Why We Avoid Longs in Corrections Even When Underlying Assets Act Bullishly

In our write up of August 28^th we urged taking a position in gold on a break out by buying the GLD ETF. We entered the position on September 2^nd as price began its move and have a comfortable cushion in the position.

The stock market has entered what appears to be its first significant correction of the bull market that began in March, but you’d never know it from the price of gold. Granted, price has traded lower, but unlike many bullish stocks there has been no panic stricken pullback and price remains comfortably above its 50 MA.

Not so gold mining stocks. A good proxy for them is the GDX ETF. Yesterday it broke below its 50 MA on volume and undercut a prior low, signaling that its uptrend is very much in doubt. Unlike gold itself it has surrendered the entire gain since the September break out. Price is bouncing today but it will have to close back within its recent trading range to escape technical damage.

Why the disconnect? Simply stated gold miners are companies that have underlying fundamentals that go beyond the price of gold. Their stocks are equities, not commodities, and will usually trade in sympathy with the stock market regardless of the price of the underlying asset.

O’Neil’s half century study of stocks’ behavior indicates that at least three out of four will follow the market’s general direction. Given the recent aggressive pullback that means long positions other than intraday trades face a headwind that puts them at a disadvantage from the moment you push the buy button.