After severely lagging the broader market for the past year, gold and silver mining stocks finally are starting to look interesting. The past week has brought a crescendo of selling pressure that has weighed heavily on mining stocks, setting up opportunities for nimble traders. But be wary: Mining stocks still are dangerous here, and extreme caution is in order.
How bad has it been? In the three months ended May 15, the Dow Jones U.S. Platinum & Precious Metals Index declined 30.23% — making it the worst performer of the 99 Dow Jones industry groups — while Dow Jones U.S. Gold Mining checked in as the third-worst industry with a loss of 25.95%. What makes this selloff so noteworthy is that in the past three months, the gap between the performance of the miners and the precious metals themselves has opened up considerably.
The following chart shows the relative performance of the Market Vectors Gold Miners ETF (NYSE:GDX) versus the SPDR Gold Trust (NYSE:GLD). The rising line indicates outperformance for GLD; a falling line indicates underperformance:
The chart of the Global X Silver Miners ETF (NYSE:SIL) versus the iShares Silver Trust (NYSE:SLV) paints a similar picture:
The selloff in precious metals stocks hasn’t just reached extremes in terms of relative performance. A look through the charts of some key industry players shows that on a 10-year basis, the most recent downturn is second only to the 2008 crisis selloff in terms of its magnitude. The long-term chart of Barrick Gold (NYSE:ABX) is typical in this sense:
On a fundamental basis, the valuations of precious metals producers have fallen to multiyear lows as measured by their price-to-book ratios. The five-year chart below shows how a handful of select names from the sector have returned to crisis-level valuations:
In addition, mining stocks have fallen so far that certain technical indicators — such as depressed RSIs and breaks of their lower Bollinger bands — are showing extreme oversold condition. This creates the opportunities for traders to take advantage of rallies such as the one we witnessed last Wednesday, May 9, when most miners logged gains in the 5%-10% range.
Opportunities Balanced by the Risks
On the surface, these factors would seem to make the mining stocks a screaming long-term buy here. After all, mining bulls have been pounding the table about the underperformance of the stocks relative to the metals since last summer.
The trouble is, the metals themselves have been lagging due in part to the rally in the U.S. dollar, which has occurred as the latest round of the European debt crisis has sparked a flight out of the euro. As long as fears about Europe are driving the dollar higher, it’s going to be tough for mining stocks to gain sustained traction.
Miners also have seen their underperformance pick up considerably in the wake of Argentina’s move to nationalize oil producer YPF (NYSE:YPF). It might be a coincidence, but since the date of the nationalization, GDX has fallen 15.7%, while SIL is off 19.1%. Clearly, the metals are seen as being a superior investment with the new set of political risks faced by basic materials producers.
The most compelling case against jumping into the miners with both feet is the technical picture for the metals themselves. GLD has broken its lower trendline and is trading below its 200-day moving average, and it is testing its support level at $150. Similarly, SLV is nearing its support level at $25.65, below which it enters into a technical no-man’s land. As long as these two charts remain vulnerable to a further breakdown, the potential for further downside in the mining names remains high.
Add it up, and the miners still look more like trading vehicles here than strong buy-and-hold candidates. Short-term investors need to keep a close eye on these stocks, since they’re likely to provide some outstanding trading rallies through the summer. However, anyone who is investing in this sector needs to be aware that the risk-reward profile still is extremely dicey — even with such large losses already in the books.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
