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.

Yesterday’s rally was likely triggered by the fundamental news, so let’s start with it, before moving to the technical part of today’s analysis.

The Battle and the War

While I’ve been warning for months that the Fed is materially behind the inflation curve, the floodgates officially opened on Nov. 10.

For context, I wrote on Oct. 21:

The Commodity Producer Price Index (PPI) is a reliable leading indicator of the following month’s headline Consumer Price Index (CPI). And if the former stays flat for the next three months (which is unlikely) – referencing releases in November 2021, December 2021 and January 2022 – the readings will still imply year-over-year (YoY) percentage increases in the headline CPI in the 4.75% to 5.50% range.

Furthermore, this is an extremely conservative forecast since the commodity PPI has increased month-over-month (MoM) for the last 17 months. Thus, it’s more likely that the headline CPI rises above 6% YoY than it falls below 5% YoY.

And while the forecast came to fruition slightly sooner than expected, the headline CPI surged by 6.2% YoY in October – the highest YoY percentage increase since 1990.

Please see below:

However, inflation is merely an appetizer in our fundamental thesis: the main course is how will surging inflation impact the Fed? And in turn, how will the Fed’s reaction function impact the PMs?

Well, there seems to be a misnomer that with U.S. debt levels near their all-time highs, the Fed can’t raise interest rates. As a result, nirvana should confront the PMs, as surging inflation, a weaker U.S. dollar and historically low interest rates combine to create a Goldilocks environment for gold, silver, and mining stocks. For context, the U.S. federal debt as a percentage of GDP is still north of 125%.

Please see below:

However, the important thing to remember is that real interest rates are near their all-time lows and nominal interest rates are less important. To explain, if the U.S. 10-Year Treasury yield rose to 3%, 4% or 5%, it really doesn’t matter as long as 10-year inflation expectations rise along with it.

For example, if an individual borrows $100 at 3% interest per year and inflation is running at 4% per year, the value of the individual’s asset should rise with the inflation rate (theoretically, holding all else constant). And while the individual still pays $3 in interest per year, the value of the asset is increasing by $4 per year. Thus, borrowing the money results in a net-gain of $1 per year. And while this is a simplified example, the reality is that real interest rates are historically low, and a small rise is unlikely to cause a calamity.

For one, even during the taper tantrum in 2013, the U.S. 10-Year Treasury yield surged from 1.66% to 3.02% and the U.S. 10-Year real yield surged from -0.74% to 0.92%. And while we expect a much more modest rise this time around, the U.S. economy didn’t crater. Economic growth forged on, and the U.S. unemployment rate declined from north of 7% to less than 4% over the next six years.

More importantly, though, the U.S. 10-Year real yield was either above or near 0% from 2014 until 2020 (when COVID-19 struck). And with the metric now south of -1.10% – and it hit an all-time low of -1.19% in August – the path of least resistance is higher, not lower. As a result, a rally back to the 2021 high of -0.56% remains more likely than a plunge below -1.75%.

Conversely, the Eurozone is a different story. With the bloc comprised of 19 countries, the hot-and-cold nature of different economies creates policy headwinds. In all fairness to ECB President Christine Lagarde, she has to conduct monetary policy with several countries in mind. For example, if Germany’s economy is hot and Italy’s economy is cold (hypothetically), she can’t tighten and ease monetary policy at the same time. Thus, she has to lean dovish and balance competing interests.

In stark contrast, Fed Chairman Jerome Powell only has to worry about the U.S. And with inflation surging alongside strong U.S. economic growth, falling U.S. unemployment and real interest rates that are near their all-time lows, the FOMC can tighten without crashing the U.S. economy.

As evidence, let’s compare the PMs’ competing fundamental interests: on the one hand, the recent decline of the U.S. 10-Year real yield has helped underwrite gold’s recent rally.

Please see below:

To explain, the gold line above tracks the London Bullion Market Association (LBMA) Gold Price, while the red line above tracks the inverted U.S. 10-Year real yield. For context, inverted means that the latter’s scale is flipped upside down and that a rising red line represents a falling U.S. 10-Year real yield, while a falling red line represents a rising U.S. 10-Year real yield.

If you analyze the 2021 relationship, you can see that gold often overshoots and undershoots the U.S. 10-Year real yield. However, if you focus your attention on the right side of the chart, you can see that the recent U-turn in the latter has helped uplift the former.

However, if you turn to the price action in March, you can see that when the U.S. 10-Year real yield rose to a 2021 high of -0.56% (the lowest point of the red line), gold hit a 2021 low. And with the metric south of -1.10% and the Fed in the midst of its tightening cycle, the U.S. 10-Year real yield should move higher over the medium term, not lower.

To that point, let’s analyze the behavior of the U.S. dollar. With the EUR/USD falling to a new 2021 low on Nov. 10 and the USD Index rising to a new 2021 high, do currency investors expect the Fed to let inflation run rampant and crash the dollar?

Of course not. The USD Index’s fundamental rally is built on the thesis that surging inflation will force the Fed to raise interest rates sooner than expected.

As evidence:

Source: CNBC

For context, futures traders previously expected a rate hike in September 2022. Now, that forecast has been pulled forward to July 2022. To that point, I wrote on Oct. 26:

Originally, the Fed forecasted that it wouldn’t have to taper its asset purchases until well into 2022. However, surging inflation pulled that forecast forward. Now, the Fed forecasts that it won’t have to raise interest rates until well into 2023. However, surging inflation will likely pull that forecast forward as well.

What’s more, St. Louis Fed President James Bullard said on Nov. 9 that “if inflation is more persistent than we are saying right now, then I think we may have to take a little sooner action in order to keep inflation under control.”

And with Bullard a voting FOMC member in 2022, he added (Also, please remember that this comment was made before the CPI surged to a more than 30-year high on Nov. 10.):

Source: CNBC

Even more revealing, surging inflation is now rattling The White House. Releasing a “Statement by President Biden on Today’s Economic News” on Nov. 10, an excerpt read:

Source: The White House

Moreover, Biden added:

“I am travelling to Baltimore today to highlight how my Infrastructure Bill will bring down these costs, reduce these bottlenecks, and make goods more available and less costly. And I want to reemphasize my commitment to the independence of the Federal Reserve to monitor inflation, and take steps necessary to combat it.”

Finally, while the PMs may have won the recent very short-term battle, they’re unlikely to win the medium-term war (they are clear winners in the long run, though). With inflation surging, markets rattled, The White House rattled and precious metals investors assuming that policymakers will do nothing (even as their anxiety accelerates), the calculus boils down to one fundamental question: do you believe the U.S. dollar, or do you believe the PMs?

Please see below:

To explain, the gold line above tracks the GDXJ ETF (our short position) in 2021, while the green line above tracks the inverted (scale flipped upside down) USD Index. If you analyze the relationship, you can see that when the USD Index rises (the green line falls), the GDXJ ETF often heads in the opposite direction.

However, with the U.S. dollar betting that the Fed will tighten and the junior miners betting that it won’t, we expect the former to win out over the medium term. And while the pieces of the fundamental puzzle may seem confusing, the outlooks for the PMs, the U.S. dollar, real interest rates and the Fed’s reaction function remain unchanged. If anything, the dollar’s fundamentals are now at 2021 highs and the Fed should turn even more hawkish than we expected last week. As a result, lower lows should confront the PMs over the medium term.

Interestingly, during yesterday’s session both: gold and the USD Index moved higher. But only one of them reversed before the end of the day: gold.

The USD Index just broke above its previous 2021 highs, above its September 2020 lows, above its March 2020 low, and above its January 2020 low.

There was no invalidation of the breakout, and no intraday reversal as the rally continues. This is in perfect tune with what I wrote based on USD’s tendency to decline significantly after the first invalidation, but then to correct only a little after the second invalidation of the breakout.

On Nov. 8, I wrote the following on the USD Index:

However, similar developments were also present in August and October. After the dollar basket attempted to make new highs and failed, the greenback eventually regained its composure and achieved the milestones. As a result, another 2021 high should occur sooner rather than later.

Please see below:

The first failed attempt to break above the previous highs triggered sizable short-term declines. This happened in August (marked with red). The second – September – attempt triggered only a small correction (marked with green) that was then followed by a bigger rally.

Similarly, the – marked with red – October invalidation was followed by a sizable decline, and the current one (marked with green), is relatively small. And it’s likely to be followed by a short-term rally, just like the September correction was.

Given the no-looking-back breakout, and the similarity between now and 2014, it seems that we can now expect the USD Index to launch a powerful rally.

Circling back to the previous question – the indications coming from the USD Index are decisive, meaningful, and strong. What about the indications for the precious metals sector?

Unlike the USD Index, gold reversed before the end of yesterday’s session. At one point, it was up $36.10, but then it gave away most of its daily gains, ending the day only $17.50 higher. This made yesterday’s session a reversal, and since it formed on huge volume, it should be considered as an important one.

I marked a few other cases when the volume was high, and that was when gold either formed a local top or when it was close to it. These were not reversal sessions, though, so the current combination of factors is actually more bearish.

Now, what appears to be bullish on the above chart is that gold rallied above the inverse head-and-shoulders pattern. I marked the neckline with blue. In yesterday’s intraday Gold & Silver Trading Alert, I wrote the following:

Based on today’s intraday rally, gold moved visibly above the neck level of the pattern, therefore almost (!) triggering bullish implications. Why “almost”? Because the breakout should be confirmed by three consecutive daily closes above a certain level (in this case, the neck level of the patten = approximately the previous highs).

…

So, what does it all mean? It means that NOW the situation has NOT changed. It might become more bullish IF the breakouts in gold and GDX are confirmed. Gold already gave away $10 of its earlier gains, and I can easily see the situation in which gold reverses today, or later this week, thus invalidating the breakout above its inverse head and shoulders formation.

The above remains up-to-date.

What about the mining stocks and their relative strength?

Well, the HUI Index closed just slightly above its intraday October highs, while gold closed visibly above the analogous highs. Miners are visibly below their August highs, while gold is above its August highs.

So, are gold stocks strong relative to gold? Absolutely not. In other words, the key bull market indication is still missing.

Furthermore, looking at another proxy for the precious metals mining stocks – the GDX ETF - provides us with an even more bearish indication.

The GDX ETF rallied on huge volume yesterday (marked with red dashed line to make comparisons easier), and there were only 4 cases in the recent past when we saw something like that after a visible short-term rally.

In EACH of those 4 cases, GDX was after a sharp daily rally.

In EACH of those 4 cases, GDX-based RSI indicator (upper part of the chart) was trading close to 70.

The rallies that immediately preceded these 4 cases:

1. The July 27, 2020 session was immediately preceded by a 29-trading-day rally that took the GDX about 42% higher. It was 7 trading days before the final top (about 24% of time).
2. The November 5, 2020 session was immediately preceded by a 5-trading-day rally that took the GDX about 14%-15% higher (the high-volume day / the top). It was 1 trading day before the final top (20% of time).
3. The January 4, 2021 session was immediately preceded by a 26-trading-day rally that took the GDX about 17%-18% higher (the high-volume day / the top). It was 1 trading day before the final top (about 4% of time).
4. The May 17, 2021 session was immediately preceded by a 52-trading-day rally that took the GDX about 30% higher. It was 7 trading days before the final top (about 13% of time).

So, as you can see these sessions have even more in common than it seemed at the first sight. The sessions formed soon before the final tops (4% - 24% of time of the preceding rally before the final top), but the prices didn’t move much higher compared to how much they had already rallied before the high-volume sessions.

Consequently, since the history tends to rhyme, we can expect the GDX ETF to move a bit higher here, but not significantly so, and we can expect this extra move higher to take between an additional 1 and 8 trading days.

Why 1 – 8 trading days? Because that’s 4% - 24% of time based the preceding rally (that took 30 trading days).

Since it’s unlikely to take the mining stocks much higher, and the reversal could take place as soon as today, I don’t think that making adjustments to the current short positions in the mining stocks is justified from the risk to reward point of view.

Is there a meaningful resistance level that would be likely to trigger a decline in mining stocks? Yes! The GDX ETF is just below its 38.2% Fibonacci retracement level based on the August 2020 – September 2021 decline. The resistance is slightly above $35, so that’s when the final top could form.

Today’s pre-market rally in gold doesn’t invalidate any of the above. In fact, it fits the above-described narrative. Let’s keep in mind that if/once gold invalidates its breakout above the neck level of the inverse head and shoulders pattern, gold miners could fall particularly hard.

Naturally, it’s your capital, and you can take any decision as you want, but it’s my responsibility to report to you the situation exactly as I see it and it’s exactly like I wrote above. In fact, it seems that now is a good time to be entering short positions in the mining stocks if one didn’t have any previously (I wouldn’t increase the size of the existing positions, though). This trade is definitely testing our patience, and while I can’t make any promises regarding market performance, if the history does indeed repeat itself and the decline that follows is similar to what we saw in 2013, the patience should be extremely well rewarded.

Overview of the Upcoming Part of the Decline

1. It seems to me that the current corrective upswing in gold is about to be over soon, and the next short-term move lower is about to begin. Since it seems to be another short-term move more than it seems to be a continuation of the bigger decline, I think that junior miners would be likely to (at least initially) decline more than silver.
2. It seems that the first 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.
3. After the above-mentioned correction, we’re likely to see a powerful slide, perhaps close to the 2020 low ($1,450 - $1,500).
4. 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.
5. I plan to exit all remaining short positions when gold shows substantial strength relative to the USD Index while the latter is still rallying. This might take place 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 might also happen with gold close to $1,375, but it’s too early to say with certainty at this time. I expect the final bottom to take place near the end of the year, perhaps in mid-December. It is not set in stone that PMs have to bottom at that time. If not then, then early 2022 would become a likely time target. The official start of tapering will serve as an additional indication or confirmation of the bottom.
6. 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 additional confirmation will come from the tapering schedule, as markets are likely to move on the rumor and reverse on the fact as they tend to do in general.
7. 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

The PMs rallied on Nov. 10 and their momentum has teetered on euphoria. However, when prices diverge from fundamentals, sharp sell-offs often occur when sentiment shifts. As a result, caution is warranted, and the PMs’ recent bout of optimism will likely end in disappointment. This disappointment could start within the next few days, based on analogies to very similar cases in mining stocks. The decline in the GDX could start right away or once it moves to or slightly above $35.

Since it seems that the PMs are likely about to start another short-term move lower more, I think that junior miners would be likely to (at least initially) decline more than silver.

From the medium-term point of view, the key two 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 following 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.

By the way, we’re currently providing you with the possibility to extend your subscription by a year, two years, or even three years with a special 20% discount. This discount can be applied right away, without the need to wait for your next renewal – if you choose to secure your premium access and complete the payment upfront. The boring time in the PMs is definitely over, and the time to pay close attention to the market is here. Naturally, it’s your capital, and the choice is up to you, but it seems that it might be a good idea to secure more premium access now while saving 20% at the same time. Our support team will be happy to assist you in the above-described upgrade at preferential terms – if you’d like to proceed, please contact us.

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: $35.73; 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: $16.18; 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: $32.08; 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: $41.38

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: $12.48

HZD.TO – alternative (Canadian) inverse 2x leveraged silver ETF – the upside profit-take exit price: $30.48

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