Briefly: In our opinion speculative long positions (full) in gold, silver and mining stocks are justified from the risk/reward perspective.

Gold rallied yesterday but gold stocks plunged by more than 3.5%. Strong underperformance of gold stocks has often indicated local tops in the past. Is this the case also this time or have we just seen a pause after a major daily rally?

In short, we think that we saw just a pause within the corrective upswing. The following charts will explain why (charts courtesy of http://stockcharts.com).

Yesterday, we wrote the following:

We have now seen both: 3 days of lower prices and a breakdown below the rising support line. The breakdown is not confirmed yet, but the situation has definitely already deteriorated.

The breakdown is still not confirmed, but unless the USD Index rallies and closes above 86 today – it will. The next week would begin with a confirmed breakdown and with a much more negative outlook.

How low can the USD Index move during the corrective downswing? It could decline to 82 (81.96 is the 61.8% Fibonacci retracement based on the May - October rally), but the decline could end as soon as the USD reaches 84.2 or so (84.16 is the 38.2% Fibonacci retracement based on the July – October rally). Either way, the USD Index is quite likely to decline at least by additional 1.4 index points, which is quite a lot. Even if the USD declines to 84.2 and bottoms, this decline would still be likely to trigger a bigger upswing in the precious metals sector.

Why? Because gold, silver, and mining stocks are negatively correlated with the dollar in the short term.

The Correlation Matrix is a tool, which we have developed to analyze the impact of the currency markets and the general stock market upon the precious metals sector. In the short-term (30 trading days) column we see values very close to -1 in case of gold/USD, silver/USD, and HUI/USD correlations. Consequently, the markets are very strongly negatively correlated, and a move lower in the USD is quite likely to impact precious metals in a positive way.

Moreover, please note that the correlation between the stock market and silver (0.73) and between the HUI and the stock market (0.72) is visibly higher than it is between the stock market and gold (0.55). Consequently, it shouldn’t surprise us that miners and silver have not performed so well recently – stocks have been declining. Once stocks bottom, it seems that silver and gold stocks will catch up with gold.

Having said that let’s take a look at the yellow metal.

The question that we would like to reply to in today’s alert is how high gold is likely to move during this corrective upswing. In our opinion, it’s quite likely to rally to the combination of resistance levels: the long-term rising (grey) line and the declining red dashed line. These lines intersect just a little above the $1,250 level, so it seems to makes sense to expect the next local top to form there. Please note that this is based on the information that we have available today. It will be crucial to monitor the USD Index and its link with gold to determine whether a top is indeed being formed or not. If we don’t see bottoming action in the USD Index, but gold reaches the above-mentioned resistance levels, it might not be the final top for gold. We will keep our eyes opened and report to you accordingly.

The situation in the Dow to gold ratio remains unchanged since we previously commented on it, but it seems worth to emphasize the implications as they are so important:

The above long-term chart is great for filtering out the short-term price swings and focusing on major moves in gold and the rest of the precious metals sector. At this time it shows us that even though the ratio has been on the rise recently, it has not yet reached an important resistance level, and thus is not likely to stop the rally just yet.

This fits our expectations based on other charts. It seems that we haven’t seen the final bottom in gold, but we might have seen a local one.

Moving back to the short-term perspective, there’s an additional gold chart that shows that the next local top might be reached soon.

When we take a look at gold priced in the Australian dollar, we see a rather straightforward picture. There is a big declining resistance line that might stop or delay any rallies. At least, that’s been the case so far this year. To be precise – in March, gold moved slightly above this line, but it plunged shortly thereafter. In case history rhymes also this time, we drew the target area at and slightly above the declining resistance line. Either way, it’s rather close, so we are quite likely to see a pause or top rather soon.

As you can see on the above chart, the situation in silver hasn’t changed much recently. The white metal seems to have bottomed at the long-term rising support line and the correction seems to be under-way. How high is silver likely to move before it declines once again? It’s a particularly tough call in case of this part of the precious metals sector as it can be, and is, very volatile at times, however, it seems that it could move to its 2013 low or the previous 2014 lows. Consequently, $18 - $18.50 is our target area based on the information that we have available today. Just as it is the case with gold, it will be crucial to consider the situation in the USD, before making trading / investment decisions regarding silver.

In yesterday’s alert we wrote the following:

The miners declined in the first part of yesterday’s session, but our stop-loss order was low enough to keep the long position intact – and it was worth it.

Gold stocks moved over 7% higher yesterday. The move was big and sharp and thanks to it gold miners invalidated all 3 recent breakdowns: below 2 declining support/resistance lines and below the 2013 low.

All of the above are bullish facts, and their combination is even more bullish.

Gold stocks declined yesterday, but the decline didn’t make the picture bearish. Not only is the HUI higher than it was a week ago, but yesterday’s decline was also not enough to take the index back below the support lines and the 2013 low. Consequently, the previous breakdown’s implications remain in place and they are very bullish.

How high can the HUI Index go (before moving lower again) based on the information that we have today? To approximately 213-215, in our opinion. That’s where the rising, green support line is. Again, the above could change and we will keep you – our subscribers – informed.

Summing up, it seems that the corrective downswing in the USD Index and the corrective upswing in the precious metals market are underway. In our opinion, it seems to be a good idea to use speculative capital to profit from these moves. Today’s alert features our estimations of where the next local tops might be in gold, silver and mining stocks, but there are still quite a few unknowns, especially in the case of the USD Index. The price targets that we provide below are “initial” meaning that they are based on our estimations at this time. We will monitor the situation and will let you – our subscribers – know (we will send a confirmation) when we think it’s a good idea to exit the current long position and take profits off the table.

A lot of money had been saved by staying out of the precious metals market in the past months with one’s long-term investments (that is if one followed our suggestions; details below), and additional gains have been made on the recent speculative short positions. The corrective upswing that we are already seeing will likely provide additional profits from the trading capital.

To summarize:

Trading capital (our opinion):

It seems that having speculative (full) long positions in gold, silver and mining stocks is a good idea:

• Gold: stop-loss: $1,172, initial target price: $1,249, stop loss for the UGLD ETF $11.29, initial target price for the UGLD ETF $13.56
• Silver: stop-loss: $16.47, initial target price: $18.07, stop loss for USLV ETF $23.94, initial target price for the USLV ETF $31.73
• Mining stocks (price levels for the GDX ETF): stop-loss: $19.94, initial target price: $23.37, stop loss for the NUGT ETF $18.25, initial target price for the NUGT ETF $28.99,

In case one wants to bet on higher junior mining stock ETFs, here are the stop-loss details and initial target prices:

• GDXJ stop-loss: $28.40, initial target price: $37.14
• JNUG stop-loss: $6.19, initial target price: $16.34

Long-term capital (our opinion): No positions

Insurance capital (our opinion): Full position

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.

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 always, we'll keep you - our subscribers - updated should our views on the market change. We will continue to send out Gold & Silver Trading Alerts on each trading day and we will send additional Alerts whenever appropriate.

The trading position presented above is the netted version of positions based on subjective signals (opinion) from your Editor, and the automated tools (SP Indicators and the upcoming self-similarity-based tool).

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.

Sincerely,
Przemyslaw Radomski, CFA
Founder, Editor-in-chief

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