Gold & Silver Trading Alert: Hidden Signs for Precious Metals

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Briefly: In our opinion, no speculative positions are currently justified in gold, silver and mining stocks from the risk to reward perspective.

Gold, silver and mining stocks moved higher yesterday, even though the USD Index moved higher as well, which had bullish implications. Based on the closing prices and the rally in mining stocks that took place in the second half of yesterday’s session, it seems that closing our extra-large short positions and taking profits off the table early in the session was a good idea. However, that’s not the only thing that changed in the precious metals market and the area surrounding it – some signs are not as clear, but just as important. Let’s take a closer look at the charts for details (charts courtesy of http://stockcharts.com).

The first chart features the breakout in the Nikkei 225 Index.

Nikkei225

Why should one care about the above chart at all? Because the Nikkei has been strongly negatively correlated with gold. The strength of the phenomenon has been the strongest since 2012, but it’s also been present previously. The major tops and bottoms in the Japanese stocks and gold are not perfectly aligned, but they do correspond to each other, more or less.

Why is this correlation significant? Well, correlation doesn’t necessarily imply causation, but since both markets are connected to the Japanese yen, it doesn’t seem that the correlation is accidental. Consequently, a bullish outlook for Japanese stocks makes the outlook for the gold price bearish.

The thing is that we just saw an important breakout (above the declining blue resistance line) in the Nikkei and thus, the outlook just became bullish from the technical point of view. This doesn’t need to have immediate bearish implications for gold and the rest of the precious metals market, but it does suggest that the next big move is likely to be to the upside in the case of the Nikkei and to the downside in the case of gold.

Another thing that is not often discussed is the link between the financial stocks and gold.

XBD - Broker/Dealer Index, proxy for the financial sector. The link between the financial stocks and gold

In the past 3 years there were 3 big price swings in the case of the financial sector. The first 2 took place in the middle of 2015 and at its end. In both cases the moves were big downswings and their early parts heralded that a big move higher in gold was just around the corner. In the case of the former move, we had to wait for the rally in precious metals for several months, but still – it happened. This is significant, because the opposite is taking place right now. Additionally, please note that the breakout in financial stocks in the middle of 2016 corresponded to the top in the precious metals sector.

Financials soared last week and the move higher continues this week. Just as the 2015 declines had bullish implications for gold, we now have bearish implications. The effect doesn’t have to be immediate, but it is a good indication that gold is likely to decline in the following weeks, regardless of what happens in the following days.

Finally, we would like to discuss the ratio between the XAU Index (it includes both gold stocks and silver stocks) and the general stock market.

XAU:SPX - Mining stocks to the general stock market ratio

The key thing on the above chart is the Stochastic indicator based on the ratio. Almost every time since the bull market in the precious metals sector started, the indicator’s sell signal close to the 80 level was followed by a big decline in precious metals mining stocks. The only exception was seen in 2009, but please note that the signal was far from being clear at that time. Right now, we almost have the signal that is very clear, with significant bearish implications. We “almost” have it, as the above is based on the monthly candlesticks and the month is not over yet. Still, with a signal this significant, it would take a big rally in mining stocks and/or a big decline in the general stock market for the signal to be invalidated and both seem unlikely at this time. If nothing happens or if we see only a small rally in mining stocks, it’s likely that the signal will remain in place anyway and the bearish implications will remain in place.

Summing up, it seems that the outlook for the precious metals market remains bearish for the following weeks, but it’s no longer bearish for the following days. The relative strength of gold, silver and mining stocks compared to the rally in the USD Index has bullish implications and so does the mining stocks’ strength relative to gold. Consequently, it seems that our yesterday’s decision to take profits off the table and wait for additional bearish signs before re-opening a short position (or for multiple bullish signs before opening a long position) was correct. The analogy to 2013 continues to suggest that the next big move will be to downside and the charts featured today confirm this outlook, but caution is advised in the very short term.

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

To summarize:

Trading capital (supplementary part of the portfolio; our opinion): No positions

Long-term capital (core part of the portfolio; our opinion): No positions

Insurance capital (core part of the portfolio; our opinion): Full position

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 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 Tools and Indicators.

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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