I recently warned that the correction was looming in the Precious Metals markets. During 08th of March, I observed that the overall sector has become quite extended on the upside from a short term perspective. I wrote that:
The three month rolling performance, seen in the chart above, shows Gold Miners have so far gifted brave contrarian investors a 30% gain. The bullish return has reached 1.5 standard deviations above its historical mean, indicating that we have moved up too far too fast. In other words, overbought conditions are now signalling caution!
Over the last two decades, I’ve marked other periods where the index became overbought by at least 1.5 standard deviations from its mean. There were 14 instances and interestingly 10 out of the 14 marked an automatic short term top and a pull back of at least 10% (sometimes much more).
Chart 1: Overbought conditions led to yet another correction in the HUI
Source: Short Side of Long
It seems that the recent overbought condition also marked an immediate top and a price reversal. Chart 1 now shows the updated version of the original I displayed on the blog all the way back in early March.
Let us not forget the bigger picture here: Miners will turn out to be a great purchase over the long term. The sector has declined for three calendar years in the row, crashed by over 60% and currently trades at great valuations (especially on relative basis to the S&P 500). Buying this sector definitely makes sense, however timing is a completely different issue. Another lower low might not happen during this basing period, but should not be ruled out either.
Personally, I would let the correction run its course and buy either a) when the price becomes oversold like it did during June and December 2013 and/or b) if the prices manages to break above the neckline resistance shown in the chart above, completely the so called “head & shoulder” bottom.