Time to Buy Precious Metals Senior and Junior Stocks?

By Przemyslaw Radomski Feb 08, 2010 7:55 am

The general stock market is highly correlated with precious metals so don't ignore the strongly bearish signals.

Gold, silver, and mining stocks have been declining very rapidly in the past several weeks and have now reached (or are even below) our previous target areas for this downswing. Is this a buying opportunity, or should precious metals investors take additional new factors into account?

In the following essay I'd like to provide you with my thoughts on the current situation in the precious metals stocks: both big senior companies (represented by the HUI Index and GDX, the Market Vectors Gold Miners ETF) and the small-cap juniors (represented by the TSX Venture Index)

Let's begin with the HUI chart for more details:


Source: StockCharts.com

The precious metals stocks are trading mostly in tune with gold and the general stock market lately (and inversely to the USD Index) and consequently the situation here is very similar to the situation in other precious metal markets -- namely that there's a high risk that the main stock indices plunge and drag the precious metal sector with them.

The current move lower in the precious metals has been very rapid and the RSI Indicator flashed a buy signal recently, but once again, high correlation between precious metals and the general stock market is a major factor here, and the latter doesn't seem to have bottomed at this point yet.

The RSI indicator was just below the 30 level, but that was also the case in August 2008, which marked a beginning of a major move down. Let's take a look on the short-term chart for more details:


Source: StockCharts.com

The value of the GDX ETF (proxy for precious metals stocks) has reached the downside target for this rally, but there are two more factors that need to be taken into account here -- volume and the high correlation with the general stock market.

As far as the volume analysis is concerned, note that major bottoms in precious metal stocks are rarely accompanied by such a huge volume that we've seen recently. Consequently, GDX may still move lower, unless we see signs of disconnection between precious metals and the general stock market.

Moving on to the juniors sector, the comments I made on the January 15 are still up-to-date. Because we may still be in the early part of the decline on the general stock market, and Premium Update subscribers have already taken advantage of this information, I'd like to make it available publicly.

There's one more thing that I'd like to comment on this week, and that is the situation in the junior sector. In the essay posted on September 19, 2008, I wrote the following:

(...) junior/senior ratio is reasonably correlated with the general stock market. This is another thing that justifies the severity of this decline. As the stock market fell, the junior/senior ratio plunged as well. The marked rectangles on the chart are periods where juniors rallied relative to the HUI Index -- it was accompanied by a rise in the general stock market. The question is what will happen next on the main stock indices.

The juniors have been rallying recently, but so did the general stock market, which is another confirmation of the points raised over a year ago. Since the general stock market is likely to move lower sooner or later, it may mean that the juniors' outperformance will also disappear for some time.

Please note that the correlation numbers currently imply that the general stock market has a very strong influence on the junior sector.

Consequently, if you are heavily invested in juniors, you may want to consider switching at least a part of your holdings into big, senior precious metal stocks, bullion, even cash (depending on your investment preferences). If you are risk averse, switching from juniors into physical gold/silver, seems to be a good idea.

Please note that juniors' outperformance ended just a few days after that update had been posted.


Source: StockCharts.com

The situation on the general stock market appears to have influenced juniors' outperformance as indicated earlier. Since we don't see signs of strength in the general stock market at this moment, and we're not in the final stage of a rally, I don't think that juniors are the best place for one's capital at this moment.

Summing up, the situation on the precious metals market is currently particularly interesting. The precious metal stocks have been moving sharply lower in the past several weeks, which should normally create a favorable buying opportunity. Still, the general stock market is once again highly correlated with precious metals (and with the USD Index), which means that one shouldn't ignore the strongly bearish signals that it generates. At this moment the general stock market appears to be one of the most important factors to consider.