Click here to access Part 1 of "Big Move Coming for Precious Metals"
Precious Metals Update
Switching gears from scenario analysis to a technical and risk management slant, the picture for gold remains bright. Gold recently hit a new all-time high so obviously the technical picture is bullish. On top of that, there is still the potential for gold to rally further before the reward-to-risk relationships shifts towards risk. Below is shown our risk indicator for bullion and readings north of 1.0 are typically resolved by either a correction (price) or by a prolonged consolidation (time) and readings below -0.50 serving as buying opportunities. Our indicator dipped below -0.50 earlier this month and signaled yet another buying opportunity in gold. At a current reading just north of 0.50 gold could easily rally into the $1600s before running into trouble. This is the case particularly when looking at the smoothed indicator in the lower panel. The smoothed indicator rests at neutral levels (0.0) and is well below high-risk levels that occur north of 0.75
Source: Bloomberg
Turning to gold stocks (Philadelphia Gold & Silver Index: XAU), gold stocks are coming off of deep oversold territory with the recent reading below -0.50 similar to the low seen in early 2010 from which the XAU rallied more than 50% to its late 2010 high. Given the low reading in our gold stock indicator there is plenty of room to run before gold stocks begin to run into any trouble from a risk perspective.
Source: Bloomberg
An Update on Silver
Two months ago I penned an article suggesting that the correction in silver had more to go in either time or price (Silver’s Destiny with 200). I made that call as our technical risk indicator for silver was still very elevated at a reading of more than 2.5 at the time, and given silver’s pattern after prior parabolic moves ('04,'06,'08) I suggested silver would likey test its 200 day moving average (200d MA). Silver could have done that by seeing its price decline to the 200d MA or by consolidating and allowing its 200d MA to continue to rise and eventually near the current price of silver. Since May our smoothed silver risk indicator has moved from highly elevated levels to below neutral, and the non-smoothed indicator has tested very oversold levels associated with significant bottoms, and has thus worked off the glaring risk posed to investors earlier in the year.
Source: Bloomberg
While silver never touched its 200d MA it was only a stone’s throw away and its path shows remarkable similarity to the 2008 correction which also never saw silver test its 200d MA and trade sideways for half a year before collapsing.
Source: Bloomberg
Using the 2004, 2006, and 2008 corrections I created a "correction composite" and overlaid silver’s current correction. As seen below, unlike the composite, the 2011 correction saw much of the bulk of the price decline occur in rapid fashion, and since parabolic moves are rarely resolved in a short amount of time it wasn’t surprising to see silver trade sideways as excessive bullish sentiment in silver was worked off. Silver put in a bottom right on cue with the composite which suggested a bottom in late June, with the correction composite suggesting strength in silver into late August. After August there is still the potential for one more short-term correction in silver heading into September before the final low is seen.
Source: Bloomberg
Conclusion
Looking at the current picture for the USD and the overall backdrop in global financial markets suggest a large move is coming for the greenback, and thus precious metals. If there is a sovereign debt default in Europe we could have another Lehman Brothers-like financial event in which massive deleveraging and margin calls ensue which sends investors fleeing for traditional safe havens like the USD. Such a scenario would likely witness stock markets decline considerably along with precious metals equities. Gold bullion may also serve as a safe haven for investors and hold up well, but if deflationary concerns mount and/or if margin calls escalate, gold bullion may also suffer from a global sell off as it did later in 2008. Conversely, if European leaders can finally work cohesively to put together a real solution for the European crisis or kick the can sufficiently far enough down the road that we have a period of calm for more than a year, and if Fed Chairman Bernanke launches another round of quantitative easing, then we will likely see a major selloff in the USD which sends precious metals vaulting northwards. Given it is currently unknown which bullish or bearish scenario will play out, investors in precious metals need to remain flexible or they may be caught by a bearish surprise (2008) or the gold bears will get taken to the cleaners as they did in the late 1970s. Given the uncertainty to the eventual outcome, watching the USD’s price action should be priority number one over the next few weeks. Currently the USD is in a bullish short-term trend while its intermediate and longer-term trends are bearish. If the USD rolls over then the 1978 analog will more likely come into play than the 2008 analog, and if the USD breaks its 2008 low those in cash need to beware. Likewise, given the dollar is in the vicinity of major support (2008 and 2009 lows) the possibility of a significant low remains and precious metal bulls should not throw caution to the wind.
Click here to access Part 1 of "Big Move Coming for Precious Metals"
