Briefly: in our opinion, small (50% of the regular size of the position) speculative long position in gold, silver, and mining stocks are justified from the risk/reward point of view at the moment of publishing this Alert.
In Friday's article, we wrote that what comes up must co..rrect and gold has indeed shown to be in a corrective mode. We also wrote that the yellow metal was unlikely to break below the 61.8% Fibonacci retracement based on the previous upswing and while gold moved to this level earlier today, it didn't break below it. At least not in any significant way - the few cents below this level doesn't really count. Let's take a closer look at gold's overnight chart to see what the decline means.
In short, it doesn't mean much. All markets, including gold, quite often correct in a zigzag fashion, and they relatively often correct between 38.2% and 61.8% of the preceding move before continuing their previous move. That's exactly what is happenning in gold.
Gold moved to the 61.8% Fibonacci retracement level based on the preceding upswing and it moved there in a zig-zag style. Gold reversed after reaching the retracement, so the bottom might be in and the yellow metal could be ready to resume its upswing shortly. If gold confirms the breakdown below the 61.8% Fibonacci retracement level ($1457), the bullish forecast for gold for the short-term might change, but that's not the case so far.
Besides, the short-term correction in the USD Index that's likely to contribute to higher gold, silver, and mining stock values in the short run is not over just yet.
Is the USD Index Done Declining?
The breakdown below the very short-term rising wedge pattern resulted in a major decline. "Major" from the very short-term point of view as the following daily downswing has been the biggest daily decline that we saw this month. After the initial decline, the move lower continued and the USDX closed the week below its 50-day moving average. The 50-day MA has been providing support quite reliably in the previous months. It was not always strong support, but often meaningful enough to make it useful as a trading tool. While it stopped the decline on Thursday, the USDX broke below it overall.
The above breakdown opened the way to even lower USDX values.
The green and blue dashed lines represent declines that are similar to the October decline. The rallies that followed them were quite sharp, but they too had smaller pauses within them. Both: March-April, and July rallies consolidated after the USDX moved above its 50-day moving average.
The short-term decline that we saw so far doesn't compare to what we saw in early April and in mid-June. Consequently, the odds are that the USD Index will decline some more before soaring to new highs.
This means that gold is likely to move higher before plunging. Consequently, the odds are that reports of gold turning bearish for the short run are premature.
Also, let's keep in mind that this decline is taking place after both gold and silver invalidated their previous breakdowns in terms of daily closing prices.
Precious Metals Short-Term
On Thursday, both precious metals closed slightly (but still) above their lowest closing prices of September. Silver didn't move back above the rising red support/resistance line, but the breakdown below the previous low was invalidated.
The resistance provided by the lows is a good reason why gold and silver corrected on Friday and earlier today. But, just as the decline in the USDX doesn't seem to be over, the rally in gold and silver seems to have more upside.
And the mining stocks?
Looking at miners' performance in one way provides us with bearish implications for the day, but looking from a different angle shows the silver lining.
The bearish case is based on the shape of the last three sessions. They look like an island top that formed right after the bullish reversal. Gold is down in today's pre-market session, so gold stocks are likely to decline today as well, in tune with implications of the above-mentioned top formation.
On the other hand, such a daily comeback close to the start of the rally is exactly what happened about a month ago, and it was a relatively normal part of the upswing. The similarity may not be obvious at first sight, but please note the three intraday attempts to reach more than about half of the preceding downswing. In the following days, the HUI Index continued to rally, but not without a daily decline first.
The positions of Stochastic and RSI indicators confirm the similarity between these two cases.
All in all, even though gold moved lower today, it doesn't mean that the short-term rally is already over.
The emphasis goes on the short-term. As far as the following months are concerned, we have little doubt that the precious metals sector is headed much lower in the next year or so.
Why would gold and the rest of the precious metals sector decline for the next year? Because of the tendency for history to repeat itself to a considerable degree. There are quite a few ways to look at the most recent developments and we will discuss the two key links today. Actually, we are going to go over them again, as we first time covered them in the previous weeks and months, and have been linking to them in all recent Alerts just before the summaries.
The analogy that provides us with the yearly time forecast is the one present in gold stocks (that's the last bullet point of the "critical factors" part of the Key Factors section below).
The Key Analogies
We analyzed this chart thoroughly last month (we strongly encourage you to read that analysis if you haven't done so already), so we don't want to go into details from scratch in today's analysis, but the long-story-short version is that if we're about to see the final part of the prolonged multi-year decline in gold miners, then it's quite likely to take place in a way that's similar to how it happened in the previous similar case.
And this previous case took place started in late 1999 and ended in late 2000. The similarity in terms of time that the final pre-slide rally took, what preceded it and in what way, is uncanny. Again, the details are available in the previous analyses, but if you're short on time, please focus on the yellow rectangles that we put on the above chart in 1999 / 2000 and the two recent ones. They are identical.
The more similar two cases are, the more likely it is that the similarity will continue and that we would see a repeat of what had happened. Back then, gold miners declined for about a year, and the decline ended in Q4 of 2000. Applying the same learning to the current situation provides us with Q4 of 2020 as the likely bottoming time target.
If you're new to our analyses, you'd likely ask why would this be the beginning of the final slide in the precious metals market. The reply is based on yet another analogy. And more precisely, it's based on a series of analogies that confirm each other extremely well.
This is the article in which we described what's happening in the USD Index, why it's happening and what it means for gold. The long-story-short version is that the USD Index is after a massive long-term breakout that was more than confirmed, which means that it's starting a major rally. Major rallies in the USDX imply major declines for gold.
There were two cases in the previous decades when the USDX was about to launch a massive rally: in 1980 and approximately in 1996. Out of these two cases, the second one is much more similar to what we saw recently in gold, while the 1980 one is similar to what we saw in 2011 (parabolic upswing in gold and a spike top). In fact (as the above link shows in detail), there is even a significant similarity in shape of gold price movement between what we saw in 2011 and now, and in the way gold behaved in the late 80s and mid-90s.
Moreover, the similarity extends to silver and gold mining stocks, which makes the follow-up action even more likely.
If the August 2019 top was just like the 1996 top in gold, it means that we're about to witness months of lower prices. Based on this analogy alone, it could be the case that gold declines for longer than just one year. Based on the positive fundamentals however, it seems that the previous analogy in gold stocks might be more useful in terms of predicting the end of the decline in terms of time.
Now, after this lengthy introduction, let's move to what's so interesting right now. The open interest for gold - i.e. the number of positions that are opened in case of gold futures.
The open interest is currently at the record high and this has profound implications, because it is very rarely when the open interest is at such levels, and because it's yet another way of measuring similarity between what we see right now and what happened previously.
Let's take a look at the charts for details. We apologize for providing the data on separate charts - we didn't want to postpone providing this analysis to you and aggregating all the data into one chart would take some time.
The above chart shows what happened in the open interest for gold at the 1980 tops and what happened in 1993 (initial top), and 1996 (final top before the slide).
The key take-away is that the open interest at the final pre-slide top was very high - even higher than what we saw during the initial top.
Something similar happened in 1979 and 1980. The more dramatic top (THE top) was accompanied by smaller open interest than the second top. However, it was the second top that started the most important gold decline of the 80s.
Let's see what happened in the following years.
Gold's open interest spiked in 2008, preceding one of the biggest declines of the past decades (especially in silver and mining stocks). It then declined and soared once again before the 2011 spike top. Zooming in on the previous chart shows that open interest spiked right before and not at the 1980 high as well - so the above is relatively normal in case of parabolic upswings.
And what happened next? There was no major action in the open interest until 2016.
As gold rallied in 2016, the open interest soared to very high levels - it spiked above 600k. That was similar to what happened in 2008 and soon before the 2011 top. The 2016 rally was sizable, but it was not a parabolic upswing, so the gold price top formed along with the open interest top.
And now - gold's open interest climbed to over 700k and this is by no means a parabolic upswing. Gold ended its sharp rally in August and it's now moving back and forth in a relatively regular manner.
Since the open interest in gold is extremely high and that's what has been indicating major medium-term (or long-term) selling opportunities, it serves as a perfect confirmation of all the bearish points that we've been making with regard to the medium term in the previous weeks and months.
Moreover - and that's really the most important thing - the above is a perfect confirmation of the analogy to what happened in 1996.
Just as the open interest in 1996 was even bigger than what accompanied the initial 1993 top, the current open interest is even bigger than what we saw during the 2016 high.
This means that the current price action is extremely likely the final part of the prolonged medium-term top and will be followed by a major multi-month decline in gold, similar to what we saw in late 2016, but more similar to what we saw in 1996, as the USD Index - being after a confirmed, long-term breakout - is starting its next massive upswing.
There's a record number of futures contracts that can be closed down as investors and traders panic and get out of the market, and the potential for making money thanks to the upcoming decline in the PMs is enormous.
As far as the next several days are concerned, though, the outlook remains bullish, but let's keep in mind that this rally is an exception, and not the rule.
Naturally, the key bearish factors for the medium term remain intact - the outlook became bullish only for the short term.
Key Factors to Keep in Mind
- The USD Index broke above the very long-term resistance line and verified the breakout above it. Its huge upswing is already underway.
- The USD's long-term upswing is an extremely important and bearish factor for gold. There were only two similar cases in the past few decades, when USD Index was starting profound, long-term bull markets, and they were both accompanied by huge declines in gold and the rest of the precious metals market
- Out of these two similar cases, only one is very similar - the case when gold topped in February 1996. The similarity extends beyond gold's about a yearly delay in reaction to the USD's rally. Also the shape of gold price moves prior to the 1996 high and what we saw in the last couple of years is very similar, which confirm the analysis of the gold-USD link and the above-mentioned implications of USD Index's long-term breakout.
- The similarity between now and 1996 extends to silver and mining stocks - in other words, it goes beyond USD, gold-USD link, and gold itself. The white metal and its miners appear to be in a similar position as well, and the implications are particularly bearish for the miners. After their 1996 top, they erased more than 2/3rds of their prices.
- Many investors got excited by the gold-is-soaring theme in the last few months, but looking beyond the short-term moves, reveals that most of the precious metals sector didn't show substantial strength that would be really visible from the long-term perspective. Gold doesn't appear to be starting a new bull market here, but rather to be an exception from the rule.
- Gold stocks appear to be repeating their performance from 20 years ago, which means that a bottom in the entire precious metals sector is quite likely to form at much lower prices, in about a year
Very important, but not as critical factors:
- Long-term technical signs for silver, i.a. the analogy in terms of price to what we saw in 2008, shows that silver could slide even below $10.
- Silver's very long-term cycles point to a major reversal taking place right now and since the most recent move was up, the implications are bearish (this is also silver's technical sign, but it's so important that it deserves its own point)
- Long-term technical signs for gold stocks point to this not being a new gold bull market beginning. Among others, it's their long-term underperformance relative to gold that hint this is rather a corrective upswing within a bear market that is not over yet.
- Record-breaking weekly volume in gold is a strong sign pointing to lower gold prices
- Extreme volume reading in the SIL ETF (proxy for silver stocks) is an effective indication that lower values of silver miners are to be expected
- Silver's short-term outperformance of gold, and gold stocks' short-term underperformance of gold both confirm that the precious metals sector is topping here
- Gold topped almost right at its cyclical turning point, which makes the trend reversal more likely
- Copper broke below its head-and-shoulders pattern and confirmed the breakdown. The last time we saw something similar was in April 2013, when the entire precious metals sector was on the verge of plunging lower.
Moreover, please note that while there may be a recession threat, it doesn't mean that gold has to rally immediately. Both: recession and gold's multi-year rally could be many months away - comparing what happened to bond yields in the 90s confirms that.
Summing up, the outlook for the precious metals sector remains very bearish for the following months (also because of the record open interest in gold), but it seems that we will first see a short-term upswing before the decline continues. Based on what we saw in the last two days, the bullish outlook remains justified. Friday's decline and today's pre-market action seem to be just a quick correction within a short-term rally. We expect to close the current long position relatively soon and open another short position at that time - so that we're once again positioned to gain from the main trend, which remains down. We expect to close the long position within the next 1-3 weeks, but it might be sooner, for instance should we see a sharp rally and a reversal shortly.
As always, we'll keep you - our subscribers - informed.
Trading capital (supplementary part of the portfolio; our opinion): Small speculative long position (50% of the full position) in gold, silver, and mining stocks is justified from the risk/reward perspective with the following stop-loss orders and binding exit profit-take price levels:
- Gold: profit-take exit price: $1,489.80; stop-loss: $1,437; initial target price for the UGLD ETN: $135.88; stop-loss for the UGLD ETN: $122.10
- Silver: profit-take exit price: $17.47; stop-loss: $16.27; initial target price for the USLV ETN: $89.33; stop-loss for the USLV ETN: $72.44
- Mining stocks (price levels for the GDX ETF): profit-take exit price: $27.88; stop-loss: $25.47; initial target price for the NUGT ETF: $30.27; stop-loss for the NUGT ETF $23.08
In case one wants to bet on junior mining stocks' prices, here are the stop-loss details and target prices:
- GDXJ ETF: profit-take exit price: $39.27; stop-loss: $35.38
- JNUG ETF: profit-take exit price: $67.97; stop-loss: $49.83
Long-term capital (core part of the portfolio; our opinion): No positions (in other words: cash)
Insurance capital (core part of the portfolio; our opinion): Full position
Whether you already subscribed or not, we encourage you to find out how to make the most of our alerts and read our replies to the most common alert-and-gold-trading-related-questions.
Please note that the in the trading section we describe the situation for the day that the alert is posted. In other words, it we are writing about a speculative position, it means that it is up-to-date on the day it was posted. We are also featuring the initial target prices, so that you can decide whether keeping a position on a given day is something that is in tune with your approach (some moves are too small for medium-term traders and some might appear too big for day-traders).
Plus, you might want to read why our stop-loss orders are usually relatively far from the current price.
Please note that a full position doesn't mean using all of the capital for a given trade. You will find details on our thoughts on gold portfolio structuring in the Key Insights section on our website.
As a reminder - "initial target price" means exactly that - an "initial" one, it's not a price level at which we suggest closing positions. If this becomes the case (like it did in the previous trade) we will refer to these levels as levels of exit orders (exactly as we've done previously). Stop-loss levels, however, are naturally not "initial", but something that, in our opinion, might be entered as an order.
Since it is impossible to synchronize target prices and stop-loss levels for all the ETFs and ETNs with the main markets that we provide these levels for (gold, silver and mining stocks - the GDX ETF), the stop-loss levels and target prices for other ETNs and ETF (among other: UGLD, DGLD, USLV, DSLV, NUGT, DUST, JNUG, JDST) are provided as supplementary, and not as "final". This means that if a stop-loss or a target level is reached for any of the "additional instruments" (DGLD for instance), but not for the "main instrument" (gold in this case), we will view positions in both gold and DGLD as still open and the stop-loss for DGLD would have to be moved lower. On the other hand, if gold moves to a stop-loss level but DGLD doesn't, then we will view both positions (in gold and DGLD) as closed. In other words, since it's not possible to be 100% certain that each related instrument moves to a given level when the underlying instrument does, we can't provide levels that would be binding. The levels that we do provide are our best estimate of the levels that will correspond to the levels in the underlying assets, but it will be the underlying assets that one will need to focus on regarding the signs pointing to closing a given position or keeping it open. We might adjust the levels in the "additional instruments" without adjusting the levels in the "main instruments", which will simply mean that we have improved our estimation of these levels, not that we changed our outlook on the markets. We are already working on a tool that would update these levels on a daily basis for the most popular ETFs, ETNs and individual mining stocks.
Our preferred ways to invest in and to trade gold along with the reasoning can be found in the how to buy gold section. Additionally, our preferred ETFs and ETNs can be found in our Gold & Silver ETF Ranking.
As a reminder, Gold & Silver Trading Alerts are posted before or on each trading day (we usually post them before the opening bell, but we don't promise doing that each day). If there's anything urgent, we will send you an additional small alert before posting the main one.
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Przemyslaw Radomski, CFA
Editor-in-chief, Gold & Silver Fund Manager