Precious Metals: Timing And Flexibility Are The Keys To A Successful Trade

Background

Gold has not glistened since the summer of 2011 when a substantial rally took it to an all-time record price of $1,900/oz.

Since then however it has been a one way trek south punctuated by an occasional weak rally or head fake. Gold’s inability to sustain a meaningful move to higher ground has been damaging to any portfolio that has acquired gold, silver or the associated mining stocks over the last 3 years or so. Gold’s bull market lasted for 10 years from 2001 to 2011 before its rally came to an end. One can be forgiven for expecting such a rally to continue indefinitely as the same data which supported the precious metals surge were more or less still in place. Gold’s fall from grace can be attributed to many reasons including the attraction of a roaring stock market, resurgence of the US dollar, cost of storage, poor sentiment, etc. Depending on the time that one entered this market determines ones current p/l position. Those who purchased gold, silver and the producers in the early years of this bull market will be sitting on handsome profits, assuming they had a buy and hold strategy. For those who are relatively new to this sector of the market it has been a roller coaster of a ride with values being in a progressive state of deterioration.

Bear phases are common in any bull market and this one has been persistent in its trek south. The bottom has been called with monotonous regularity by some of our peers in this industry; alas it has yet to materialize. The correct timing of this turnaround could make or lose a fortune for investors and speculators alike.

Gold has recently tested and penetrated the previous low of $1,180/oz but managed to bounce back and trade at $1,187/oz. Should the demise continue and the $1,180/oz be penetrated once more, the stage for sub $1,000/oz gold prices would be on the cards.

Timing gold’s change of direction

Before trying to determine gold’s direction it is first very important to understand the big picture which is subject to a number of constantly changing variables.  The race to bottom between the currencies being conducted by the major nation’s central planners plays a major role in determining the price of gold in that particular currency. The more their currency declines the more valuable gold becomes to its citizens. However, if the other major currencies are perceived to be weaker and descend faster than your currency then effect will be to push up the value of your currency, as is currently the case with US dollar.

There is also the interference in the markets by our political leaders who try to talk their own currency down as they appear to be of the opinion that a weak currency will boost their exports, improve the economy and ultimately keep them in office.

Over the last few years we have expressed our skepticism regarding gold’s capitulation which we described as a ‘capitulation of sorts’ and not a final one. A final capitulation has been somewhat thwarted by some of the perma-bulls who have consistently given ‘buy’ signals with every drop in price.

A lot of the weak hands have been driven out by gold’s lackluster performance and some of the stronger ones who still hold long positions must be having sleepless nights.

Gold, silver and the miners have been hammered as this chart of The Gold Bugs Index (HUI) clearly shows:

The HUI has fallen by 73% since making a high at 630 and has tested its lows of 2008 an important support level, but it has managed to scramble 30 points higher and now stands at 180.

If the HUI can hold above this support level then it will be a good base from which to rally and build the next bullish phase of this bull market. Should it collapse then we could see the miners test the ‘100’ level last seen in 2002.

The price of silver also needs to hold onto its recent gains in order to support gold prices and confirm that a new bull market is underway, however, having recently flirted with $15.00/oz, which we did say could happen; silver’s sparkle appears to have been lost.

On the bullish side we could argue that gold is becoming increasingly difficult to mine, demand especially from both China and Russia is growing as evidenced by the Russian central bank reporting an increase in its gold reserves by 150 metric tons of gold this year. We could list many more metrics and data points that normally propel precious metals prices to higher ground, but there is little to suggest that this bear phase in gold is over just yet. The difficulty is in identifying a catalyst that would ignite gold and silver prices other than a ‘Black Swan’ event which by definition is an unknown event.

Conclusions

In terms of what to do at this stage of the cycle we would recommend the following:

• Stay flexible and be prepared to trade either way, being a perma-bull or a perma-bear is far too ridged a stance to take in a volatile market sector such as this one.
• Decide on what you think the big picture looks like. Our opinion, for what it is worth, is that we are still in this bear phase and therefore we are looking to place short trades and puts on any decent rally.
• The current rally should be observed until it reaches your evaluation of a mini peak. As an example if we look at silver then a mini peak would be $17.50/oz. For silver to trade higher it would mean that it is forming a new higher high which would be healthy for silver, but if it doesn’t then the fall could see it trade sub $15.00/oz.

The next bounce in prices could be another false dawn disguised as a rally and we have had many of those over the last three years. Our preference is to watch the market and use any bounce in prices to establish short positions. It may be possible to trade the bounce with long positions but as traders we would need to be very nimble and move in and out with some speed and gusto, which in a bear phase is not the brightest idea.

At the moment we have 75% of our funds in cash and are comfortable with this position as it enables us to buy at cheaper entry prices or open short positions without feeling too pressured if a trade goes against us in the early days of its existence. By adopting a flexible approach whereby we can be bearish or bullish in any market sector, at any time, we have increased our cash position through short selling the weaker stocks along with the execution of some well thought out options strategies.

Got a comment, then please fire it in whether you agree with us or not, as the more diverse comments we get the more balance we will have in this debate and hopefully our trading decisions will be better informed and more profitable.

Go gently.

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