4 Signs of Gold Shares Hitting Bearish Extremes

The gold market has been bashed, battered and bruised for over a year now. And the gold mining shares have suffered an even worse fate. The technical evidence I have reviewed is suggesting that this has hit an extreme and therefore I expect that we are very close to a bottom in the recent bear market for gold miners. What follows is a brief review of that technical evidence.

At the end of August, 2011, gold reached an all-time high of over $1900 per ounce. Since then it has corrected 18.5% touching $1560 recently.

While this drop has certainly been unpleasant for holders of physical gold, it pales in comparison to the drop that has occurred in the gold miners as represented by the Gold Market Vectors ETF (GDX).

GDX has fallen over twice as much, down over 42% from its 2011 high.

Bearish Extreme #1: Gold Miners to Gold Ratio

There is technical significance to this. There is an obvious correlation between gold and gold mining shares. Directionally they should, and over longer periods usually do, track each other. One can track the ratio between the price of gold and GDX and learn from that ratio the mood of investors and how they generally feel about gold mining shares.

That ratio has fallen precipitously, hitting its lowest level since the recession of 2009. Since early 2006, when the GDX etf was first created, the typical ratio between GDX and gold was around 0.4. Today's reading is almost half that.

Even worse is the effect on the Market Vectors Junior Gold Miners ETF (GDXJ) whose ratio to gold has dropped 60% since its 2011 peak.

Bearish Extreme #2: Bullish Percent of Gold Miners

The Bullish Percent Index is credited to point and figure chartist Thomas Dorsey who first computed the BPI for the number of New York Stock Exchange listed stocks that were in bullish point and figure chart patterns compared to the total. It has since been expanded and computed for a number of different sectors. Bullish Percent Indexes fluctuate within a range of 0% (no stocks in a bullish point and figure pattern) to 100% (all stocks in a bullish point and figure pattern) though in practice the majority of readings will fall between 30% and 70%. Readings outside of those parameters are uncommon; readings outside of 20% and 80% are rare. The current bullish percent reading for the gold miners is 3.3% (not a typo).

The only other time such a low reading was recorded was at the beginning of December, 2008. In a washout day, as shown in the chart below, the BPI actually hit zero percent. To my knowledge, no other BPI has ever hit such an extreme reading. Extreme readings, such as only 3.3% of the gold miners being in an uptrend, simply do not last.

Bearish Extreme #3: Opinion on Gold

Opinion on gold, from advisers to the general public, is at extremely low levels. Public opinion on gold has dropped to its lowest level in a decade, with only 40% positive. The Hulbert Financial Digest, which tracks adviser's recommendations on gold, has gone below -10% meaning the average adviser is recommending a greater than 10% short position in gold, an extreme reached back at the bottom in 2009.

Bearish Extreme #4: Money Exiting Gold Funds

The amount of money flowing out of various managed gold products is extremely robust. The Rydex Family of Funds allows clients to switch among a broad range of assets. Gold has dropped from 20% of assets four months ago to only 9% recently. Only twice since 2003 has it dropped below 10%, both times marking a low in gold. The month of February recorded a record outflow of 100 tons during the month of February, according to Bullion Vault. The money leaving the gold sector can also be seen in the premium to net asset value that investors are willing to pay for closed end giant Central Fund of Canada (CEF). That premium has just gone negative, another rarity usually associated with market bottoms. Year to date, $3.1 billion dollars has left the SPYDR Gold Trust ETF (GLD). The last time this happened, mid-2012, gold began a significant rally.

If I have learned one thing over 30 years of investing in the stock market it is that extremes do not last long. Extremes can become more extreme, but usually only for a very short duration. A more probable outcome is a return to the mean.

Conclusion: My analysis has shown that the gold miners are exhibiting several key indications of being in the territory of a bottom. Aggressive traders may wish to initiate positions now. However it is important to note that there are still no indications of the gold miners turning up. There is merit in waiting for some positive signals of an upturn before making a full allocation to the sector. An upturn in BPI would certainly be such a signal. Also, a bullish crossover on the gold miners MACD would signal the beginning of an uptrend.