Cup in a Cup

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Briefly: In our opinion, full (150% of the regular full position) speculative short positions in gold, silver and mining stocks are justified from the risk/reward perspective at the moment of publishing this alert.

In recent alerts we’ve discussed the issues that are generally unknown to most of the investors (and in many cases, also to professionals) and today’s issue will not be different. One of the ratios that’s important for the long run is currently in a particularly interesting position – it formed a cup and handle pattern in which the handle is by itself yet another small cup and handle pattern. We are now in the “small handle” which means that a big move is likely to follow. How will gold react?

This introduction is about the Dow to gold ratio, which does not always reflect the short-term trends, but is very useful in case of determining the bigger price swings. Let’s take a closer look at the charts (chart courtesy of http://stockcharts.com).

INDU:GOLD - Dow to gold ratio chart

The cup and handle pattern is a bullish formation that is often followed by significant price moves to the upside. For instance, we saw it in gold from late 1999 to June 2002 (cup) and then to November 2002 (handle) and a major rally followed – in fact, that was how the entire bull market started.

Moving back to the above chart, the main cup formed from 2008 to 2015 and the handle has been forming since 2015. Interestingly, the ratio created a smaller cup in the first part of the handle. The ratio is now forming the final part of the big handle which is also the handle of the smaller cup. The bullish implications are stronger than they would be in case of only one formation as they now confirm each other.

With the ratio likely to move higher, gold is likely to move down as it’s in the denominator of the ratio. Since the ratio has medium-term implications, it’s likely that gold will go down in the medium term.

As far as the short term is concerned, gold and silver are depreciating slowly, but the pace of the decline is bigger in the case of mining stocks.

GDX - Market Vectors Gold Miners - Gold mining stocks

Two days ago, we commented on the HUI Index in the following way:

In the case of gold stocks, we finally have something clearer to report on. Namely, the decline showed that miners are underperforming gold once again. Yesterday’s decline alone was enough to push the HUI Index below the August 28 close. Gold is more or less halfway there (taking into account the move from the recent high to the August 28 close). The miners’ underperformance is something that we often see before and during bigger declines, so it seems likely that what we saw yesterday is just the beginning. The sell signals from Stochastic and RSI seem to confirm it.

Based on yesterday’s decline and yet another example of underperformance, we can say that the same – a close below the August 28 close – is the case with the GDX ETF. Moreover, the past 3 days showed that the price-volume link is bearish – miners are declining on relatively high volume and are moving up on relatively low volume.

However, the key issue has not yet improved dramatically.

Short-term US Dollar price chart - USD

The USD Index – because that’s the mentioned key issue – moved higher, but not yet above the short-term declining resistance line. On Tuesday, we wrote the following:

The USD Index moved visibly higher yesterday and it doesn’t take much strength for the USD to invalidate the mentioned breakdowns. The key levels (weekly closing prices) that should be invalidated are: 91.66, 92.04, 92.22, 92.28, and 93.03. Yesterday’s close of 91.85 means that if the USD closed the week without any changes, it would already invalidate the lowest of the above levels. It’s something, but it doesn’t seem enough to convince most traders about the start of a new major rally in the USD. While the USD Index hasn’t rallied enough yet, it seems that it will rally enough shortly – its ridiculously oversold not only on a short-term, but also on a medium-term basis and it declined in a parabolic fashion – that’s not sustainable. Once we see the USD visibly above 93 (say, a close at 93.5), a much bigger rally is likely to follow.

We are now much closer to the end of the week and the situation improved – the USD Index closed yesterday’s session at 92.51, which is above 4 out of 5 above-mentioned key support/resistance levels. The declining short-term resistance line is just around the corner. If the USD Index manages to rally above 93.03 and close the week above it, we will see an invalidation of the previous weekly breakdown and a breakout above the short-term resistance line. The former will be a strong buy signal from the medium-term point of view, and the latter will be a strong buy signal from the short-term point of view.

Consequently, another upswing in the USD and a close above 93.03 (preferably visibly above it) would have profound bullish implications on the value of the index and bearish implications for the precious metals market.

Summing up, mining stocks continue to show weakness by declining on relatively high volume and declining relative to gold, which has bearish implications and at the same time, the medium-term implications of the double cup-and-handle pattern in the Dow to gold ratio support a big move to the downside in the PM sector. Let’s keep in mind that the interest in gold seems to have spiked recently, along with Google searches for the phrase “gold trading”, gold’s volume (both daily, weekly, and monthly) and with the price of gold itself. It seems that the rally in gold is finally over and the USD’s close visibly above 93 and gold’s close below $1,310 and $1,300 will serve as a confirmation.

As always, we will keep you – our subscribers – informed.

To summarize:

Trading capital (supplementary part of the portfolio; our opinion): Short positions (150% of the full position) in gold, silver and mining stocks are justified from the risk/reward perspective with the following stop-loss orders and initial target price levels / profit-take orders:

Gold: initial target price level: $1,063; stop-loss: $1,366; initial target price for the DGLD ETN: $81.88; stop-loss for the DGLD ETN $38.74
Silver: initial target price: $13.12; stop-loss: $19.22; initial target price for the DSLV ETN: $46.18; stop-loss for the DSLV ETN $17.93
Mining stocks (price levels for the GDX ETF): initial target price: $9.34; stop-loss: $26.34; initial target price for the DUST ETF: $143.56; stop-loss for the DUST ETF $21.37

In case one wants to bet on junior mining stocks' prices (we do not suggest doing so – we think senior mining stocks are more predictable in the case of short-term trades – if one wants to do it anyway, we provide the details), here are the stop-loss details and initial target prices:

GDXJ ETF: initial target price: $14.13; stop-loss: $45.31
JDST ETF: initial target price: $417.04; stop-loss: $43.12

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

Important Details for New Subscribers

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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