Gold-Stock Forced Capitulation

The gold miners’ stocks suffered a rare capitulation selloff over the past month or so. Selling cascaded to extremes as stop losses were sequentially triggered, battering this contrarian sector to exceedingly-low levels. While very challenging psychologically, capitulations are super-bullish. They rapidly exhaust all near-term selling potential, leaving gold stocks wildly oversold and undervalued which births major new uplegs.

Capitulations are quite rare which makes them inherently unpredictable. The vast majority of selloffs end normally well before they snowball into capitulation-grade plummets. But very seldomly heavy selling just continues to intensify rather than abate like usual. The word capitulation means “the act of surrendering or giving up”. That’s exactly what happens in these extraordinary selling events, traders stampede for the exits.

Exceptionally-bearish sentiment definitely plays a major role in capitulations. As serious selling mounts, the resulting technical carnage leaves speculators and investors alike incredibly disheartened. The pain is so great that all but the most-hardened contrarians give up and sell low. But forced selling is equally if not more important in fueling capitulations. That likely played a bigger role than sentiment over this past month.

All prudent traders protect their capital deployed in stocks with stop-loss orders. They are essential in a sector as super-volatile as gold stocks, as significant-to-serious individual-company and sector-wide risks always lurk. Stop losses are typically set loose enough to weather any normal volatility. But when selling grows severe, stock prices are bashed low enough to trigger stops unleashing a vicious circle of selling.

The lower stock prices fall, the more stop-loss orders are tripped. That adds to the selling pressure and pushes prices lower still, hitting even more stops. So even the most-rational traders grounded so deeply in fundamentals that nothing scares them contributed to the capitulation plunge via mechanical stop-loss selling. We are in that camp, suffering quite a few stoppings in our trades despite no emotional distress.

The resulting cascading technical carnage was extreme by any measure. This first chart is updated from my early-June essay on gold’s summer doldrums. It shows how gold stocks have behaved in summers of all modern bull-market years as rendered by their flagship HUI NYSE Arca Gold BUGS Index. Every year is individually indexed to 100 as of May’s final close, with all gold-stock action recast off that common base.

This approach leaves gold stocks’ summer trading perfectly comparable in percentage terms regardless of prevailing gold-stock price levels. The yellow lines show how the HUI performed in the summers from 2001 to 2012 and 2016 to 2017. They are all averaged together in the red line, which reveals this sector’s normal summer tendencies. Typically gold stocks are flat to weaker until late July, then start rallying again.

But the recent extreme capitulation anomaly made the summer of 2018 one of the worst on record for the gold stocks, as the blue line divulges. Gold stocks usually have a center-mass drift in market summers running +/-10% from May’s final close. But at worst in mid-August, the gold stocks had plummeted a nauseating 22.8% summer-to-date! That was way beyond even the weak seasonal norms of market summers.

So realize there was nothing normal or foreseeable about gold stocks’ recent brutal plunge, everything about it was exceptional. Again very few selloffs keep on cascading into full-blown-capitulation territory. When such events rarely and surprisingly arise, all speculators and investors can do is hunker down and ride them out. Understanding what odd confluence of events fueled them clarifies what is likely coming next.

This next chart shifts to the leading GDX VanEck Vectors Gold Miners ETF, the most-popular gold-stock investment vehicle. Gold miners’ stocks are ultimately leveraged plays on the gold price, which directly drives their profits. Gold itself actually remains in a bull market birthed in mid-December 2015, so the gold stocks are too still considered to be in bull-market mode despite this recent extreme capitulation anomaly.

After hitting a fundamentally-absurd all-time low in GDX terms in January 2016, gold stocks skyrocketed in a powerful new bull. GDX soared 151.2% higher in just 6.4 months, driven by a parallel 29.9% new gold bull! Then a normal and healthy bull-market correction from those resulting wildly-overbought levels was greatly exacerbated. After Trump won the presidency, stock markets surged dramatically which hit gold hard.

Gold is the ultimate contrarian investment, tending to rally when stock markets weaken. When stocks are powering to seemingly-endless new record highs, gold investment demand really wanes. Thus gold and the stocks of its miners were trapped in long consolidations as stock markets surged over the past couple years or so. GDX settled into a meandering consolidation basing trend between $21 support to $25 resistance.

That held rock-solid from late December 2016 to early August 2018, a long 19.3-month span. Before this recent extreme capitulation anomaly, GDX’s key $21 support was challenged no less than 5 times in that timeframe. It held every single time, soon bouncing gold stocks back up higher into their consolidation trend channel. These long-term pre-capitulation technicals offered little warning of an impending breakdown.