Briefly: in our opinion, full (300% of the regular position size) speculative short positions in junior mining stocks are justified from the risk/reward point of view at the moment of publishing this Alert.
As you may already be aware, Putin ordered his troops to enter two Ukrainian regions. Russia’s narrative is that those regions are independent, and the troops are entering as peacekeepers.
Well, it looks pretty much like what we saw at the beginning of the invasion of Crimea and then its annexation. From Russia’s point of view – if it worked once, why shouldn’t it work again?
A full-blown invasion was unlikely, but unfortunately, it seems like there might be some kind of military conflict after all.
What’s going to happen next is anyone’s guess, but it doesn’t look very encouraging at this point.
What does it change in the case of our short positions in junior mining stocks?
Absolutely nothing.
I already wrote the “why” behind the above in one of my recent replies to the question that I had received about the what-if-there-is-an-invasion scenario:
What would happen then is that PMs would be likely to rally until the conflict actually starts, then a bit more, and then they would likely continue their medium-term decline. It already happened in 2014, when Russia took over Crimea. Interestingly, it was more or less at the same time of year. By mid-Feb, the majority of the rally was over. The entire rally in gold was about $200, and the part that continued after mid-Feb. was about $50.
Thus, considering December 2021 as the starting point of this rally, gold is up by about $150 now – so the history rhymes here.
Consequently, IF (and that’s a big if) the tensions escalate and Russia takes over a part of Ukraine once again, we might be looking at “only” an extra $50 rally in gold or so and a top in mid-March – and then the medium-term slide would be likely to continue.
Since it’s much more likely to me that there will be no invasion / annexation / etc. this time, it seems that the upside is much more limited, if it exists at all. [EDIT: Now, annexation of additional regions seems much more probable, but a full-blown war still seems unlikely.] Perhaps gold simply moves back up to its 2021 high (so another $20 higher or so) and then collapses, or it might decline right away (today’s pre-market decline might be indicating that, especially in light of the triangle-vertex-based reversals).
Oh, and by the way, GDXJ actually topped in mid-Feb 2014, and then it just moved back and forth until gold topped in mid-March 2014. OK, to be precise, the GDXJ’s intraday high in March was about 3% above its mid-Feb high, and it was then followed by an immediate decline.
It seems like the worst time to be exiting short positions in junior mining stocks. Instead, it might be a perfect time to be entering or adding to them (if one doesn’t have the desired exposure yet).
The above analogy is even more important now, given the recent escalation.
Let’s see how gold futures reacted so far this week:
After a brief rally to its mid-2021 high and the 2011 high, gold declined (by 0.5% so far) despite the obvious fundamental reason (Russian troops in Ukraine) to move higher.
This is a very bearish kind of reaction.
Interestingly, at the same time, silver is up by 0.55%. Consequently, we just saw the signal that often marks the final moments of a given short-term upswing.
In today’s London trading, junior miners (the GDXJ ETF is also trading on the London Stock Exchange) are up, but only slightly so, and – unlike silver – they didn’t move to new short-term highs.
This means that they are performing just like in 2014. The tensions and uncertainties regarding Ukraine seem to have peaked or are very close to their peak (at least among gold junior mining stock investors), and the rally that was to take place based on them, is likely already behind us.
What’s next? As long as the geopolitical situation remains unclear and gold’s reaction might be to rally (analogy to 2014), decline (technical situation) or trade sideways (taking both into account), it seems that junior mining stocks’ rally is over or very close to being over.
Consequently, it seems like a great moment to be entering short positions in junior gold miners, not exiting them. It’s obvious, but still, let me say it: tops are formed when everyone wants to buy and everything favorable has already happened for a given market (and it no longer responds to it as everyone who wanted to buy is already in the market). The opposite happens in the case of bottoms. To maximize profits, one wants to exit long positions and perhaps enter short positions close to the tops – and it seems that we are at one or very close to one in the case of junior gold miners.
Having said that, let’s take a look at the markets from a more fundamental point of view.
The Big Picture
After Russian President Vladimir Putin ordered troops to enter Ukraine to “maintain peace,” the conflict escalated on Feb. 21. However, while the Russia-Ukraine saga will likely dominate the headlines in the short term and may uplift the PMs in the process, the outlook is much different over the medium term.
To explain, with inflation still elevated, Fed officials continue to sound the hawkish alarm; and with a March rate hike likely a done deal, the liquidity drain that hurt the PMs in 2021 should accelerate in 2022.
For example, Fed Governor Lael Brainard said on Feb. 18 that officials will use rate hikes and quantitative tightening (QT) to “bring down inflation over time”. “The market is aligned with that. We’ve already seen the kind of tightening facing households and businesses that is consistent with the economy’s outlook,” she added.
As a result, she expects a “series of rate increases” in the coming months.
Please see below:
Source: Bloomberg
Echoing that sentiment, Cleveland Fed President Loretta Mester said on Feb. 17 that sticky inflation may force the Fed to shift away from explicit forward guidance and instead convey an “overall trajectory of policy and give the rationale for our policy decisions.”
In a nutshell: she means that surging inflation may prevent the Fed from providing investors with “advance notice.” If the Consumer Price Index (CPI) keeps running hot, the Fed will have to react in real-time instead of telegraphing its next move.
Please see below:
Source: Reuters
On top of that, Fed Governor Michelle Bowman said on Feb. 21 that she is undecided about a 50 basis point rate hike in March:
"I, as all of my colleagues will as well, will be watching the data closely to judge the appropriate size of an increase at the March meeting.” However, she added: "I intend to support prompt and decisive action to lower inflation."
As a result:
Source: Reuters
If that wasn’t enough, New York Fed President John Williams (a major dove) conceded on Feb. 18: “I think we can steadily move up interest rates and reassess.” As a result, even the doves expect a 25 basis point rate hike in March.
Furthermore, while I warned throughout 2021 that surging inflation would elicit a hawkish shift from the Fed, officials’ overconfidence is coming back to bite them. Moreover, with Fed officials materially shifting their stance, institutional investors are also showcasing heightened anxiety.
For example, Bank of America’s latest Global Fund Survey shows that 39% of institutional investors believe inflation is permanent, while slightly more than 50% believe it’s transitory. However, in September 2021, 28% of respondents thought that inflation was permanent, and 69% thought it was transitory. As a result, institutional investors are also grappling with the change in sentiment.
Please see below:
To that point, inflation and central banks have become the most significant tail risks confronting the financial markets.
Please see below:
To explain, a “tail risk” is a low probability, high-risk event that could impair financial assets. If you analyze the chart above, you can see that inflation fears increased in February, while the risk of hawkish central banks remains in the top spot.
Furthermore, if you analyze the row labeled “Russia-Ukraine conflict,” you can see that institutional investors aren’t apprehensive about the medium-term impact on their portfolios. As a result, while the conflict has uplifted the PMs in the short term, it’s prudent to look beyond the current headlines and focus on the coming months.
For context, I wrote on Feb. 14:
With another dire warning from the White House uplifting gold and mining stocks on Feb. 11, Russia and Ukraine's 'will they or won't they' saga has shifted sentiment. However, it's important to remember that geopolitical risk rallies often have a short shelf life and dissipate over the medium term.
To explain, I wrote on Sep. 21:
When terrorists attacked the World Trade Center roughly 20 years ago, gold spiked on Sep. 11, 2001. However, it wasn’t long before the momentum fizzled and the yellow metal nearly retraced all of the gains by early December. Thus, when it comes to forecasting higher gold prices, Black Swan events are often more semblance than substance.
As further evidence, when Russia annexed Crimea from Ukraine in 2014, similar price action unfolded. For example, when rumors swirled of a possible invasion, gold rallied on the news. Then, when Russia officially invaded, the yellow metal continued its ascent. However, after the short-term sugar high wore off, bearish medium-term realities confronted gold once again. And in time, the yellow metal gave back all of the gains and sunk to a new yearly low.
Please see below:
Thus, while conflicting reports paint a conflicting portrait, the algorithms don’t care whether Russia invades Ukraine or not. With the rumor enough to pique investors’ interest, quantitative traders see it as an opportunity to capitalize on the momentum. However, once that momentum fizzles, history shows that the quants rush for the exits. As a result, is this time really different?
To that point, while the general stock market continues to suffer, the Russia-Ukraine saga has propped up the PMs. In the absence of that, gold, silver, and mining stocks would likely confront some of the pressures plaguing the NASDAQ Composite. For context, the PMs and Big Tech benefit from low real interest rates. However, the fundamental dynamic often hurts both asset classes when the outlook shifts.
Please see below:
To explain, the light blue line above tracks the NASDAQ 100, while the dark blue line above tracks the equity risk premium. If you analyze the relationship, you can see that spikes in the latter often result in drops in the former. With the Fed’s fears helping to uplift the equity risk premium in recent months, the NASDAQ 100 finally cracked.
More importantly, though, when the Fed’s rate hike cycle roiled the NASDAQ 100 in 2017-2018, the GDXJ ETF suffered too. Thus, while the Russia-Ukraine drama has provided a distraction, the fundamentals that impacted both asset classes back then are present now.
Please see below:
To explain, the green line above tracks the GDXJ ETF in 2018, while the black line above tracks the NASDAQ 100. If you analyze the performance, you can see that the Fed’s rate hike cycle initially rattled the former and the latter rolled over soon after. However, the negativity persisted until Fed Chairman Jerome Powell performed a dovish pivot and both assets rallied. As a result, with the Fed Chair unlikely to perform a dovish pivot this time around, the junior miners have some catching up to do.
Finally, while a strong U.S. economy keeps the pressure on the Fed, The Confidence Board released its Leading Economic Index (LEI) on Feb. 18. While “the U.S. LEI posted a small decline in January, as the Omicron wave, rising prices, and supply chain disruptions took their toll,” Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board, said that the bullish medium-term outlook remains intact:
“Despite this month’s decline and a deceleration in the LEI’s six-month growth rate, widespread strengths among the leading indicators still point to continued, albeit slower, economic growth into the spring. However, labor shortages, inflation, and the potential of new COVID-19 variants pose risks to growth in the near term.
“The Conference Board forecasts GDP growth for Q1 to slow somewhat from the very rapid pace of Q4 2021. Still, the US economy is projected to expand by a robust 3.5 percent year-over-year in 2022 – well above the pre-pandemic growth rate, which averaged around 2 percent.”
Please see below:
The bottom line? While the Russia-Ukraine saga may continue to drive the short-term narrative, history shows that bullish sentiment doesn't last over the medium term. Moreover, with the Fed even more hawkish than in 2021, geopolitical factors have distracted the PMs from the more important fundamental development. As a result, the 'big picture' signals that their medium-term prospects are profoundly bearish.
In conclusion, the PMs were mixed on Feb. 18, as positive and negative developments in the Russia-Ukraine conflict continue to shape sentiment. However, while the short term is difficult to predict in geopolitics, the medium-term implications for the precious metals market remain intact: the Fed is hawked up, and tighter monetary policy supports a stronger USD Index and higher U.S. real yields. With the PMs often moving inversely to their main fundamental adversaries, this time shouldn't be any different. Also, this week’s weak reaction to what’s happening in Ukraine suggests that the precious metals sector is not far from its top.
Overview of the Upcoming Part of the Decline
- It seems to me that the corrective upswing is now over or very close to being over , and that gold, silver, and mining stocks are now likely to continue their medium-term decline.
- It seems that the first (bigger) stop for gold will be close to its previous 2021 lows, slightly below $1,700. Then it will likely correct a bit, but it’s unclear if I want to exit or reverse the current short position based on that – it depends on the number and the nature of the bullish indications that we get at that time.
- After the above-mentioned correction, we’re likely to see a powerful slide, perhaps close to the 2020 low ($1,450 - $1,500).
- If we see a situation where miners slide in a meaningful and volatile way while silver doesn’t (it just declines moderately), I plan to – once again – switch from short positions in miners to short positions in silver. At this time, it’s too early to say at what price levels this could take place, and if we get this kind of opportunity at all – perhaps with gold close to $1,600.
- I plan to exit all remaining short positions once gold shows substantial strength relative to the USD Index while the latter is still rallying. This may be the case with gold close to $1,350 - $1,400. I expect silver to fall the hardest in the final part of the move. This moment (when gold performs very strongly against the rallying USD and miners are strong relative to gold after its substantial decline) is likely to be the best entry point for long-term investments, in my view. This can also happen with gold close to $1,375, but at the moment it’s too early to say with certainty.
- As a confirmation for the above, I will use the (upcoming or perhaps we have already seen it?) top in the general stock market as the starting point for the three-month countdown. The reason is that after the 1929 top, gold miners declined for about three months after the general stock market started to slide. We also saw some confirmations of this theory based on the analogy to 2008. All in all, the precious metals sector is likely to bottom about three months after the general stock market tops.
- The above is based on the information available today, and it might change in the following days/weeks.
You will find my general overview of the outlook for gold on the chart below:
Please note that the above timing details are relatively broad and “for general overview only” – so that you know more or less what I think and how volatile I think the moves are likely to be – on an approximate basis. These time targets are not binding or clear enough for me to think that they should be used for purchasing options, warrants or similar instruments.
Summary
Summing up, it seems to me that the corrective upswing in junior mining stocks is over, or that we won’t have to wait too long for it to be over. The situation in case of gold and silver is not as clear especially due to gold’s tendency to react to geopolitical news in the very short term. Any additional rallies here are not likely to last, though.
Moreover, let’s keep in mind that there are triangle-vertex-based reversals in mid- and late-February, so even if we see more back-and-forth trading soon, it’s likely that the decline resumes later this month.
I continue to think that junior mining stocks are currently likely to decline the most out of all the parts of the precious metals sector.
From the medium-term point of view, the two key long-term factors remain the analogy to 2013 in gold and the broad head and shoulders pattern in the HUI Index. They both suggest much lower prices ahead.
It seems that our profits from the short positions are going to become truly epic in the coming months.
After the sell-off (that takes gold to about $1,350 - $1,500), I expect the precious metals to rally significantly. The final part of the decline might take as little as 1-5 weeks, so it's important to stay alert to any changes.
Most importantly, please stay healthy and safe. We made a lot of money last March and this March, and it seems that we’re about to make much more on the upcoming decline, but you have to be healthy to enjoy the results.
As always, we'll keep you - our subscribers - informed.
To summarize:
Trading capital (supplementary part of the portfolio; our opinion): Full speculative short positions (300% of the full position) in junior mining stocks are justified from the risk to reward point of view with the following binding exit profit-take price levels:
Mining stocks (price levels for the GDXJ ETF): binding profit-take exit price: $34.63; stop-loss: none (the volatility is too big to justify a stop-loss order in case of this particular trade)
Alternatively, if one seeks leverage, we’re providing the binding profit-take levels for the JDST (2x leveraged) and GDXD (3x leveraged – which is not suggested for most traders/investors due to the significant leverage). The binding profit-take level for the JDST: $14.98; stop-loss for the JDST: none (the volatility is too big to justify a SL order in case of this particular trade); binding profit-take level for the GDXD: $25.48; stop-loss for the GDXD: none (the volatility is too big to justify a SL order in case of this particular trade).
For-your-information targets (our opinion; we continue to think that mining stocks are the preferred way of taking advantage of the upcoming price move, but if for whatever reason one wants / has to use silver or gold for this trade, we are providing the details anyway.):
Silver futures downside profit-take exit price: $19.12
SLV profit-take exit price: $17.72
ZSL profit-take exit price: $38.28
Gold futures downside profit-take exit price: $1,683
HGD.TO – alternative (Canadian) inverse 2x leveraged gold stocks ETF – the upside profit-take exit price: $11.79
HZD.TO – alternative (Canadian) inverse 2x leveraged silver ETF – the upside profit-take exit price: $29.48
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 we describe the situation for the day that the alert is posted in the trading section. In other words, if 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 to decide whether keeping a position on a given day is in tune with your approach (some moves are too small for medium-term traders, and some might appear too big for day-traders).
Additionally, 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: UGL, GLL, AGQ, ZSL, 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" (GLL for instance), but not for the "main instrument" (gold in this case), we will view positions in both gold and GLL as still open and the stop-loss for GLL would have to be moved lower. On the other hand, if gold moves to a stop-loss level but GLL doesn't, then we will view both positions (in gold and GLL) 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 daily 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. Furthermore, 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.
Thank you.
Przemyslaw Radomski, CFA
Founder, Editor-in-chief
