Wednesday, May 26, 2010

Gold Stocks, Gold and the Stock Market - What's Next?

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It's fun to guess, thought those that lay out predictions of the future in black and white leave themselves open to criticism, as nobody knows the short to intermediate-term for certain. It's hard enough to get the long term right. Ask those who have predicted every year that Gold will go down in price...

Those who have been reading my market thoughts over these past few months know that I have been very bullish on Gold and Gold stocks. Recently, I have finally given up the ghost on my Gold stock bullishness to allow for a greater amount of time for Gold stocks to rest/correct before their next leg higher begins. I like to play Gold stocks from the long side using leverage and I am not a buy and hold investor when it comes to these stocks. I am a buy and hold physical Gold holder, but I don't buy and hold any stocks "for the long haul," Gold stocks or otherwise. It's a conscious choice I made once I realized we were in a secular bear market.

I recently got out of my leveraged Gold stock positions at a small profit, which was much less than what I had hoped (it would have been better if I would have waited one more day to close the positions, but such are the breaks when speculating). I have decided to wait for a deeper correction before committing new leveraged money to the Gold mining sector. I am actually looking for a continuation of the current short term bounce higher in the Gold patch over the next week or so, but then I expect Gold and Gold stocks to briefly roll over. I may be wrong, as I have been many times in the past, which is why I don't trade my physical metal. I also hold several small positions in "lottery play" junior Gold miners that I will hold until they move significantly higher or go out of business (I assume some will do one while some will do the other).

I remain bullish on Gold stocks and Gold for the longer term and I by no means have a gloom and doom prediction. I am simply going to hold out for a better price before I get back into a leveraged Gold stock position again. My hope was that we were on the threshold of the 2002 Gold stock bull run this spring. I still think we are, but I realize I may need to give the Gold stocks more time to correct. Gold stocks can rise higher during a regular stock bear market, but they have failed to show decent relative strength compared with Gold, which is never a good sign.

I analyze fundamentals first. I am not a "pure" chartist/technical analyst. That to me is like trying to be a fundamental analyst in the paper currency markets. Too much cognitive dissonance for me. The Gold mining sector has better fundamentals now based on the "real" price of Gold than at any other time during this secular Gold bull market with the exception of the panic lows in the fall of 2008. Using a ratio of Gold divided by a basket of commodities to look at the secular fundamental picture for Gold stocks ignores important differences between miners in terms geopolitical risk, management, unique characteristics of individual properties, etc. This is a way to analyze the sector, not individual miners. I have ZERO experience in Gold mining. I tend to play the sector as a whole (e.g., using call options on GDX or GDXJ ETFs) or blue chip/popular miners (e.g., Goldcorp, Yamana) when making leveraged bets.

Here's the secular forest for Gold miner profitability in its idealized form over the past 25 years ($GOLD:$CCI linear scale weekly ratio chart thru 5-25-10):

Forget inflation. If Gold isn't rising faster than oil, for example, inflation and/or a rising Gold price doesn't help make miners more money as costs can rise faster than the price of the final product. It's the same as in any business.

The point of this exercise is to point out that the fundamentals are there for Gold stocks, it's simply now a decision as to whether to buy now or later with new money. Many with more wisdom and experience than me would say to just buy and hold and let the bull market bail you out. I am doing this with physical Gold, but I like speculating in an attempt to augment the gains of this secular bull market.

Anyway, I became bearish on Gold stocks when their relative strength failed to materialize as I was anticipating it would. I think the depth of Gold stock correction was adequate into their recent February lows, but now I realize perhaps not in terms of the length of time.
Let me show you what I mean using the chart of the Gold Bugs Mining Index ($HUI) back in the 2000-2002 time frame of interest:

And here's a similar pattern from the 2002-2005 time frame:

This yields the "idealized" Gold stock index corrective pattern prior to a massive launch higher into the next leg of the Gold stock bull market:

Finally, here's a current daily candlestick chart of the $HUI over the past 21 months thru today's close:

As far as Gold goes, I am hoping for a slightly higher high, but will have an itchy trigger finger as we get closer to the prior $1250 highs and will likely implement stop losses. I don't like that Gold stock indices couldn't best their December highs and the other thing that has me worried is the palladium/platinum complex. I see a confirmed breakdown in the mini-parabolic rise in palladium, which has been the best performer in the precious metals complex over the past 18 months. See this prior post about my concerns related to the parabolic move in palladium.

Here's an updated 20 month chart of palladium thru today's close:

Between the busted palladium parabola, the failure of Gold stocks to make new highs, and the recent 98% bulls reading recently for a Gold sentiment indicator, I think the Gold patch is telling us that it needs a rest. Of course I could be wrong and you and you alone are responsible for your own trading decisions, but this is the way I see it. I wish it weren't so and I wish we were going to the moon right now, but I am trying to make money here and I don't like the long side other than for a scalp currently.

In the mean time, Gold could easily spike to a new all-time high before a multi-week correction begins (this is actually what I am expecting [hoping?] to happen). Perhaps we pop into the $1270-1325/oz range as the U.S. Dollar makes an overdue correction back to its 50 day moving average. After that though, Gold needs to recharge. A trip back to the low to mid $1100s would be a nice base from which to launch a trip to the $1500-$1750 range by the end of the year. I wouldn't bet against Jim Sinclair's prediction for $1650 by January of 2011.

Since the stock market has finally broken down (only about a full year after I initially expected - oops!), I am now turning my attention to establishing a large short position. I think we will bounce higher over the short term (couple of days to 2 week time frame). I am looking at commercial real estate again and plan to buy puts on the triple bullish DRN ETF as well as puts on the triple bullish S&P500 ETF (ticker: UPRO). I'm with Richard Russell on this one. A hard rain is coming to use his words.

For Gold bulls, this is not a bearish message. It is a message that patience will be rewarded. If you are a "buy and hold" investor in Gold stocks, it means another 1-2 months or so before a BIG payoff. If you're a trader or waiting to add new money to the sector, it means a great buying opportunity is coming. Please remember that the 2002 and 2005 bull market runs in Gold stocks that followed the corrective patterns shown in the charts above were the strongest of the secular Gold stock bull market so far (150%+ gains for the $HUI in 6-12 months in both cases!). Now that I am black bile bearish on the stock market, this Gold stock pattern makes sense to me. Gold stocks would likely need to correct a little bit more if a vicious bear market slide materializes as I believe it is going to, particularly given their lack of ability to lead the Gold price.

I believe there is more money to be made shorting the stock market over the next 1-2 months than there is to be made waiting for Gold stock indices to figure out where they want to go. I can only react to to Mr. Market and what he tells me, and this is my interpretation of recent events in the Gold patch. Don't forget my favorite big picture chart, which is set to reward Gold bulls at the expense of their paperbug brethren, the Dow to Gold ratio (15 month daily candlestick chart thru today's close):

It is my hope that I can make a few more nickels shorting the general stock market over the next 1-2 months, then take those nickels and turn them into shiny physical Gold coins for my savings account and leveraged bullish bets on Gold stocks for my trading account. In fact, I'll say it now: if we get back to the 360-370 level on the $HUI, I think it will turn out to be the best intermediate-term speculative buying opportunity of this secular Gold stock bull market since it began in the fall of 2000.

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