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August 6, 2010

Seeking the Trade Winds

One of these days, mining shares... of the precious metals sort... are going to have the wind at their backs and be able to set their sails at the same time. This lucrative combination of circumstances has been elusive since late last year. During the strong bounce by equities out of the February low, gold action remained choppy, thereby keeping a lid on the miners' rally. More recently, the surge out of the July low by stocks coincided with a slump by our little yellow friend into a deeper correction. As gold finally bounced, stocks were ready for a pause. Then we started the current week with a 2%+ session for both silver and stocks, but gold took the day off and held mining shares down. Even today, miners were in the mood to rally, posting solid gains out of the gate, only to see those gains pared as equities hit some late-morning doldrums.

I don't mean to imply that mining shares are lagging. The sector certainly held up better than the general equity market in the most recent correction.

gold miners diverge from stocks

One could also note that the 6% bounce by the XAU over the last two weeks versus a flat S&P 500 isn't too shabby. However, when the conditions align properly, these stocks will sail higher 6% or more in a single session.

gold miner rally

Back to the recent action... the net result of all the crosswinds hindering the mining sector has been a multi-month consolidation of the post-crash recovery.

gold mining shares consolidate

Every wonder why such action is labled "consolidation?" When stocks surge into peaks as did PM miners late last year, smart money is unloading shares to irrationally exuberant retail traders (to borrow a phrase from our ex-nemesis). Then as the stocks chop sideways for an extended period, retail traders grow impatient and puke their shares back to the big boys. In other words, the shares are consolidated back into the hands of smart money for the next move higher. One can now comprehend why the performance divergence noted above is so important... it tells us big money still has this sector in play.

In fact, the intermediate cycles of gold and the dollar are indicating another large run is in the works for the second half of this year, helping confirm the read on the XAU chart. I have a sneaking suspicion that the alignment of favorable circumstances we are seeking will occur just as the XAU breaks out of its multi-month consolidation.

Now keep in mind that miners are still grossly undervalued in terms of the asset they produce:

gold miners priced in gold

When the next major leg of this sector's bull market kicks into gear, the gains should be truly spectacular to behold.


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