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Precious Metals Update

  • Written by Syndicated Publisher 324 Comments324 Comments Comments
    January 13, 2011

    With the rise in the USD in the last month gold and precious metal stocks have taken a beating and have become the favored short by the CNBC “Fast Money” and hedge fund community. While precious metals may be the favored short by the momentum crowd, it’s quite likely a short-term low is in, though I believe more work needs to be done before an intermediate low arises.

    Breadth Implies Short-Term Low

    It’s been a while since I wrote about precious metals and given we are in corrective mode I wanted to update many of the indicators I used to call an intermediate low in precious metals last August (Intermediate Low in Precious Metals?). Below is a multi snapshot of a custom precious metals index I created composed of 33 members. Looking at the bottom three panels it does look like at least a short-term low is in. The 10 day advancing to total volume ratio is at a level associated near bottoms as is the percentage of stocks above their 50 day moving averages (50d MA). Additionally, as my precious metals index (top panel) has been making new short-term lows over the past week the percentage of stocks making new 30 day lows is declining (bottom panel), indicating fewer and fewer stocks are participating in the correction, a hallmark for short-term bottoms (see green arrows in bottom panel). While I think a short-term low is in, given over head resistance in key precious metal indexes at the 20d and 50d MAs, I think another decline after a brief respite is in the cards as I don’t think we are quite yet at an intermediate-term low in precious metals.

    custom index of 33 stocks breadth

    Source: Ned Davis Research

    More Work Needs to be Done for an Intermediate Low

    Looking at the percentage of stocks within the Market Vectors Gold Miners ETF (GDX) above their 20d and 50d MAs also argues for a short-term low being in place. However, looking at a more intermediate-term moving average like the 100d MA suggest we aren’t quite near an intermediate-term low as we are at neutral levels presently.

    gdx stocks above 20d ma

    Source: Bloomberg

    Even momentum measures like the 20 day rate of change (ROC) or the 60 day ROC suggest we aren’t quite near the readings associated with intermediate-term lows but certainly well on our way there.

    reversion chart

    Source: Ned Davis Research

    While I do not feel we are at an intermediate-term low in precious metals, I don’t think we are that far off. My proprietary gold indicator is very close to intermediate-term low readings, but the smoothed indicator (bottom panel) still has a little more room to go. That said, much of the froth seen in December has now largely been worked off, setting up for better ground for precious metals to advance from.

    gold term gold indicator

    Source: Bloomberg

    While I think gold and gold stocks may be nearing an intermediate low in the next several weeks, silver on the other hand still looks very extended and my intermediate-term silver indicator is coming off the third most elevated risk level in more than a decade after reaching levels that marked major long-term peaks (2004, 2006, 2008 tops). I think silver has much more consolidating and even correcting to do before heading higher, with the recent top likely representing THE top for perhaps a year or more. Prior major peaks in silver bullion have been spread out by 2-4 years, so we may have to wait a while fore a new high in silver. That said given the monetary environment we are in all bets are off, but from my vantage point gold posses the better reward to risk ratio than silver and while likely outperform silver for the next 6-12 months.

    silver term silver indicator

    Source: Bloomberg

    The Long Term Picture for Gold Looks as Bright as Ever

    Given gold reached new all-time highs recently many have voiced their bubble calls for gold. I for one think that rather than reaching a bubble peak, gold may not be that far off from another major low, not just an intermediate low. A long-term indicator I developed for gold has done a fairly good job in spotting the major tops in gold (2006, 2008). Surprisingly, despite the run up in 2010 my long-term indicator for gold has remained much closer to neutral readings and given its current weakness and potential weakness in the weeks to come, is likely approaching a potential major buying opportunity. Major buying opportunities occur when my indicator reaches -0.5 to -1.0 which helped identify lows that were seen prior to significant moves in the past. Examples of prior lows include the low in 2005 that occurred before the 75%+ run up to the 2006 high, the low in 2008 before the 45%+ run up to the early 2009 peak, and the low later in 2009 before the 63%+ run up to the 2010 highs. Gold correcting back to the 2010 summer highs and 200d MA near $1275 would easily push my long-term indicator near the -1.0 reading and present a major buying opportunity for gold investors.

    long term gold

    Source: Bloomberg

    For all the bubble talk about gold, it is nowhere close to reaching the levels in the gold to S&P 500 ratio seen at prior major secular peaks. I would call bubble territory at ratios near the 4+ region and with a current reading of 1.08 the gold to S&P 500 ratio is far from bubble territory. In fact, just to reach mid bubble territory near the 2.25 range gold would have to double from here while holding the S&P 500 constant. Gold in a bubble, please!

    bubble territory

    Source: Bloomberg

    The Key to Successful Investing – Remaining Flexible

    While analysts and investors may have preconceived notions about the market, an asset class, or the economy, unless one is open to the idea that they are wrong and know what to look for to tell them so they are unlikely to prove successful in the long run as humility is an investor’s best friend. In that spirit, I’ve made the case that we are close but not quite at an intermediate low, there are a few things I’d be on the look out for to support the bullish case from present levels (an intermediate low is in NOW) and the bearish case (a major top is in and a much lower prices are before us).

    Below is a sketch of what I anticipate the AMEX Gold Bugs Index (HUI) to look like into February. I think the 20d and 50d MAs act as resistance for a short-term top before rolling over to test the June 2010 top and the October 2010 low near $500, with the 200d MA coming in to that level as well. If the HUI can break above the 20d and 50d MAs and head north of the 560-570 level then the intermediate low is likely in and precious metals will likely head to new highs. Conversely, precious metal investors need to watch the 500 level I mentioned closely since if that level is taken out then a much more serious correction would be underway that would likely test the next major support in the high $300s to low $400s.

    hui chart

    Source: StockCharts.com

    Not only should one look to the gold indices for clues of an intermediate low in precious metals, but also the USD. If the USD Index holds the 50d MA (blue line) then I’d expect a move up through the 200d MA (red solid line) towards the mid $80s, while a break below the 50d MA would likely signal the low is in for precious metals.

    usd chart

    Source: StockCharts.com

    PFS Group Portfolio Manager, Fundamental Analyst
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