Briefly: in our opinion, full (300% of the regular position size) speculative short positions in mining stocks are justified from the risk/reward point of view at the moment of publishing this Alert.
Yesterday’s session (and this week in general) have been rather inconsequential as the markets appear to have simply paused. This is definitely true in case of precious metals and mining stocks, which in turn means that I have very little to report to you today on the technical front. The situation and outlook simply remains as I described it yesterday (short-term factors) and on Monday (more important, medium- and long-term factors), especially that gold is down by about $10 in today’s pre-market trading (at the moment of writing these words).
In other news, I recently received a question about inflation, so today’s fundamental commentary will revolve around this topic.
Inflating the Dollar
After the U.S. Consumer Price Index (CPI) soared by 5.3% year-over-year (YoY) on Sep. 14, investors celebrated the news due to the perceived impact on the Fed. To explain, accelerating inflation could expedite the Fed’s taper timeline and force the central bank to raise interest rates much sooner than expected. However, when inflation is perceived as peaking, investors price in more patience from the Fed and the optimism helps uplift the PMs.
However, it’s an illusory state of happiness. For example, the S&P Goldman Sachs Commodity Index (S&P GSCI) closed at a new 2021 high on Sep. 15. For context, the S&P GSCI contains 24 commodities from all sectors: six energy products, five industrial metals, eight agricultural products, three livestock products and two precious metals.
Please see below:
To explain, the green line above tracks the S&P GSCI’s current rally off of the bottom, while the red line above tracks the S&P GSCI’s rally off of the bottom in 2009-2010 (following the global financial crisis). If you analyze the middle of the chart, you can see that the S&P GSCI has completely run away from the 2009-2010 analogue. For context, at this point in 2009-2010, the S&P GSCI had rallied by 65% off of the bottom. However, as of the Sep. 15 close, the S&P GSCI has now rallied by 139% off of the April 2020 bottom.
Furthermore, while I’ve been warning for months that speculation in the commodities market is the main driver of the inflationary surge, proclamations of $100 oil are mutually exclusive to the Fed achieving its dual mandate.
To explain, the weighting of the S&P GSCI is of immense importance. With energy accounting for roughly 54% of the index’s movement (the red box below), WTI – which is up by 4.15% this week and up by 6% since the beginning of September – is trading like the Fed is on hold. However, while investors want to have their cake and eat it too, higher commodity prices will only increase the inflationary momentum and put more pressure on the Fed to act.
Please see below:
Source: S&P Global
To that point, the S&P GSCI declined by roughly 2.5% in August. As a result, it’s no coincidence that inflationary pressures calmed once commodity prices stopped rising. For context, ‘calmed’ is quite inaccurate. However, since 5.3% YoY inflation seems to pass for good news these days, we’ll oblige. Looking ahead, though, the S&P GSCI has already risen by more than 3% in September. And if the monthly strength continues, higher prices should put upward pressure on the Commodity Producer Price Index (PPI) and reignite cost-push inflation’s impact on the U.S. economy.
For context, I highlighted on Sep. 15 that the PPI/CPI relationship remains on trend:
As further evidence, while proponents of the “transitory” narrative cite used cars & trucks, lodging away from home and airfares as items that will mean revert (we agree), reopening components actually fell in August while the overall CPI remained elevated.
Please see below:
To explain, the blue (energy), orange (non-reopening) and red (reopening) bars above segregate the various contributors to the headline CPI. If you analyze the right side of the chart, you can see that reopening components peaked in June and have come down. Conversely, if you focus your attention on the blue bars, notice how energy accounts for roughly one-third of the headline CPI and its share actually increased in August? Furthermore, the blue bars don’t account for the inflationary contributions of industrial metals, agricultural commodities, plastics, or shipping costs (which are at all-time highs). As a result, even if the reopening metrics begin to fade, higher commodity prices and prospective rent inflation should add upward pressure to the headline CPI over the medium term.
Decomposing the former, with the Delta variant surging since late July, social activities have been the hardest hit. And after the entire reopening basket declined month-over-month (MoM) in August, progress on the health front could reverse that decline in the future.
Please see below:
To explain, the blue line above tracks the seven-day moving average of U.S. airport traffic. If you analyze the right side of the chart, you can see that traveler demand peaked when the Delta variant surged and has rolled over ever since. Thus, it’s no surprise that airfares also declined. However, if (once) the Delta variant fades, travel demand should re-accelerate and airlines will likely raise prices again. Summing up, while we consider the reopening basket an immaterial piece of the inflationary puzzle, further declines in “transitory” components still seems unlikely at this point.
Moving on, the New York Fed released its Empire State Manufacturing Survey on Sep. 15. And after plunging in August, the headline index increased from 18.30 to 34.30 in September. Moreover, checking off all of the Fed’s boxes, the report revealed:
“New orders, shipments, and unfilled orders all increased substantially. The delivery times index reached a record high. Labor market indicators pointed to strong growth in employment and the average workweek…. Looking ahead, firms remained very optimistic that conditions would improve over the next six months, and capital spending and technology spending plans increased markedly.”
More importantly, though:
“The prices paid index held steady at 75.7, and the prices received index edged up two points to 47.8, marking its third consecutive record high.”
Please see below:
Source: New York Fed
On top of that, while input and output inflation remains the talk of the town, wage inflation is still on the up and up. And after Walmart (the largest employer in the U.S) announced a wage increase on Sep. 2, Amazon (the second-largest employer in the U.S.) followed suit on Sep. 15 and said that its average starting wage will increase to more than $18 per hour. Moreover, the company plans to hire another 125,000 warehouse and transportation workers to prepare for the holiday season.
Please see below:
Source: Reuters
Finally, with inflation surging and the Fed’s patience exasperating the problem, the only way for inflation to prove “transitory” is for the Fed to strengthen the U.S. dollar and reduce the incentive for investors to bid up commodity prices. If not, the dovish rhetoric will only accelerate commodities’ fervor and the cost-push inflationary spiral will continue. However, while Chairman Jerome Powell may come across as slow-witted, he likely understands what’s happening. And with political survival often a motivator of policy initiatives, inflationary pressures are already affecting consumer sentiment. As a result, continuing QE is actually doing more harm than good.
The bottom line? The Fed’s taper timeline remains on track and the USD Index likely awaits the fundamental cue. Moreover, the longer the Fed delays the announcement, the faster it may have to move over the medium term (which is bullish for the USD Index). And with that, Scotiabank told its clients that the Fed may deliver an autumn surprise and that the U.S. dollar should benefit from the hawkish move.
“We think a combination of modest economic revisions (by the Fed) and steady messaging on the interest rate outlook should be supportive for the U.S. dollar, given that many other central banks are likely to lag the Fed's policy normalization process by a substantial margin.”
In conclusion, gold underperformed on Sep. 15 and stock-market euphoria wasn’t enough to uplift the gold miners or sink the USD Index. And with the former demonstrating relative weakness (considering other commodity producers were on fire) and the latter demonstrating relative strength, prior bouts of euphoria often coincided with sharp declines in the USD Index. However, with the Fed’s taper timeline inching closer and inflation likely to accelerate until a formal announcement commences, the Fed’s policy conundrum will likely uplift the U.S. dollar and upend the PMs over the medium term.
Overview of the Upcoming Part of the Decline
- It seems to me that the corrective upswing in gold is over or close to being over, and the big decline seems to be already underway.
- 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.
- 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 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 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.
- 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
To summarize, the previous strength in the precious metals sector was reversed, just like it was likely to, and the most bearish thing about it is that it happened practically without a good fundamental trigger. This means that the precious metals sector simply can’t wait to decline to much lower levels.
It seems that our profits from the short positions are going to become truly epic in the following weeks.
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 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: $16.96; 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: $35.46; 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: unclear at this time - initially, it might be a good idea to exit, when gold moves to $1,683
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: $11.38
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
