Monday, February 8, 2016

Golden Fetters

It’s that time of year again when technicians, traders and the generally superstitious nervously watch the Super Bowl, and despite Denver’s victory, pray for an NFC victory to deliver a positive year and after last Friday’s stunning 1.85% loss, who could blame them?  Their confidence must have taken a hit as 2015’s invincible “FANGs” pulled the S&P 500 lower where it almost closed the week below the 1880 level that has provided major support since 2014 and the Super Bowl Indicator does have a great “track record,” except around major turning points like 2001 and 2008.  Plus 2016 is the third year in a row where the market recorded an early loss in January and looking back, the Dow Jones did go on to finish 2014 in the green after the Seahawks won Super Bowl XLVIII while the Patriot’s victory in 2015 was followed by our first down year since 2008.  But they aren’t the only ones looking for hope in historical patterns as for the third year in a row, gold mining stocks have turned market weakness to their advantage and started off the year strong leaving investors to wonder if they have the strength to go the distance and or will they falter again on the thirty-yard line?

Putting aside the bad sports analogies, our readers know that the miners aren’t a regular Monday morning topic at ETF Global because, like the Super Bowl, they only tend to catch the interest of investors about once a year in the first quarter and we’re assuming it isn’t just mere coincidence.  A lot of damage has been done to the miner’s reputation as a “safety play” during their long rout over the last five years, but the mining stocks did typically outperform the S&P 500 throughout the long bull market of the 80’s and 90’s whenever the broader market went into the red only to give up those gains when equity sentiment again turned positive.  In fact, not only is this the third year in a row that the miners have outperformed the S&P 500 in January (while the market has been down), but since good things like to travel in packs of three, if they can manage to stay positive for the rest of this month, it will be just the third time since the Great Gold Bear Market began in 2011 that the Market Vectors Gold Miners ETF (GDX) will have been up for three consecutive months.  Laugh if you want but intrepid investors who were willing to wager on the miners over the last three months have seen the sort of point spreads that make tactical managers go all sweaty with the GDX go up over 22% while the S&P 500 is down nearly 10%!

Even with a seemingly perfect backstory for the miners, how come the only place you can find any of the mining funds on the weekly ETFG Quant Movers report is among those funds with the biggest percentage drop in their fundamental score?  Partly, it’s structural as the miners face almost the opposite dilemma we discussed several weeks ago that plagues the utilities funds; there the issue was that their relatively low implied volatility meant that price momentum had to reach almost extreme levels for them to make the list of top scoring behavioral funds while for the miners, the situation is reversed.  The miners typically have such high volatility and short interest that it takes a fairly significant price move for their momentum score to rise enough to make the list of top movers so instead they tend to creep their way up the list and even then they aren’t well-represented at the top.  In fact, a 19.99% return last week was only enough to help keep GDX at #62 while an 18% gain for the Sprott Gold Miners pushed it up to #100.  But what has us wondering whether GDX and the rest of the miners have what it takes to break out and end the year higher is the fact that even with that 19.99% return, GDX’s weekly behavioral score actually fell.

How was that possible?  We’re guessing that a big part of GDX’s gains last week came from short covering as piling on the miners might have seemed a safe bet as Federal Reserve became on the only central bank to hike rates and support a rising dollar while five straight years of losses made shorting the fund the only “safe” way to make money off it.  But when is the “safe story” ever truly safe as central banks across the globe open the spigot leaving the Fed the odd man out and leaving traders to ask how much longer that can last?  Short covering might also explain why GDX, the largest and most well-known mining fund, also strongly outperformed funds whose focus was on the more volatile junior minors like the Market Vectors Junior Gold Miners ETF (GDXJ) with an average market cap of $599 million and up a mere 14% last week.  Or consider the Global X Gold Miners Fund (GLDX) whose highly concentrated portfolio of 21 names and micro-cap focus with an average market cap of just $146 million would seem almost too good for a gold bug to resist and instead ended up “only” 14.1% last week to bring its three month gain to 8.4% compared to GDX’s 22% take.  So again, either investors are putting their capital to work with the name they’re most familiar with, or those overconfident long dollar/short gold positions are being covered as speculation grows that the Fed’s rate hike agenda might be on an indefinite hold.

Does that mean the miner’s last breakout is too good to be true?  Possibly, but that all depends on your holding period as GDX’s parabolic move last week pushed the fund into short-term overbought territory while the miners could still be in the very early stages of a positive trend if the Fed does choose to halt its rate hikes or even worse, goes negative and eliminates the opportunity cost of holding GDX completely.  But no matter what, the outcome doesn’t depend on who wins a football game.

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