GDX SENDS A BEARISH MESSAGE ABOUT PRECIOUS METALS (September 26, 2010): During the past several weeks, there has been a huge surge in bullishness among nearly all investors toward precious metals. Gold has repeatedly set new all-time highs, moving above $1300 per troy ounce on an intraday basis, while silver has retested its all-time peak from March 2008 near $21.50 per troy ounce. The media have excitedly tracked these developments, but have overlooked a vital bearish omen: GDX, the most popular exchange-traded fund of primarily largecap gold mining shares, has repeatedly failed to surpass its zenith of 56.87 from March 14, 2008.

Since gold began trading on global exchanges on the first business day of 1972, gold mining shares have consistently been the most reliable leading indicator for the yellow metal. Following important bottoms for gold mining shares in March 2003, May 2005, and October 2008, gold mining shares dramatically outperformed gold bullion by gaining an average of 4% for every 1% rise in the gold price. On all three occasions, this indicated that a sharp rally was underway and would continue. In sharp contrast, from early November 2007 through the middle of March 2008, the price of gold soared, but gold mining shares struggled to make new highs. This was a sure sign that precious metals and their shares would soon retreat. They did so spectacularly: gold bullion slid from $1033 on March 17, 2008 to $679 on October 24, 2008, for a decline of 34.2%. Silver slumped from $21.50 per troy ounce to $8.73, which was a pullback of 59.4%. GDX, an exchange-traded fund of largecap gold mining shares, plummeted 72.1% over the same period of time, from its intraday high of 56.87 on March 14, 2008 to 15.83 at the open on October 24, 2008. After gold mining shares had completed an important peak in December 2003, a similar negative divergence between the shares and the metal led to persistent underperformance for this sector through May 2005.

We are getting a repeat of this negative divergence at the present time. No matter how many times gold bullion is capable of setting new all-time highs, GDX keeps trying and keeps failing to surpass its March 2008 peak. In my opinion, there is only one logical conclusion: precious metals and their shares are likely to dramatically disappoint over the next 12 to 18 months, just as they have done on past occasions following similar underperformance. Especially since analysts have turned nearly unanimously bullish toward this sector, it is far more likely that a significant price decline for all precious metals and their shares is about to ensue.

It is not just gold mining shares which are likely to suffer. Most global equities remain in important bear markets which began on or near January 11, 2010 for most commodity-related shares and since April 26, 2010 for most general equity indices. Some equity sectors have set new 2010 peaks and even all-time highs, including emerging-market bourses in Peru, Chile, Columbia, Thailand, Indonesia, Malaysia, Turkey, Hong Kong, and Singapore. In many of the same countries, these global equity bubbles have been accompanied by even more dangerous housing bubbles; the history of the United States, Ireland, and many other countries during the past five years demonstrates the severe economic vulnerability of any region with a housing bubble. This is because housing bubbles encourage even more leveraging and other reckless borrowing than stock-market bubbles, which will become substantial economic headwinds once these housing bubbles inevitably collapse.

Another worrisome bubble currently exists in high-yield corporate bonds worldwide, which have received such powerful investor inflows from those unhappy with microscopic money-market yields that in many cases they yield less than municipal bonds of similar duration. Any extraordinarily popular investment inevitably performs poorly, and this will not be the first-ever exception to the rule.

I have recently been selling short SLV (an exchange-traded fund of silver bullion). Selling short QQQQ, a fund of technology shares, probably also makes sense as this sector has become unusually popular just during the past few weeks. For those who prefer not to sell short, it is highly unpopular but essential to keep the vast majority of your net worth in the safest time deposits available. Return of capital--meaning not losing money--is paramount when everyone else is concerned about return on capital.

As a final thought, it is no coincidence that the movie "Wall Street" opened this past weekend. We all know what happened to the financial markets shortly after the original film was released in 1987. It's not different this time. Greed is always most popular just before the greediest are most severely punished.