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.
Today’s technical part of the analysis is going to be very brief, as very little changed during yesterday’s session, and whatever changed was:
- Bearish;
- Covered by yesterday’s second Alert (and comments below the Alerts on Golden Meadow).
Namely, silver rallied relative to gold, while miners almost ignored metals’ gains. This is simply a bearish combination. Other than that, there was no important breakout / breakdown in the PMs or related markets. The outlook remains just as we outlined yesterday.
Having said that, let’s take a look at the markets from a more fundamental point of view.
Introduction
Investors exuded Christmas spirit on Dec. 8, as the S&P 500 rallied by 0.75%. Moreover, gold jumped by 0.19%, silver by 1.41%, the GDX ETF was flat and the GDXJ ETF by 0.19%. Conversely, the USD Index fell by 0.29%, while the U.S. 10-Year real yield rose by four basis points.
Consequently, while seasonality keeps bullish hopes alive, the medium-term technicals and fundamentals continue to deteriorate.
Santa Can’t Save Gold
While gold’s sleigh is flying high, is a crash on the horizon?
With so many narratives floating around, bullish seasonality, recession fears and consumer resilience have combined to create a mixed picture on Wall Street. However, with the gold price running well above its fundamental value, investors’ game of hide-and-seek should end in substantial liquidations.
For example, the S&P 500 has fallen by more than 17% in 2022. Yet, the bulk of the decline has been driven by four sectors.
Please see below:
Source: Fidelity
To explain, the red box above shows how communication services, consumer discretionary, real estate and information technology have been the worst-performing S&P 500 sectors year-to-date (YTD). In contrast, financials and materials (where the PMs live) have endured low double-digit declines, while defensive sectors like utilities, consumer staples and health care have fallen modestly.
Now, the four laggards have largely suffered due to higher interest rates, while economically-sensitive sectors like financials, materials, industrials and energy have mostly escaped investors’ wrath. For context, their outperformance is another example of why positioning does not support the ‘imminent recession’ narrative.
But, the important point is that with recession winds poised to grow stronger in late 2023, economically-sensitive sectors should catch up to the laggards and decline substantially.
Please see below:
To explain, the S&P 500 is a market-cap-weighted index, so large companies like Apple, Microsoft, Amazon and Alphabet have an outsized influence on the S&P 500’s performance. Conversely, an equal-weighted S&P 500 index assigns the same weight to all companies, so smaller stocks have more say.
Therefore, if you analyze the blue line above, you can see that the S&P 500 equal weight/S&P 500 ratio has rallied sharply recently, and has largely been in an uptrend since mid-2021. This means the average stock is outperforming Big Tech, as investors rotate money into economically-sensitive sectors like financials, materials, industrials and energy.
However, while Big Tech suffered mightily and liquidity-fueled assets like the ARK Innovation ETF (ARKK) and Bitcoin slumped as the U.S. federal funds rate (FFR) rose, the ‘old economy’ stocks should be the next shoe to drop, and a realization is profoundly bearish for gold.
To that point, Morgan Stanley’s Chief U.S. Equity Strategist Mike Wilson said on Dec. 8:
“I don’t think there’s as much of a distinction between value and growth at this stage of the economic cycle unless you’re talking about the defensive parts of value [like] utilities and staples and health care.”
More importantly:
“The problem with the value stocks now is they’re probably is just as vulnerable to the economic slowdown as the over-earning growth stocks were six or 12 months ago.”
So, while resilient consumer spending and solid growth have investors hiding out in economically-sensitive sectors, they should suffer the same bearish fate as the pandemic winners. In a nutshell: it’s only a matter of time before the same slowdown that haunted technology stocks comes for financials, materials, industrials and energy. Likewise, while the gold price remains supported right now, that should change materially in the months ahead.
Furthermore, after retracing 38.2% of its preceding decline, the S&P 500 sunk below its late-June high; and combined with a similar development confronting world stocks, the S&P 500’s technical outlook also remains highly bearish. In addition, with the fundamentals and the technicals in sync, the index’s medium-term backdrop is highly ominous.
As further evidence, Morgan Stanley’s model predicts “significant downside” to S&P 500 earnings per share (EPS) growth in 2023.
Please see below:
To explain, the blue line above tracks the year-over-year (YoY) percentage change in realized 12-month S&P 500 EPS growth, while the gold dashed line above tracks Morgan Stanley’s model estimate.
If you analyze the relationship, you can see that the pair often move in the same direction, and the gap on the right side of the chart shows how the gold line signals material weakness ahead.
As a result, with the technicals screaming risk off and an earnings recession poised to spook the bulls in 2023, the S&P 500’s suffering should weigh heavily on the gold price.
On top of that, let’s not forget about the bearish ramifications of silver’s outperformance. We’ve noted repeatedly that silver often runs away from gold before major drawdowns occur; and with the white metal correcting 50% of its 2022 decline, its recent outperformance is an important sell signal.
Overall, there are a plethora of bearish indicators supporting lower gold prices. So, while seasonality keeps sentiment uplifted, don’t let the short-term strength cloud your medium-term judgment. As stated previously, every inflation fight since 1954 has ended with a recession, and this bout should be no different.
Food for Thought
While we've noted how the recession narrative lacks fundamental credibility, earnings resilience is bullish for the FFR, real yields and the USD Index. For example, Dave & Buster's – which operates 203 sports and entertainment restaurants in North America – released its third-quarter earnings on Dec. 6. CEO Chris Morris said during the Q3 conference call:
“As indicated by our third quarter results, guests continue to visit and spend at healthy rates.... As we head into Q4, our Special Event sales teams and operating teams are aggressively focused on delivering a strong holiday banquet season. We are optimistic that the upcoming holiday season will provide additional momentum as we enter the New Year as our Special Events business has nearly recovered to pre-COVID levels.”
More importantly, he noted that consumer demand remains elevated despite higher menu prices.
Please see below:
Source: Dave & Buster's/The Motley Fool
Thus, please remember that restaurant and entertainment spending are discretionary, and this is not the kind of rhetoric you hear when an economic collapse is imminent. If average Americans were on the brink of insolvency, they wouldn't be dining out, and Dave & Buster's wouldn't be raising prices with such ease.
As a result, the crowd underestimates the Fed's inflation fight, and while lower oil prices may suppress the Consumer Price Index (CPI) on Dec. 13, the central bank should confront immense challenges in 2023.
The Bottom Line
Seasonality continues to drive sentiment, as the crowd doesn't want to give up on a Santa Clause rally. Furthermore, with the PMs largely outperforming the S&P 500, investors' game of hide-and-seek is mainly about moving money from one sector to another. However, bear markets are not about rotations; they're about liquidations; and with sticky inflation poised to uplift the FFR, real yields and the USD Index, the medium-term ramifications are far from priced in. As such, we believe this bear market has plenty of room to run.
In conclusion, the PMs mostly rallied on Dec. 8, as the USD Index declined and the U.S. 10-Year real yield rose; and while the crowd is happy to ignore the fundamentals and focus on the short term, 2022 has shown that uninformed optimism ends badly for the bulls. Consequently, this time should be no different.
Overview of the Upcoming Part of the Decline
- It seems to me that the corrective upswing is over (or about to be over) and that the next big move lower is already underway (or that it’s about to start).
- 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 prices close to $1,500 - $1,550.
- I plan to switch from the short positions in junior mining stocks or silver (whichever I’ll have at that moment) to long positions in junior mining stocks when gold / mining stocks move to their 2020 lows (approximately). While I’m probably not going to write about it at this stage yet, this is when some investors might consider getting back in with their long-term investing capital (or perhaps 1/3 or 1/2 thereof).
- I plan to return to short positions in junior mining stocks after a rebound – and the rebound could take gold from about $1,450 to about $1,550, and it could take the GDXJ from about $20 to about $24. In other words, I’m currently planning to go long when GDXJ is close to $20 (which might take place when gold is close to $1,450), and I’m planning to exit this long position and re-enter the short position once we see a corrective rally to $24 in the GDXJ (which might take place when gold is close to $1,550).
- I plan to exit all remaining short positions once gold shows substantial strength relative to the USD Index while the latter is still rallying. This may be the case with gold prices close to $1,400 and GDXJ close to $15 . 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 can also happen with gold close to $1,400, but at the moment it’s too early to say with certainty.
- 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 nor clear enough for me to think that they should be used for purchasing options, warrants, or similar instruments.
Letters to the Editor
There are no new letters for today, but I wanted to keep the below reminder in place, just to make sure that everyone had the chance to see it:
Please note that this section is going to go away within the next 1-8 weeks, as you can add comments/questions below the article on Golden Meadow – the platform that we’re using to provide our analyses. Your notification e-mails include an invitation link that allows you to access the “Gold Trading Alerts” space.
The first premium analysis had over 30 comments below it, and once I finish writing this article, I’ll head over to the comments section and catch up on yesterday’s comments.
Also, if you haven’t had the chance to see the video, in which I’m talking about the new platform and why we essentially moved from Sunshine Profits to Golden Meadow, I strongly encourage you to do so:
Summary
Summing up, it seems that the major bottom in the USD Index is in, while the correction in stocks, gold, silver, and mining stocks is over.
The nature of the recent corrections was mostly technical. No market moves up or down in a straight line, and seeing market corrections is rather normal. The excuse that markets used to correct this time was an incorrect (in my view) expectation that the Fed is going to make a dovish U-turn. The fact that even the positive employment numbers were ignored as a bearish indication of further rate hikes shows the extent of the recent/current irrationality.
However, as the irrationality ends, the medium-term trend is likely to be resumed. And this trend is down in case of the junior mining stocks. The latter are likely to decline profoundly based on declines in both: gold and the stock market.
In my opinion, the current trading position is going to become profitable in the following weeks, and quite possibly in the following days. And while I can’t promise any kind of performance, I fully expect it to become very profitable before it’s over and to prolong our 2022 winning streak.
After the final 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.
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 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: $20.32; 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). The binding profit-take level for the JDST: $27.87; stop-loss for the JDST: 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: $12.32
SLV profit-take exit price: $11.32
ZSL profit-take exit price: $74.87
Gold futures downside profit-take exit price: $1,504
HGD.TO – alternative (Canadian) 2x inverse leveraged gold stocks ETF – the upside profit-take exit price: $18.47
HZD.TO – alternative (Canadian) 2x inverse leveraged silver ETF – the upside profit-take exit price: $46.87
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’ve 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 (as 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 K. Radomski, CFA
Founder, Editor-in-chief
