This essay is based on the Premium Update posted on December 11th, 2010

In our previous essay we've covered the situation on the gold market, however since rallies (and declines) often correspond to the rallies (and declines) in the mining stocks, this time we will focus on the latter and check if we can spot any divergences or confirmations.

Let's begin with looking at the very-long-term XAU Index (proxy for gold- and silver mining stocks) chart (charts courtesy of http://stockcharts.com)

The above chart shows a decisive move above previous highs, which means that the uptrend has finally been resumed. The post-breakout correction is barely visible so but a move down to the 210 level would be both normal and healthy at this time. This breather could very well precede yet another rally and unless this 210 level does not hold, the medium-term sentiment for the mining stocks remains bullish.

Let's take a look at the GDX chart for more short-term details

The GDX ETF chart shows a pause in the recent decline. In our recent Market Alert we mentioned that we have been looking for a low volume move to the upside. It seemed as though this was a good possibility at the time and would provide Subscribers with an excellent opportunity to short the market. No upturn has been seen however (the 0.38% move up is more of a pause) and therefore, implications of the volume analysis are not meaningful. The chance to short did not arise yet.

Support levels, which will likely hold on the downside, are at 60 and the 57-58 range. Either of these levels could become the next local bottom for the GDX ETF and a rally from there is quite possible.

Let's not forget that there's more to the mining stock sector than just the big senior gold and silver producing companies - there are also juniors. In the previous essay, we've mentioned volume spikes for the GDX:SPY ratio and their implications for the short term.

The volume spikes are significant not only in the relative performance of the senior sector, but that is the case also with juniors.

The GDXJ:SPY is a ratio between a proxy for the juniors and a proxy for the general stock market.

The GDXJ ETF is the junior counterpart of the well-known GDX ETF, and its performance relative to other stocks quantifies the part of the performance of junior sector (small-cap, small-volume, early-stage companies) that can be attributed to individual investors' perception of the market.

Most institutional investors are not involved in this market due to company size, monetary constraints, and other regulations. The buying pressures, therefore, lie mostly on individual investors who are naturally more emotional most of the time (!). It is likely that this ratio is very much an emotional barometer of individual gold and silver investors.

Since the general stock market drives the prices of these small cap companies, the ratio is calculated by dividing by the SPY. This isolates the influences of other stocks. If the ratio rises, the indication is that investor's sentiment is high. This, in turn, allows us to analyze moments when the optimism is excessive in order to take the opposite position as it means that the current move will soon end. In this case, it means that everyone, who wanted to enter the market, is already in it and there is nobody left to support further rallies - new capital needs to enter the market if the price was to rise.

Yes, the GDXJ:SPY ratio take the individual investors into account only, and the gold market is driven by many other entities, but - once you take into account the fact that the public enters the market mostly at the end of a given move - it occurs that it doesn't really matter.

While the sentiment is not extremely high in absolute terms (we don't see much gold-related headlines in the major financial portals), on a relative basis we see an upswing confirmed by volume. This could be viewed as a bearish factor.

Namely, volume levels were extremely high last week. This is important to note because in the past, high volume levels such as this have been an indication that downtrends have not yet completed.

Speaking of juniors, we would like to take this opportunity to comment on this sector in general.

Our SP Junior Long-Term Indicator has been moving slowly higher since July 6th (except a single day downswing which was so insignificant that we specifically advised to ignore it). As of today we did not see a sell signal (suggesting switching from junior stocks to senior stocks) in the form of a decline in the indicator. The above indicator suggests switching from big senior gold/silver producers to juniors if it is below the lower dashed line and starts to rise, and it suggests switching from juniors to seniors if it is above the upper dashed line and starts to decline. It was designed to catch the major moves, not the short-term ones. Please note that juniors (GDXJ ETF) moved over 60% higher since July 6th, while seniors (here: GDX ETF) moved up by only 25% since that time. Consequently, this indicator alone generated substantial value for those who took it into account while making their investment-related decisions.

Right now it is above the upper dashed line, but it did not start to decline visibly. Consequently, holding juniors still appears a good way to go. The situation could change in case of a plunge on the general stock market - as you may see in the correlation matrix, main stock indices are one of the main drivers of the junior prices.

Summing up, the ratios point to an overall weakness at this time in the mining stocks and consequently in gold and silver. This confirms our analysis from the previous essay - namely, that the situation remains mixed, with a slight bearish bias.

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Thank you for reading. Have a great and profitable week!