Dangerously Flawed Conventional Wisdom

• Posted by Robert Sinn
• on July 11th, 2012

Late last year I produced one of my better blog posts which highlighted the precarious position of gold mining shares. Despite my long term bullish bias on gold itself the tremendous disconnect between sentiment & performance in the sector really stood out to me at the time. While the crowd reiterated the same conventional wisdom about the miners being cheap relative to the gold price, the inability of the sector to hold breakouts even while gold traded north of $1800/ounce was a troubling sign for bulls.

Seven months later we can use 20/20 hindsight to observe just how powerful of a contrarian setup a short position in $GDX was on December 7th, 2011 near $59/share:

• As I pointed out in the blog post the GDX chart had many troubling signs including heavy distribution during the multiple failed breakouts above $60
• Positive sentiment on the sector despite price action that was mediocre at best
• Overwhelming conventional wisdom that the gold miners were cheap relative to gold, and perhaps even more troubling was the repeated uttering of the idea that “the downside is limited”
• Extremely low short interest in the sector which helped to emphasize the bullish consensus view

As it turned out the gold miners went on to disappoint with production shortfalls and operational cost overruns throughout the first half of 2012. To make matters worse, gold ($GC_F $GLD) has remained under pressure and persistent worries regarding a China hard landing have continued to weigh on commodity related equities as a group:

 

Reviewing moments in the market such as the one above can help us to learn from the past and identify similar opportunities in the future. What is the next example of a market with multiple “negative divergences” from the consensus view in which taking a variant view could be potentially quite profitable? (i’m interested to hear your thoughts in the comments section)

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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