Based on the May 10th, 2013 Premium Update. Visit our archives for more.
T.S. Eliot called April "the cruelest month" in his famous poem, and without a doubt April was cruel to many gold investors. Sunshine Profits subscribers who followed ouravoided a share of the pain. Probably no one suffered more than hedge fund manager John Paulson. He is joined byhedge fund manager David Einhorn whose Greenlight fund took a big hit on its gold miners holdings. Einhorn said recently what we would consider an understatement: "We were somewhat surprised by the swift decline in the price of gold in April." If they were following fundamental valuations and analysis only, then that's not surprising. Paying attention to the breakdown below the key support level at that time provided a sell signal.
According to reports, Paulson's $700 million gold fund lost 27 percent in April due to leveraged bets on gold, when the price of the metal swooned by 17 percent over a two-week stretch. What must hurt is that the majority of the money invested in the Paulson gold fund is believed to be the billionaire's own. Regulatory filings show that at the end of last year Paulson's firm was the largest holder of the SPDR Gold ETF, with 21.8 million shares. Paulson made his fame and fortune after he made $15 billion for his firm in 2007 by betting against subprime mortgages before the housing collapse.
Paulson started his gold purchases in early 2009, betting that gold would rise due to the government money printing machines. Paulson took a $1.3 billion stake in AngloGold Ashanti Ltd. (AU) and $2.8 billion of GLD when the metal was trading around $950 an ounce. He was the biggest holder of both at the end of last year, the most recent figures available. Even with all the negative press gold is still trading more than 50 percent higher than when Paulson started investing in the metal.
To analyze if there is more pain to come for Paulson in the coming weeks let's take a look at one of the more interesting ratios there are on the precious market - mining stocks vs. gold and(charts courtesy by ).
Before we being, we would like to point out that we believe that the long-term picture for gold remains bullish, as the fundamentals remain in place. This, however, does not mean that gold can't move even lower temporarily.
The above chart (gold stocks' performance relative to gold) provides a very bearish picture. Please note that the trading channel and the next horizontal support intersect at a point much lower than where this ratio is today. Of course, the existence of a target level by itself is no indication that it will be reached; the trend has to be in place as well. The point here is that the ratio has already broken below the previous late 2008 major low and is now a bit more than 5% beneath it. This is a major breakdown and it was confirmed. The implication is that the trend is still down.
With the trend being down and accelerating and the recent breakdown being confirmed, there is a good possibility that the miners will decline significantly once again. This makes the previously mentioned target level a very important one. At this time it seems likely that the ratio will move to its 2000 low â close to the 0.135 level.
If gold stocks decline relative to gold as they did late in 2000, and gold declines to $1,300 or slightly higher, the target level for the HUI Index would coincide with a Fibonacci retracement level.
The GDX to GLD ratio chart (another way to look at the miners to gold ratio), seems to confirm that the mining stocks are clearly not leading gold higher also from the short-term point of view. Volatile back and forth daily moves have been the norm recently, and overall the situation is unchanged - still looks like a consolidation within a bigger decline and most likely is one.
Additional confirmation comes from the silver to gold chart which is an extension of our analysis from the essay on.
We see there has still been no sharp drop in the ratio, which indicates that the silver bulls are not giving up just yet (or that lots of short positions are not being opened just yet). This is something, which is usually seen in the final part of a major decline, so it seems that this decline has some time to go yet.
Summing up, the situation for metals and mining stocks remains bearish and the correction is likely still not over. If you're interested in our target levels for precious metals and would like to be informed when to get back on the long side of the market, please.
Thank you for reading. Have a great weekend and profitable week!
Przemyslaw Radomski, CFA