The NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (also known as the HUI Index) is a modified equal dollar weighted index of companies involved in gold mining. The Gold BUGS Index is listed on the NYSE Amex under the symbol “HUI“. The HUI Index and Philadelphia Gold and Silver Index (PHLX: XAU) are the two most watched gold indices on the market. The Gold BUGS Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years. The HUI Index was developed with a base value of 200.00 as of March 15, 1996. The AMEX Gold BUGS Index currently consists of 15 of the largest and most widely held public gold production companies.

AMP Readers ask – Now What ?

 The sheer potential of the gold stocks after this imminent breakout is breathtaking.

Gold stocks mine gold of course, so its price determines their long-term profitability. And universally in the stock markets, profitability determines any stock’s long-term price level. This past spring’s gold-stock capitulation ignited a big divergence between gold stocks and gold, the miners’ stock prices aren’t reflecting their profitability.

Since April, the HUI has largely languished in a band between 400 and 450. It is shaded a darker blue in this chart. Note that during this latest episode, gold was trading around $1600. Is that situation rational fundamentally, have this year’s summer-doldrums gold-stock prices reasonably reflected prevailing gold levels? Not a chance. This is readily apparent when considering past 400-to-450 HUI consolidations.

The previous one before this summer’s ran from late 2009 to mid-2010. Where was gold trading then? Around $1100. So despite this summer’s baseline gold price being about 45% higher, the HUI was trading at the same levels as several years ago. This makes no sense at all, it is irrational and illogical. The incredibly low valuations of gold stocks prove this past summer’s levels were fear-driven, not fundamentally justified.

Another episode of the HUI consolidating between 400 and 450 happened in early 2008 before that year’s epic once-in-a-century stock panic. Where were prevailing gold prices then? Around $900. This past summer’s $1600 gold was 78% higher than the spring of 2008’s, yet the gold stocks as measured by their flagship index are trading at the same levels! This fundamental anomaly can’t persist for long.

And that is why the imminent gold-stock breakout is so exciting and hyper-bullish. Since May’s capitulation, investors and speculators have simply been blinded by fear whenever they looked upon this sector. But a major breakout, as we’ve seen in gold in recent weeks, works wonders in rapidly bleeding off bearish sentiment. So once the HUI shoots decisively above 460, the scales will fall from traders’ eyes.

As they take a fresh look at gold stocks, they are going to be flabbergasted at the vast fundamental disconnect. They will start to realize that having the gold stocks trading as if gold was at $900 or $1100 when it is really around $1700 is a monumental bargain. And capital will start flooding in to ride the gold-stock mean reversion back up to more reasonable levels relative to gold. Hedge funds will lead the way.

During this past summer when gold stocks were as deeply out of favor as they’ve been since the stock panic, elite hedge-fund managers started nibbling as they examined this sector’s core fundamentals. Their gold-stock holdings continued to grow as the HUI recovered in August. And other hedge-fund managers, eyeing those big profits in a year where finding performance is challenging, are salivating.

Since they are seeing their contrarian peers making money in gold stocks, and they are already interested, it won’t take much to push them into buying mode. So a major upside breakout will almost certainly prove more than sufficient. Nothing attracts capital like upside momentum, and the HUI’s should accelerate considerably once it breaks out. And interestingly, the summer’s 460 resistance may not even be the biggest breakout.

Really big moves in gold stocks, both uplegs and corrections, nearly always persist for more than a few months. So the summer resistance may be considered too short-term by some to get excited about breaking out of. But look carefully at the chart above, and you’ll see the HUI’s black 200-day moving average is just a little higher. This critical metric is currently around 470, merely a single good up day’s rally higher from here.

When a sector in a secular bull with amazing fundamentals crosses back over its falling 200dma after a major correction, it is supremely bullish. The last similar event occurred way back in early 2009, during the stock-panic recovery. Once the consolidating HUI broke decisively above its falling 200dma, it surged from around 300 to 600 in the subsequent couple years. Gold stocks doubled after that similar breakout!

Could they again? Could the HUI’s next major upleg ultimately carry it from around the recent 450 levels to over 900? Absolutely, it isn’t even a stretch. And the reason is because gold stocks remain so anomalously cheap relative to prevailing gold prices. This is easiest to understand when viewed through the lens of the venerable HUI/Gold Ratio, the HUI close divided by the gold close charted over time.

Gold is already climbing higher in its major seasonal rallythat accelerates almost every autumn. On average since its secular bull was born in early 2001, gold powers 19% higher between late July and late May. This year gold was trading around $1577 at worst in late July. From that base, a merely average seasonal rally between now and May would carry gold to $1875.

At $1875 and a 0.511x HGR, the HUI would be over 950! This is more than double today’s levels in a relatively short time frame, well under a year. Will it happen? No one but God knows the future. Could it happen? Absolutely. It is not much of a stretch at all to merely expect an average seasonal gold rally given global central banks’ fast money-supply expansion, and gold stocks will inevitably once again reflect prevailing gold prices sooner or later.