GOLD STOCKS FAIL TO REACH NEW HIGH -- THIS IS THE FOURTH TIME THIS HAS HAPPENED IN THE LAST DECADE AND USUALLY LEADS TO A GOLD PULLBACK -- GOLD SHARES UNDERPERFORM BULLION BUT OUTPERFORM STOCKS

GOLD MINERS FAIL TEST OF HIGHS... On Tuesday I showed the Market Vectors Gold Miners ETF (GDX) hitting a new four-month high which set up a test of its late 2010 and spring 2011 peaks. Chart 1 shows that test of prior resistance at 64 failed this week as miners have sold off pretty sharply. Of course, the main reason for that failure is the tumble in gold prices this week from an extremely overbought situation. That also pushed silver and its related stocks lower. I decided to go back and reexamine how many times gold miners have failed to confirm an upmove in gold and what happened after each one. I found three times that's happened over the last decade.

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Chart 1

PREVIOUS GOLD STOCK DIVERGENCES... Chart 2 compares gold stocks to bullion since the bull market began during 2002. The flat lines show three previous instances when gold stocks trended sideways for a period of time and failed to confirm the uptrend in bullion. The first one lasted from mid-2002 to mid-2003, the second one from early 2004 to late 2005, and the third one from spring 2005 to late 2007. None of those instances prevented the price of gold from rising, although they did slow its advance. The two periods from 2004 through 2006 and early 2005 to late 2007 caused gold to correct or move sideways for a period of time. The three upside breakouts in gold stocks (see circles) helped gold resume its uptrend. The message seems to be that bullion does better when gold stocks are rising along with it. But there may be a reason why gold stocks are lagging behind bullion.

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Chart 2

GOLD STOCKS HAVE UNDERPERFORMED SINCE 2008... There may be another dynamic at work which helps to explain why gold stocks aren't keeping pace with bullion. Gold is a commodity and, maybe more importantly, an alternate currency. As a result, investors and central bankers have been loading up on gold as a hedge against global debt problems and economic weakness. The existence of gold ETFs also makes it more easily accessible to investors and institutional traders. Although gold stocks are tied to the commodity and generally rise along with it, they're also common stocks. In other words, they're also tied to the fortunes of the stock market. Chart 3 shows gold and gold stocks rising together over the last decade. The GDX/GLD relative strength ratio below the chart, however, shows that gold stocks have underperformed bullion by a wide margin since late 2007. Coincidentally, that's also when the S&P 500 (bottom line) peaked as well. In fact, the two lines below Chart 3 have generally trended in the same direction over the last four years.

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Chart 3

Chart 4

GOLD STOCKS TREND BETWEEN GOLD AND STOCK MARKET ... Chart 4 compares bullion (black line), gold shares (blue line), and the S&P 500 (red line) over the last four years. Gold has been the top performer (+155%) while the S&P 500 (-18%) has been the worst. Gold stocks are in between (+54%). That's because they're tied to a rising commodity but also to a weaker stock market. That would seem to suggest that bullion will remain the preferred choice until the stock market turns back up again (and once gold's correction is over). It also suggests that while gold stocks have been weaker than bullion, they're still a better choice than the S&P 500.

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Chart 5

GDX STILL IN UPTREND... Chart 5 shows the Gold Miners index (GDX) to be in trading range since last December. The inability to clear resistance at 64 has kept it in that trading range. So far, however, no serious chart damage has been done to its chart pattern. Prices remain above their 50- and 200-day moving averages and no support levels have been broken. This week's selloff is tied partly to the selloff in bullion and a short-term rebound in the stock market. Neither of those short-term trends is expected to turn into long-term trends. In other words, odds still favor a lower stock market and higher gold once these short-term corrections have run their course. In my view, that still makes gold stocks a pretty good hedge against a bear market in global stocks and a more conservative way to play the secular uptrend in gold. The rising GDX/SPX relative strength ratio (below chart) shows that gold shares have still been pretty good safe havens since the market downturn this summer. In order for that positive view of gold and gold stock to change, the GDX would have to drop below its summer low. That doesn't appear likely to happen.