Yesterday I talked about how silver’s relative weakness could have helped identify the top in gold and silver on Friday, but there was another way to spot the same warning signal if you were watching the gold stocks relative to gold itself. Sometimes the clearest tells don’t come from the headline asset, but from what’s happening just beneath the surface.
Above is a 60-minute chart of GDX, the ETF that tracks gold mining stocks. In the lower pane is a ratio line of GDX versus GLD. Early on, this relationship was about as clean as it gets. As GDX moved higher, the ratio line followed it almost lockstep picture perfect, with no divergences at all. That kind of action confirms a rally. When gold stocks are outperforming or at least keeping pace with gold, it tells me the move is healthy and broad-based.
That all changed at point B. GDX pushed to a new high, but the ratio line did something very different. Instead of confirming the move, it made a much lower high. That’s a classic relative weakness divergence, and it immediately put the rally on notice. The reason for that divergence becomes clear when you look at what gold itself was doing at that moment. GLD was exploding to the upside, yet the gold stocks could only manage a marginally higher high. In other words, the miners were no longer keeping up with the metal.
That disconnect matters. Gold stocks are leveraged plays on gold, so when gold is surging and the miners aren’t responding with equal or greater strength, something is wrong. The ratio line captured that weakness perfectly. You didn’t need to predict anything you just needed to observe the relationship.
Sure enough, the confirmation came quickly. The first large red candle in GDX was the signal that sellers had taken control. From there, the damage accelerated. GDX sold off sharply, gapped down at the open, and closed near its lows for the day. The divergence didn’t tell you exactly when to exit, but it put you on high alert and kept you from being blindsided.
What’s even more compelling is that this wasn’t isolated to GDX. Other gold stocks like NEM, AU, and AEM showed the same type of relative weakness leading into the selloff. When multiple names flash the same signal, it adds weight to the message.
This is a great example of why I rely so heavily on relative strength and weakness. Price alone can be deceptive. The ratio line helps answer a critical question: is the market truly strong, or is the move starting to crack? In this case, it was clearly the latter.
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