In my previous essay I wrote the following:

The precious metals stocks have corrected and are now at the minor support level, which is combination of a minor trend line and 50-day moving average. The drop here was rapid, but most corrections need more time to complete than just a few days. Knowing that PM stocks often correct in the zigzag (or a-b-c-) fashion, one can infer that the precious metals stocks will experience at least one more small decline. That would ideally correspond to the $30 GDX level or HUI at 250-260. (...)

Fibonacci retracement levels have so far (during this rally) proven a very good indication of where the correction will ultimately end - please take a look at the areas marked with red circles. This does not mean that this particular tool is perfect, but it seems that it is currently one of the best that we can use. For this correction, the first retracement level is just under the previously mentioned $30 level. The second one corresponds to the previous local low around the $27 level. Should the first retracement level not hold PM stocks, the second one (-50%) will most likely do.

This is exactly what happened – we had the GDX ETF just under $30 and the HUI Index at 254.95. Where do we go from here? I am long-term bullish and I am not advocating waiting with one’s long-term capital to make the final purchases of the precious metals. Short- and medium-term, however, is a different matter. It is difficult to say what the PM markets will do next, because there are several factors that need to be taken into account here and the signals are rather unclear.

Let me digress here - why do we bother with the short term? Because it is the diversification between investment AND speculation that allows us to improve our risk/reward ratio – meaning more money in the long run.

The first factor that we need to take into account while trying to estimate the most probable short-term outcome for the precious metals market is the situation on the USD market. Please take look at the following chart (charts are courtesy of www.stockcharts.com):

This rally was similar to the preceding one, so it may be a fairly good indication of where we are going to go next. We have just broken below the rising trend line, and the previous time it happened, we had a brief pullback - that may be the case also here. This is not probable enough to make us open a speculative position, but it is probable enough to make us consider taking profits off the table (we use options and options have time value, so the situation is not symmetric). The USD is generally negatively correlated with the prices of commodities (particularly precious metals).

The key word in the previous sentence is generally, as precious metals have lately traded in tune with the dollar, which some found very confusing. Does this pose a serious long-term threat to the precious metals market, because the USD is long-term bearish? I don’t think so, because:

1. This situation is not the “default mode” of the market, and will most likely change in the future.
2. Even if USD rises further temporarily, precious metals have other important fundamental factors to ensure that they will be higher in the long-run
3. We have just witnessed subtle signs that tell us that this situation may be changing.

Please take a look at the following chart for more details:

The precious metals stocks have touched their trend line, and for the last two days they have been rising along with declining dollar. If we get a small upswing in the USD and gold drops modestly, then it will be probable that we are in for another strong upleg. On the contrary, if gold continues to rise and fall along with the dollar in the coming days, this would mean that we may wait a while before this bull market resumes its upward path.

To put the current situation in the proper context, please take a look at the gold market from the long-term perspective:

From this point of view, the gold market is testing the long-term support level. We may rally directly from here, but it is also probable that we will trade sideways for a week or two, especially if the USD is to rise temporarily, and the correlation between USD and gold will turn negative again. This would most likely imply temporarily breaking the dashed support line and re-testing the solid one.

Should that take place, many technical traders will get concerned, but I believe that as long as we remain above the solid line (which currently means the $900 level), and don’t get a confirmed breakdown below that line, things will look bullish in the medium term. Again, the situation is unclear here, so I am not opening a speculative position right now.

Summing up, the precious metals could rally from here, but it seems probable that before climbing much higher, we will trade sideways for a while.

Of course the market might prove me wrong, as nobody can be right 100% of the time. Should my view on the market situation change substantially, I will send an update to the registered Users along with suggestions on how to take advantage of it. Register today to make sure you won’t miss this free, but valuable information. You’ll also gain access to the Tools section on my website. Registration is free and you may unregister anytime.

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P. Radomski