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.
While silver stole the spotlight recently, in yesterday’s analysis, I emphasized the importance of what’s happening in the USD Index and gold. Developments in both markets had bearish implications for the precious metals market overall, and we didn’t have to wait long for the results.
Namely, gold moved lower once again in today’s pre-market trading and it’s currently testing its 2021 lows.
Figure 1
In yesterday’s analysis, I wrote that the yellow metal’s breakdown below the rising red support line was not yet confirmed, but that the situation had already become more bearish. Gold closed below this line for the second day yesterday and given today’s decline, it seems that it’s going to close below it for the third consecutive day. This means that the breakdown is almost confirmed, and the implications are strongly bearish.
Now, given the proximity of the triangle-vertex-based reversal, I wouldn’t rule out a quick comeback and then another downturn within the next several days.
Theoretically, it’s possible that gold slides to $1,700 shortly and reverses there, but we wouldn’t bet the farm on this happening this or the next week. However, it is very likely to take place in February (more likely) or in March (less likely).
Why is this move likely to happen soon? Because of what happened in the USD Index.
Figure 2
The U.S. currency just confirmed two important breakouts:
- Breakout above the neck level of the inverse head-and-shoulders pattern
- Breakout above the declining medium-term resistance line based on the March 2020 and November 2020 highs.
The above is important also due to another – even more critical – reason.
Figure 3
Based on the remarkable similarity to early 2018 (also in bitcoin and dogecoin, and most likely also in stocks to some extent), the breakout above the declining resistance line (and the 50-day moving average) is likely to mark the start of a big, sharp upswing.
Back in 2018, the rally continued until the USD Index moved to its previous medium-term high. Afterwards, it started to move in a more moderate manner.
If the history rhymes once again (the similarity has been uncanny in the previous months), then the next temporary stop for the USD Index is a bit below 95, as that’s when the USDX topped in September 2020. Precisely, that was 94.80, so to be conservative, we can say that the next particularly significant resistance for the USD Index is at about 94.5.
Will this level correspond to gold at $1,700? This might be the case, but it could also be the case that gold declines to $1,700 even sooner. Given the current gold-USD dynamics, I don’t expect to see the USD Index at about 95 without seeing gold decline to at least $1,700.
Figure 4
Silver is not doing much today, so my comments from yesterday on this precious metal remain up-to-date:
Well, was silver’s rally just temporary?
This seems to have been the case. The white metal declined back below not only the 2020 highs, but also back below this year’s early high. Please remember that invalidations of breakouts have immediately bearish implications and we just saw more than one in case of silver.
So far today (Feb. 3), silver is quiet, but let’s keep in mind that back in September, it took only a few sessions for the white precious metal to move from approximately the current price levels to about $22.
Will silver slide as much shortly? This is quite likely, although the downswing doesn’t have to be as quick as it was in September.
Terms like the silver shortage, the size of the silver market and silver manipulation became incredibly popular in the last couple of days, which - together with huge SLV volume, and this ETF’s inflows - confirms the dramatic increase in interest in this particular market. This is exactly what happens close to market tops: silver steals the spotlight while mining stocks are weak. I’ve seen this countless times, and in most cases, it was accompanied by multiple voices of people “feeling” that the silver market is about to explode. For example, please consider what happened in early September 2020 on both (above and below) charts. Silver jumped and almost reached its August 2020 high, while the GDX was unable to rally even to (let alone above) its mid-August high.
Don’t get me wrong, I think that silver will soar in the following years and I’m not shorting silver (nor am I suggesting this) right now and in fact I haven’t been on the short side of the silver market for months. In fact, I expect silver to outperform gold in the final part of the next massive upswing, but… I don’t think this massive upswing has started yet.
Gold had it’s nice post-Covid panic run-up, but it didn’t manage to hold its breakout above the 2011 highs, despite multiple dovish pledges from the Fed, the open-ended QE, and ridiculously low interest rates. Plus, while gold moved above its 2011 highs, gold stocks have barely corrected half of their decline from their 2011 highs. Compare that to when the true bull market started about two decades ago – gold miners were soaring and multiplying gold’s gains in the medium run.
Let’s take a look at mining stocks, using the GDX ETF as a proxy for them.
Figure 5 – VanEck Vectors Gold Miners ETF (GDX)
Miners didn’t do much yesterday either, so again, yesterday’s comments remain up-to-date:
Are miners weak right now? Of course, they are weak. It was not only silver that got attention recently, but also silver stocks. The GDX ETF is mostly based on gold stocks, but still, silver miners’ performance still affects it. And… GDX is still trading relatively close to the yearly lows. Silver moved a bit above its 2020 highs – did miners do that as well? Absolutely not, they were only able to trigger a tiny move higher.
And based on yesterday’s decline, most of the recent run-up was already erased.
Interestingly, the most recent move higher only made the similarity of this shoulder portion of the bearish head-and-shoulders pattern to the left shoulder (figure 2 - both marked with green) bigger. This means that when the GDX breaks below the neck level of the pattern in a decisive way, the implications are likely to be extremely bearish for the next several weeks or months.
Due to the uncanny similarity between the two green rectangles, I decided to check what happens if this mirror-similarity continues. I used purple, dashed lines for that. There were two important short-term price swings in April 2020 – one shows the size of the correction and one is a near-vertical move higher.
Copying these price moves (purple lines) to the current situation, we get a scenario in which GDX (mining stocks) moves to about $31 and then comes back up to about $34. This would be in perfect tune with what I wrote previously. After breaking below the head-and-shoulders pattern, gold miners would then be likely to verify this breakdown by moving back up to the neck level of the pattern. Then, we would likely see another powerful slide – perhaps to at least $24.
All in all, it seems that silver’s run-up was just a temporary phenomenon and the next big medium-term move in the precious metals and mining stocks is going to be to the downside.
Please note that the GDX is already down in today’s London trading:
Figure 6
As you can see above, miners are very close to their 2021 lows. It’s now clear that the recent extreme popularity that mining stocks got was unable to generate a lasting response. It was most likely just a blip on the radar screen.
Having said that, let’s take a look at the markets from the fundamental point of view.
Walking a Tightrope
For weeks, I’ve been warning that excessive speculation could lead to a significant drawdown of U.S. equities. And given their strong-to-moderate correlation with the S&P 500, the negativity would likely cascade across the precious metals’ market.
On Jan. 20, I wrote that fund managers’ cash positions hit their lowest level since 2013 (the red circle below).
Figure 7
To explain, long-only institutional investors (like mutual funds) often keep 4% to 5% of their portfolios in cash (the horizontal red lines above). However, the vertical gray bars represent cash positions at different points in time. For context, the smaller the bar, the less cash they’re holding. And if you analyze the gray bar intersecting with the red circle, it’s another sign of the euphoric times.
But turning it up a notch, mutual fund managers are now holding less than 2% of their portfolios in cash – an all-time low.
Figure 8 - Source: SentimenTrader
Moreover, with fear of missing out (FOMO) taking a sledgehammer to valuation, pension funds are also following the bad behavior. If you analyze the chart below, you can see that pension fund cash positions have fallen to 2.6% – also an all-time low.
Figure 9 - Source: SentimenTrader
Furthermore, as money pours into U.S. equities, more of it than ever is flowing into companies that are near financial distress.
Please see below:
Figure 10
To explain, the red line above represents companies with ‘weak balance sheets.’ Essentially, these are companies with high leverage ratios that rely on a strong economic backdrop to service their debt. At the end of 2019, these companies made up roughly 6% of the Russell 2000 index. Today, that figure has nearly doubled to an all-time high of more than 11%.
And why is this happening?
Because as the U.S. Federal Reserve floods the system with excess liquidity, investors chase the riskiest assets that they can find. Case in point: special purpose acquisition companies (SPACs) raked in nearly $26 billion in January. And if you analyze the right side of the chart below, you can see that the amount of money flowing into speculative investments is occurring at an unprecedented rate.
Figure 11
To explain the term, SPACs are, essentially, publicly traded hedge funds. SPAC managers raise money and IPO the company with the intent of purchasing private and/or public companies. However, the key word is ‘intent.’ Investors that purchase SPAC shares have no idea when an acquisition will be made. Furthermore, because the majority of SPAC managers target early-stage technology companies, investors end up buying unprofitable companies at multiples akin to the dot-com bubble.
As evidence, the FTSE Renaissance Global IPO Index – which tracks the activity and performance of the global IPO market – has made a vertical move higher since 2020. In addition, the percentage of companies with negative earnings hitting the IPO market is only slightly below the 2000 high (~80%).
Please see below:
Figure 12
If that wasn’t enough, companies with EV/sales ratios that exceed 20 are exchanging hands like its 1999.
Figure 13
To explain, EV is an acronym for enterprise value. And enterprise value is the sum of a company’s equity and debt, less its non-operating assets. The key point is: the higher the EV/sales ratio, the higher a company’s valuation is relative to its revenue. Or to put it more bluntly, the more expensive the stock. In addition, companies with the highest EV/sales ratios tend to reside in the technology sector. And as you can see from the dark blue line above, today’s investors are trading these stocks just like their predecessors did before the 2000 bubble burst.
As a symptom of all of the above, the NASDAQ 100 is now outperforming the S&P 500 by a record margin. Eclipsing the previous high set in 2000, today’s technology companies are trading in uncharted territory.
Please see below:
Figure 14
To explain, the green line above depicts the performance of the NASDAQ 100 relative to the S&P 500. When the green line is rising, it means that the NASDAQ 100 is outperforming. Conversely, when the green line is falling, it means that the S&P 500 is outperforming. As you can see, 2000 is no longer the main course.
But while equities make their vertical move higher, the U.S. economy remains stuck in reverse. On Feb. 3, the U.S. Federal Reserve released its annual Small Business Credit Survey. And nearly one year after the pandemic struck, 88% of U.S. small businesses said that their revenue is still tracking below pre-pandemic levels.
Please see below:
Figure 15 - Source: U.S. Federal Reserve’s Small Business Credit Survey
Even more telling, 30% of the nearly 10,000 respondents said that without additional government aid, it’s somewhat-to-very unlikely that their companies will survive.
Figure 16 - Source: U.S. Federal Reserve’s Small Business Credit Survey
In addition, these struggling businesses have taken on more debt than ever. Relative to 2019, the percentage of companies with more than $100,000 in financial liabilities has increased by more than one-third.
Figure 17 - Source: U.S. Federal Reserve’s Small Business Credit Survey
But saving the best for last: what stood out the most?
Well, at the beginning of the report, the text reads:
“The SBCS is an annual survey of firms with fewer than 500 employees. These types of firms represent 99.7% of all employer establishments in the United States.”
That number again: 99.7%.
The bottom line? While pundits claim that the U.S. economy is experiencing a robust recovery, soldiers on the ground are telling a different story.
Circling back to the PMs, how could all of the above affect the metals?
Well, like I mentioned at the beginning, a drawdown of U.S equities will likely cascade across the precious metals’ market. If you exclude the one-day divergence on Jan. 29 (due to silver’s short squeeze mania), a more than 2% drawdown of the NASDAQ 100 significantly impacts the PMs.
Please see below:
Figure 18
In conclusion, U.S. equities continue to walk a tightrope, but the line is becoming narrower by the day. And when you combine excessive speculation that exceeds the dot-com bubble with economic fundamentals that mirror the 2008 financial crisis, valuations are completely divorced from reality. As a result, a reversion to the mean could drag down the PMs. However, after the dust settles, the PMs will likely continue their long-term uptrend.
Letters to the Editor
Q: Third stimulus check update: Democrats move ahead on bill that includes $1,400 payments as Biden meets with Senate Republicans. What will be the effect on gold?
A: I don’t think that it will affect gold in any meaningful or lasting way. Gold wasn’t able to hold its breakout above the 2011 highs despite an open-ended QE, previous stimulus actions, extremely low interest rates, and even a small raid on Capitol Hill. I don’t think another round would really matter.
Overview of the Upcoming Part of the Decline
- I expect the initial bottom to form with gold falling to roughly $1,700, and I expect the GDX ETF to decline to about $31 - $32 at that time. I then plan to exit the short positions in the miners and I will consider long positions in the miners at that time – in order to benefit from the likely rebound.
I expect the above-mentioned decline to take another 1 – 6 weeks to materialize and I expect the rebound to take place during 1-3 weeks.
- After the rebound (perhaps to $33 - $34 in the GDX), I plan to get back in with the short position in the mining stocks.
- Then, after miners slide once again in a meaningful and volatile way, but silver doesn’t (and it just declines moderately), I plan to switch from short positions in miners to short positions in silver (this could take another 1-4 weeks to materialize). I plan to exit those 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 $1,500 and the entire decline (from above $1,700 to about $1,500) would be likely to take place within 1-5 weeks and I would expect silver to fall 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 gold has already declined substantially) is likely to be the best entry point for long-term investments in my view. This might happen with gold close to $1,500, but it’s too early to say with certainty at this time.
Consequently, the entire decline could take between 3 and 14 weeks, while the initial part of the decline (to $1,700 in gold) is likely to take between 1 and 6 weeks.
The above is based on the information available today and it might change in the following days/weeks.
Summary
To summarize, it’s likely that the case that the next big short-term downswing has just begun as miners broke below the neck level of their almost-yearly head-and-shoulders formation and Thursday’s (Jan. 28) and Friday’s (Jan. 29) invalidation has “accidental” written all over it.
The outlook for the precious metals sector remains bearish, especially when it seems that we are entering the “winter” part of the Kondratiev cycle. Silver’s strength seems bullish at first sight, but taking a closer look at this move, and comparing it with previous cases (when silver got so much attention) and with miners’ weakness, provides us with bearish implications for the medium term.
The confirmed breakout in the USD Index is yet another confirmation of the bearish outlook for the precious metals market.
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 mining stocks is justified from the risk to reward point of view with the following binding exit profit-take price levels:
Senior mining stocks (price levels for the GDX ETF): binding profit-take exit price: $32.02; stop-loss: none (the volatility is too big to justify a SL order in case of this particular trade); binding profit-take level for the DUST ETF: $28.73; stop-loss for the DUST ETF: none (the volatility is too big to justify a SL order in case of this particular trade)
Junior mining stocks (price levels for the GDXJ ETF): binding profit-take exit price: $42.72; stop-loss: none (the volatility is too big to justify a SL order in case of this particular trade); binding profit-take level for the JDST ETF: $21.22; stop-loss for the JDST ETF: 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. In our view, silver has greater potential than gold does):
Silver futures downside profit-take exit price: unclear at this time - initially, it might be a good idea to exit, when gold moves to $1,703.
Gold futures downside profit-take exit price: $1,703
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
