A historic divergence between gold miners and gold

Key points:

• Gold miners reside in the lower half of their 3-year range, while gold trades near the upper end
• Similar divergences led to a rally in the miners every time over the subsequent six and twelve-month periods
• Gold futures struggled, and the S&P 500 was higher every time from two to twelve months later

Should we expect a catch-up rally from gold mining stocks?

Gold's impressive ascent, triggered by a historic oversold condition and fueled by Middle East tensions, has brought about a striking divergence between gold miners and the precious metal. 

For only the 7th time in more than five decades, gold futures closed higher than 91% of all other prices over the trailing three years as a gold mining index resided in the bottom half of its range with a reading of 36%, creating a massive divergence.

When I calculate the difference between the two range ranks, the spread recently fell to -60, a phenomenon observed in less than 1% of cases since 1969. While rare, readings below -60 tend to ignite an explosive rally, with annualized returns exceeding 76%. 

Similar range rank divergences suggest gold miners rally

While the sample size is small, whenever the 3-year range rank for gold miners resides below 40% while the rank for gold futures exceeds 90%, the Gold BUGS Index (HUI) was higher over the subsequent six and twelve months every time.

While gold tends to rally over the next few weeks, the medium-term outlook is not encouraging. From a long-term perspective, the path is pretty straightforward. Either gold is about to top like 1974 and 1987, or it's in a sustainable uptrend like the other precedents. A decisive breakout above the previous resistance around 2051 would suggest the latter.

Why do gold miners rally when gold struggles?

One plausible reason gold miners rally as gold struggles is an overall favorable backdrop for the stock market. The S&P 500 was higher every time from two to twelve months later. 

Focusing on the signal dates illustrated on the chart highlights that these divergences coincide with bullish inflection points for the broad market. i.e., gold miners suffered under the weight of an overall market drawdown as gold held up in a flight to safety trade. When it reverses, miners rally, and gold struggles. 

My colleague, Jay Kaeppel, recently published a three-part series on a cycle calendar for gold mining stocks. Please click here, here, and here to review. 

What the research tells us...

Commodity-based assets, like gold mining stocks, often face challenges in sustaining long-term upward trends due to the mean-reverting nature of commodities. This characteristic makes adopting a buy-and-hold strategy challenging. Nonetheless, during cyclical upswings, returns can be spectacular over a short period. The current historical discount of gold mining stocks compared to gold, based on a three-year range rank, suggests that we might be witnessing one of those opportune moments in history to participate in an upswing. After similar divergences, the Gold BUGS Index (HUI) was higher over the subsequent six and twelve-month time frames every time.