Gold stocks breakout!

—Short covering rally could be imminent, John Hathaway

Yesterday’s continuation of Tuesday’s record high close in the Gold BUGS Index (HUI) has gold traders speculating whether the big rally in gold shares is finally near.

The Gold BUGS Index, which stands for Basket of Un-hedged Gold Stocks, closed at a record high of 597.14 on Wednesday from its previous record high of 576.48 set on Dec. 7, 2010.

As gold traded within a relatively tight range of $1,306.00 and $1,444.40 set on Sept. 29, 2010, and March 7, 2011, respectively, a significant number of gold stock traders remained convinced that gold’s rally would stall for a while, then correct.

Fears of another trigger for a “risk-off” event from growing uncertainties in the Middle East, the protracted European debt crisis, unresolved U.S. budget woes, then, black swan events in Japan, oil and commodities prices, or the steady accumulation of all those episodes would finally crack the equities market’s winning streak.

“Gold shares have been hesitant, acting as if gold didn’t belong at $1,440; and now that gold seems to want to stay there I think people have to revise their expectations for the gold stocks,” John Hathaway, director and general partner of Tocqueville Asset Management, told King World News on Tuesday.

Hathaway’s view of the gold stocks sector is consistent with larger marquis name hedge fund managers John Paulson, George Soros and David Einhorn, who presently hold significant amounts of gold shares among their top picks, according to SEC documents.

But many lesser-known hedge fund managers hold insignificant portions of gold shares, if at all.  In fact, hedge fund managers as a group have taken outright short positions on the gold miners while simultaneously taking long positions in the world’s preeminent monetary metal—a net bet that gold shares will underperform the metal on the way up, or down.  That could change dramatically, according to Hathaway.

“I just see three, four, five percent moves in some of the big cap stocks, not the little ones,” he said, “and that’s a sign of money coming in either to cover shorts or to initiate positions on a breakout.”

Since the start of the gold rally in 1999, gold stocks had outperformed the metal (HUI/Gold ratio) until Jan. 2004.  Since the start of 2004, however, the ratio dropped until May of 2005, at which time the ratio began to rise again.  But as the HUI/Gold ratio neared the Jan. 2004 high in Feb. 2006, the ratio again declined and has not come close to an assault on the Jan. 2004 high since.

Today, the ratio is 0.409 (above the 50-day and 200-day moving averages), down 35% from the Jan. 2004 high of approximately 0.625.

However, the gold stocks may soon have their day in the sun as the HUI achieves a new high, and will soon burn those hedge funds on the wrong side of the gold stocks trade, said Hathaway.

“I keep breadth on my screen and I think it was a 9-to-1 upside day which is very, very good.  You know there was nothing wishy washy about this at all so yeah, I think these hedge funds are going to get roasted.”

3 Gold Stocks on the Move

Goldcorp Inc. (NYSE: GG)

Barrick Gold Corp. (NYSE: ABX)

Yamana Gold Inc. (NYSE: AUY)

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