As the gold miners drift lower during a seasonally weak part of the year (mid-October) for the sector, a textbook complex head & shoulders top pattern has formed:

HUI Gold Bugs Index (Daily)

The gold miners as represented by the HUI Gold Bugs Index are testing a key area of support between 195 and 200 (equates to roughly $26.00-$26.60 in the GDX) for the second time in less than a month. There are a few things going on here that I'd like to point out:

  • The powerful uptrend that existed between the end of May and the end of August has given way to a rangebound oscillation characterized by lower highs and declining Relative Strength. 
  • The Daily-ADX(14) is down at 13.56 but it is just beginning to turn higher. This is characteristic of a trendless market, however, the trendless market could quickly transition to a downtrend if support near 195-200 is broken (in that event we are likely to see the ADX quickly rise back above 20).
  • The more times a support level is tested the more likely it is to break. This is only the 2nd test of support since the August 52-week high was put in place, however, it is coming after a shallow bounce and a failure to get back above the 50-day moving average. 
  • Sentiment on gold and the gold miners has been turning south for several weeks, however, we are not yet at the deeply overbearish conditions that are consistent with a sustainable low (we could reach deeply overbearish sentiment levels in the next few days).
  • Seasonality will remain a headwind for the next two weeks and then the goldies will have tailwinds from the end of October until the end of the year (in the last 20 years the HUI has averaged a 4.7% gain from the end of October through the end of the year).

A lot of people are pointing out this 'Captain Obvious' chart pattern today. From my experience when lots of eyeballs are staring at the same chart patterns they rarely play out according to the textbooks. In the case of the head & shoulders top in the gold miners a breach of the neckline of the topping pattern would target an additional ~15% of downside. While such a large decline is certainly possible, I believe the more likely scenario is a failed breakdown below the neckline followed by a sharp upside reversal OR a decline to test the rising 200-day moving average (about 7.5% below current levels) before an upside reversal takes hold. 

I believe it's important to remember that bull markets regularly experience 50% declines along the way before the dominant trend reasserts itself. I know I will be using any additional weakness in gold mining shares over the coming days to add more exposure to my favorite names in the sector.

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