, rivaling the traditional HUI NYSE Arca Gold BUGS Index. Since GDX holds a voluminous 51 component gold stocks, this flagship ETF well represents its underlying sector.

The simplest way to measure GDX trading volume is the raw number of shares changing hands each day. Such traditional price-and-volume charts are ubiquitous on the Web. But they suffer a crippling limitation when considering spans of time beyond the very-recent short term. As share prices naturally shift over time, trading volume isn't equivalent or meaningfully comparable at different prevailing share prices.

At GDX's all-time high near $67 in September 2011, 1000 shares were worth $67k. Not a lot of traders wield that kind of firepower for single trades. But at GDX's all-time low just over $12 in January 2016, the same 1000-share block was only worth $12k. In terms of the capital flows that ultimately drive stock prices, high-share-price volume is more important and significant than the same low-share-price volume.

This problem is easily overcome by looking at capital volume instead of raw volume. Capital volume is a simple construct that multiplies shares traded each day by that day's share price. That renders volume in equivalent, comparable terms even across long spans of time. The amount of dollars traded in GDX or any stock is far more important than the number of shares. Capital volume offers a purer read on trends.

These charts look at GDX capital volume. For share price, I averaged each day's intraday high and low instead of going with the closing price. That's slightly more accurate in a sector as highly volatile as the gold stocks. Since capital volume itself varies wildly from day to day, it is best smoothed for analysis. So GDX capital volume's 21-day moving average, one month, is superimposed in yellow over the red raw data.

Gold stocks' strong new upleg since mid-December has proven quite powerful. GDX is up 34.6% at best in just 1.8 months, trouncing the rest of the sectors in these Trumphoria-riddled stock markets. But the trading volume behind this recent rally has proven quite weak by this past year's standards. I've been watching this mounting volume divergence with increasing interest in recent weeks, trying to understand it.

Early last year the gold stocks started powering higher in a mighty new bull market. In just 6.4 months, GDX skyrocketed from its fundamentally-absurd all-time low at the depths of despair to a magnificent wealth-multiplying gain of 151.2%! After such a dazzling run gold stocks were overbought and ready to correct last summer. That was exacerbated by extreme market distortions following Trump's surprise win.

But throughout the great majority of gold stocks' roller-coaster ride last year, GDX's capital volume was meandering in a well-defined horizontal trading range. When this volatile data is smoothed by that one-month moving average, this ran between $1.5b and $2.2b. That was the total value of GDX shares that were changing hands each day. GDX's capital volume exited last year near this range's lower support line.

Year-to-date GDX has blasted 19.2% higher, an impressive gain. Yet capital volume has continued to wane dramatically, a major divergence. This Wednesday, the data cutoff for this essay, GDX's capital volume was just $0.7b. That was the lowest since that shortened Black Friday trading day back in late November. Excluding that single half-day, GDX's capital volume has slumped to its lowest levels since late March.

This is part of a longer downtrend that started back in late September, reflecting slumping participation in the gold-stock sector. Just a couple weeks ago, GDX capital volume's 21dma slid under its $1.5b lower support. It is now running just $1.3b, the worst levels seen in an entire year. That's almost been cut in half from the peak near $2.6b in 21dma terms. Low volume betrays the lack of enthusiasm for gold stocks.

This could be very bearish, a serious problem for gold stocks. If speculators and investors have lost all interest in gold stocks, it's going to be all but impossible for their young new upleg to persist. Big capital inflows are usually necessary to drive big stock rallies. Back in February and March last year when this new gold-stock bull was getting underway, capital volume was rocketing higher as traders flocked to this sector.

It stayed high as GDX continued powering to new highs last spring and summer, generally remaining elevated until gold stocks suffered a mass stopping in early October. As gold slipped below key support at $1300, gold-futures stop-loss orders triggered leading to cascading selling. That quickly spilled into the gold stocks, hammering GDX 9.9% lower and driving its highest capital-volume day ever witnessed at $5.6b!

That brutal mass stopping was exceedingly damaging to gold-stock psychology. The gold stocks had already suffered a major correction off their summer peak, and had ground higher on balance for over a month by early October. That led traders including me to believe their necessary and healthy correction was over. So when they plunged from already-low levels to deeper depths, the sentiment impact was devastating.

That's when gold-stock capital volume reversed and started to wane. Many investors and speculators that had enthusiastically chased the gold-stock momentum last summer were very disheartened. By mid-October nearly half of the entire gold-stock bull of early 2016 had already been reversed! Such extreme volatility is difficult to weather even for hardened contrarians, let alone mainstream traders not used to it.

GDX capital volume continued to decline as the increasingly-bearish sentiment was exacerbated by two more mass stoppings last quarter. One came in the days after Trump's win when gold was dumped in the face of the emerging Trumphoria stock-market rally. That was followed by another in mid-December when gold fell after the Fed's more-hawkish-than-expected rate-hike forecast for 2017. GDX was crushed.

This leading gold-stock ETF had plunged 39.4% in just 4.4 months, erasing nearly 2/3rds of all the gold stocks' bull-market gains in the first half of 2016! That naturally spawned extreme bearishness, motivating many investors and speculators to flee this wild sector. You can't blame them, as most people simply don't understand that high volatility is the cost this sector inflicts for enjoying gold stocks' epic gains.

Unsurprisingly capital volume generally reflects popular sentiment in this sector. When traders start to get excited about a gold-stock rally powering even higher, they rush to buy shares to ride the expected gains. Rising capital volume reveals growing greed. But when gold stocks sell off on balance for some time, traders mentally extrapolate that weakness continuing indefinitely. So they pull their capital out of this sector.

There is a key exception to this volume-sentiment correlation though. While it's certainly true for volume generally, major down days with steep gold-stock selloffs spawn the greatest capital-volume spikes ever seen. Not only do big drops trigger much automatic stop-loss selling that ramps volume while amplifying downside, fear is a potent motivator. Traders rush for the exits when gold stocks plunge, driving huge volume.

But such fear-driven volume spikes are fleeting, immediately evaporating as the heavy selling quickly passes. So they usually don't skew capital-volume trends very much. The moving averages soon smooth them away, distilling down the core volume trend. And in gold stocks as represented by GDX, it remains very weak. A similar situation exists in the broader stock markets today, and that is undoubtedly very bearish.

One of the damning arguments against the staying power of the Fed-conjured stock-market levitation in recent years is the waning volume. While the major stock indexes are driven to new highs periodically, it is nearly always on weak and declining volume. Low-volume rallies near major highs are suspect, since they reflect low conviction and buying exhaustion. Major bull markets die in topping low-volume complacency.

But remember volume is a complex nuanced indicator. The implications of capital-volume trends are very different depending on where they arise within greater cycles. The markets perpetually meander in great bull-and-bear cycles, oscillating like giant sine waves. And the same weak volume that is bearish late in a mature bull is actually bullish early in a young bull! Interpreting volume trends requires broader context.

This next chart zooms out for a much-larger perspective on this GDX capital-volume data. Despite their powerful bull run early last year, gold-stock price levels remain very low in historical context. Gold and its miners' stocks were hammered between 2013 and 2015 as the stock markets levitated on the Fed's extreme open-ended third quantitative-easing campaign. Gold stocks are low and unloved, not high and euphoric.

Even as GDX climbed to all-time highs by late 2011, gold stocks' capital volume remained very low by recent standards. It actually started rising in mid-2013 despite the brutal gold-stock bear, but slumped again in early 2015. Despite relatively-low GDX share prices in historical context early last year, capital volume exploded to record highs. Traders enthusiastically flocked back to gold stocks as they rocketed higher.

The growing popularity of exchange-traded funds certainly contributed to last year's massive rise in GDX capital-volume levels as well. During the last gold-stock bull, ETFs were relatively new and not as universally accepted. Many investors preferred owning individual gold stocks instead of GDX. But now even hedge funds are heavy ETF buyers, betting on entire sectors instead of ferreting out individual winners.

But the critical point today is that gold-stock prices and thus GDX remain very low relative to precedent. Gold stocks aren't late in an enormous multi-year secular bull market like general stocks. At best they are just 13 months into a young new bull. Gold stocks' last secular bull ran from November 2000 to September 2011, a 10.8-year span where that flagship HUI gold-stock index skyrocketed 1664% higher!

And since gold stocks are far closer to bear-market lows than bull-market highs, sentiment in this sector remains heavily bearish. Investors and speculators alike naturally remain highly skeptical of the beaten-down gold stocks, as GDX plummeted 81.3% over 4.4 years ending in January 2016. Gold stocks' low capital volume today reflects that lingering super-bearish sentiment, which is typical after long and deep bears.

That's a sharp contrast to the situation in the general stock markets, where the leading S&P 500 broad-market stock index has blasted an astounding 247.2% higher over almost 8.0 years! That is one of the biggest and longest stock bulls ever witnessed, leaving stocks radically overvalued and complacency off the charts. Waning capital volume late in a long-in-the-tooth bull is very bearish, warning of buying exhaustion.

But waning capital volume early in a young bull after a brutal bear is an entirely different story. Instead of suggesting an old rally has run out of sustaining capital inflows since everyone has already bought, it indicates the opposite. Waning capital volume early in a new upleg within a young bull shows investors and speculators haven't even started buying yet. They remain too skeptical, mired in all the residual bearishness.

This is super-bullish for gold stocks today, implying the serious real buying is still yet to come. It hasn't been material new buying that has catapulted this sector much higher since mid-December, but a lack of selling. After suffering an extreme three mass stoppings in the fourth quarter alone, all the traders susceptible to being scared into selling low are already out. Selling exhaustion was hit after the Fed in December.

But sooner or later these strong recent gold-stock gains are going to catch the attention of the sidelined investors and speculators. They love winners, and will start moving capital back into this sector to ride the upside momentum. Their capital inflows will snowball like they did in early 2016, as buying begets buying. That's when this new gold-stock upleg will really start in earnest, all we've seen so far is the pre-game show.

The most-likely catalyst to reignite major gold-stock buying is these silly Trumphoria-fueled general stock markets rolling over. They are wildly overdue for a major selloff, and that will rekindle big investment demand for gold for prudent portfolio diversification. Gold tends to move counter to stock markets, so this anti-stock trade grows popular when stock markets weaken. Gold stocks naturally follow gold higher.

The stunning Trumphoria stock-market rally since the election has distracted traders from gold. Gold is usually forgotten when stock markets apparently do nothing but rally. Investors feel no need to diversify their risky stock-dominated portfolios. So the gold and gold-stock buyers of recent months are likely just the hardcore contrarians. Vastly more buying will erupt when these crazy stock markets inevitably slide.

Interestingly after shunning gold since the election as stock markets surged on mere hope, big investors have just started to aggressively buy gold again. Just this month, the dominant GLD gold ETF started to see major capital inflows that can only be hedge funds! They see the writing on the wall, the extreme dangers inherent in these euphoric stock markets and the serious upside potential for gold as they roll over.

While speculators and investors alike can certainly play gold stocks' big coming gains with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals. Their upside will trounce the ETFs', which are burdened by over-diversification and underperforming gold stocks. A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.

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The bottom line is gold stocks' capital volume has diverged from their new upleg in recent months. This reflects waning interest in this sector, the product of much residual bearishness following last quarter's miserable mass stoppings. The rally since mid-December was driven more by a lack of sellers than new buyers. But this is actually quite bullish, as it implies this upleg's big gold-stock buying is still yet to come.

These Trumphoria-fueled stock markets have been a huge distraction, lulling traders into extreme levels of complacency. That's allowed gold stocks' young new upleg to fly under their radars. But once these stock markets roll over and gold starts surging again, gold-stock demand is going to just explode. And that's when gold-stock capital volume will soar, reversing the divergence and really amplifying gold stocks' gains.


Feb 17, 2017
Adam Hamilton, CPA

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

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