Notes On Carnage In Gold And Silver

Last week I observed some very extreme sentiment from both the bulls and bears on gold and silver that was really quite striking.  On the bear side I saw one technical analyst I follow (that is usually bullish on the metals) state that he “is tired or hates gold and silver”, something I hadn’t seen him ever admit before.  A podcast I follow where they normally are bullish on gold and silver basically said there was no reason to buy gold and silver, and they didn’t see any reason why it wouldn’t keep going down.  That podcast has also basically capitulated on being bearish on the general stock market.  I saw Business Insider had an article entitled “Gold Looks Like Death” written by one of their prominent dollar bulls, basically rubbing it in the face of anyone bullish on gold or silver.

On the bear side of the metals I see very exuberant and overly confident commentary from the bears.  I see an all out attack now on dollar bears from the likes of CNBC and Business Insider who proclaim that dollar bears and gold bulls have gotten it wrong for too long now and need to give up.  In reality the gold bulls have been wrong since September 2011, but they were right from 2001 until September 2011.  The bulls have been wrong during this recent bear market in the metals but it’s still left to be seen if the secular gold bull is actually over or not.  But the bears in the metals are super confident given the fact metals have declined for 3 years now and silver recently broke support.


Looking at a long term chart of silver you can see that we are in rare oversold territory here, with the 30-day RSI only getting under 30 a couple of other times in the last 7 years.  You can see why it took so long for silver to break support too with former resistance acting as strong support for a long time.  I see a couple of different scenarios here but the bottom line is probably that silver will decline somewhat further before bottom.  It’s possible it gets into the 15s but I would be surprised if it fell much further than that.  With capitulation in the air I think it’s very close to the final bottom of this bear market.

Gold And Silver Still Better Off Than Earlier This Year

Even though this summer was a sentiment wasteland for the precious metals markets, right now feels like a close second.   After rallying strongly in August and September the metals have declined for almost 3 months now culminating in a recent smash down.  And it feels especially worse since the reaction of gold and silver to the open-ended $85 billion per month quantitative easing announcement from Ben Bernanke has been the opposite of what most would expect.

Seeing through the negativity though the situation is better off for the metals than it was 6 months ago.  During the summer, gold built a multi-month base in the $1500s which further validated that zone as being a massive support zone.  Then the surge higher off of that base has created a big positive divergence in momentum that often precedes a major move higher in price.  Even if gold were to drop back into the $1500s, the divergence in momentum should still be in place, and technicians will undoubtedly pick up on that fact if a bunch of demand comes rushing back into the gold market.

Silver looks similar to gold except the positive divergence in momentum is larger and extends back to the start of 2012.  This could be a sign of even more underlying strength in silver than in gold.  Notice that just like gold, there’s a bunch of hammer candlesticks over the last 2 years once silver breaks below a certain level.  This reinforces the supply and demand dynamics at that level (which is about $27.50 on silver) as strong support.  Buyers were able to overwhelm sellers repeatedly once those levels were attempted to be breached to the downside for both metals.

Back in 2011 I postulated that it would be hard for silver to break $25 since the entry point on that trade would be phenomenal for anyone wanting to enter a long term long position in this ongoing secular bull market.  The reason was it took silver almost three years to build a base at the $20 level and then it broke out of that base on huge volume.  So the closer silver got to $25 the better the risk/reward of the trade for someone wanting to buy a pullback, and have strong support at $20 for downside risk.  Since silver is likely still in a secular bull market that would give the trade 20% or so risk to the downside, which is pretty good considering the upside potential could be much higher.  So I assumed that $25 would be a good level of support for silver as it entered a new trading range on the correction from $50.

Mining stocks are continuing to demonstrate that they are in the later throes of this ongoing correction in the metals.  Back during the summer, almost every mining stock was trading at its lows for the year, or close to them.  Now the situation is mixed across the mining space, which indicates some underlying strength.  Some mining stocks, such as AEM and FNV, are barely off of recent highs.  Others are about at the mid range between their summer low and their September high, such as AUY, HL, and KGC.  And some mining stocks have made new lows below their summer lows.  Due to more mining stocks holding above their summer lows the GDX to GLD ratio continues to form a Stage 1 base with positive divergence in momentum.  And this continues to be significant since major rallies in gold usually are accompanied by outperformance by miners.

Looking at the short term picture, the trading on December 20th looked like possibly an important turning point or maybe the beginning of one.  It was definitely a throw in the towel day for many metals bulls (possibly a lot of weak hands) as both the GLD and SLV ETFs saw the biggest downside volume they’ve seen since March.  But looking at a daily chart, their emotional distress was causing them to dump their positions right at the upper range of support from the summer.  And the miners showed some nice strength last Thursday as almost every mining stock performed better than the metals that day.  This often happens towards the bottom of pullbacks in the metals as first the miners get dumped early in the correction, then the metals get dumped and the miners show some divergent strength.

The bottom line is there’s some short term and long term underlying strength to this recent pullback in the metals.  Even if the bears can panic the bulls into selling their positions further into support levels, the bulls still have a positive divergence in momentum that has formed over multiple months and demonstrated long term support at lower levels.  It isn’t uncommon to see the lower end of a trading range tested one last time before a new rally either.

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The views and opinions expressed are for informational purposes only, and should not be considered as investment advice.  Please see the disclaimer.

Partly Falling With A Chance Of Pain

It’s usually constructive to go over the landscape of the market and get a feel for where things are at.  Since the end of April we’ve seen the market undergo a definitive change of character.  Instead of seeing most of the market in one big rally mode that we’ve become used to since September 2010, we’re seeing corrections, non-confirmations, and trend changes across different parts of the market.

1.  U.S. Dollar has gone from a falling market to a rising market

Probably the most important change has been the V-bounce in the dollar over the past three weeks and counting.  Back in late April it looked like the dollar was about to fall off a cliff as Bernanke was making his televised speech.  With the benefit of hindsight we can see that there was enough pessimism in the dollar at that time for it to find at least a short term bottom.  The chart below is a weekly chart of UUP, which is a widely followed ETF that tracks the dollar.  A couple of things are noteworthy on this chart.  First notice how the dollar for the most has tended to trend over the past 3 years, there hasn’t been much sideways grinding action.  The countertrend rallies in the dollar have been explosive, while the primary trend down has been a slower moving affair.  Notice the big increases in volume on UUP when the dollar has staged countertrend rallies.  This increase in volume confirms the change in trend.  The TRIX has been a good trending indicator for the dollar, it crossed over to the downside in 2008 and didn’t look back even though the dollar tried to make a higher high in early 2009.  The TRIX has rolled over since the spike top in the dollar in 2010 during the Euro crisis and hasn’t made a clean break to the upside since.  If this dollar rally has staying power we should see the TRIX move back to the upside.

2.  The leadership sectors have been taken out

Silver was the market leader heading into the end of April but its parabolic move came to an end at the start of this month.  Gold has pulled back along with silver, and mining stocks have also been hit hard.  Quint Tatro likes to say that “from failed moves come fast moves” and that is exactly what happened to the mining stocks over the past two months.  A failed breakout above 600 on the HUI Gold Mining Index has produced a fast move down to the 500 level.

If you go back and look at how gold stocks have traded during June and July over the past decade you’ll see that for the most part those two months have resided in range bound periods, where the miners aren’t really going anywhere.  You’ll also see a lot of tails on monthly candlesticks, which means at some point during the month prices dipped lower but recovered by the end of the month.  This “tail risk” makes it hard to own mining stocks during this period as the volatility often shakes people out.  Due to the range bound nature of the coming months, at best gold stocks are still probably going to be locked in the same trading range they’ve been in, but don’t count out dips below the current trading range.

Not only have precious metals suffered intense damage but the commodity sector as a whole, which was basically leading the market since last September, has taken a hit.  The two major dollar rallies over the past 3 years produced the only two big corrections in commodities.  So at best if this rally in the dollar continues we should expect commodities to be range bound if they follow past precedent.

With commodities not likely to lead the market higher anytime soon the market is going to need to find new leaders if it wants to continue moving higher.

3.  Defensive sectors are stretched

Speaking of new leaders the defensive sectors in the market, Consumer Staples, Healthcare, and Utilities have been on a tear lately.  This is actually not a good sign though according to the Sector Rotation Model.  Money tends to rotate into defensive sectors when it anticipates a pullback in the markets.

4.  Financial sector is reeling

The financial sector has trended lower this year despite most of the rest of the market rallying.  As is usually the case its hard for the market to sustain a long term rally without participation from the financial sector, so this divergence is noteworthy.

6.  International markets have failed to make new highs

Some of the best performing international markets have formed a lower high recently as U.S. markets made a higher high.  At a minimum this could be a warning that a more significant correction is in store for U.S. markets, but it could be worse if the international markets continue to rollover and breakdown.

6.  Volatility is starting to perk up

The Volatility Index is starting to move up after making a multi-year low in April.  And zooming in on the index shows a inverse head and shoulders pattern that measures to around 22 if it were to play out.

Notice how the momentum on the TRIX indicator has crossed back above zero which has only happened a few times in recent history.  During big pullbacks the momentum in volatility tends to keep building until enough panic produces a bottom in the markets.

As a whole if I were making a weather forecast on the current market environment a good characterization would be “partly cloudy with a chance of rain”, or to give it more of a market characterization I’d call it “partly falling with a chance of pain”.  We’re either seeing some deterioration that has the potential to turn into something worse, or just a murky environment that will clear up with some healing in sectors that have had recent pullbacks.  Two things I’m keeping an eye on are the dollar and the volatility index.  We’ve seen impulsive moves higher in the dollar coincide with deep market pullbacks in the past.  And a break higher in the volatility index usually signals a storm on the horizon for the markets.

Silver’s New Trading Range

Silver’s destiny with its 200-day moving average appears to be sealed this week as a brief bounce earlier in the week failed at the 50-day moving average.  From peak to trough so far this correction has run about 35%, which is still less than the 37% correction silver underwent from its parabolic peak in 2006.  And the rally in 2005-2006 for silver was dwarfed by this recent run.  In 2005-2006 silver went from $6.64 to $15.21 for a 129% gain.  The 2010-2011 rally took silver from $17.22 to $49.75 for a 189% gain.  So if this recent silver parabola follows the “higher they rise, harder they fall” rule then we should see a bigger correction than 37% peak to trough.

Silver has followed a repetitive spike, crash, and consolidate pattern during this silver bull market.  The bulk of each crash lasted approximately two months, so if this crash follows the same pattern it should bottom sometime in June.  Then silver should stage a recovery rally.  The recovery rally has tended to be followed by a consolidation period, where silver just grinds sideways.  If the crash is the “scare you out” phase, then the consolidation after the recovery rally is the “wear you out” phase.  The goal of both of these phases is to recreate the wall of worry necessary to drive the next major rally.

Markets typically need time to repair the damage after a crash and that is essentially what the recovery rally and consolidation phases accomplish.  It usually takes a period of time and multiple attempts for a market to overcome the resistance created by a sharp crash.  Therefore silver investors should adjust their expectations and prepare for a sideways grind after the current crash has run its course.  Expecting silver to race back up to 50 and make new highs right away is not out of the realm of possibility, but it isn’t probable based on how markets normally behave.

Based on past precedent the new trading range for silver is likely to be from the mid-20s to the recent high right below 50.  There’s some support on the chart between 26-30 and this zone also resides underneath the 200-day moving average, so that area would likely prove tough to penetrate to the downside.

It should be interesting to see how long it takes silver to repair the damage done before it can attempt to stage a real breakout past 50.  One important thing to note about bull markets is they tend to overcome corrections quicker as the bull market becomes more mature and accelerates to the upside.  This next chart of the tech bull market shows how the market consolidated for years at a time early in the bull market, but later in the bull market it only took a matter of months to complete each consolidation period.