Without fail, at least once a year, we see precious metals buck the uptrend like a ferocious bull coming out of a bucking chute (the small enclosure which opens from the side in an arena). For 8 seconds, it's our job to grip the braided rope in our riding hand, while the other remains free, as all 2800 pounds of the gold bull market bucks, rears, kicks, spins, and twists in an effort to throw us off the greatest bull market of the last 10 years.
The typical buck from the precious metals bull can reach a correction of up to 30%. Remember the 10-week rodeo from December 2009 to February 2010? That was a 28.7% correction from the .40 high in the diversified Market Vectors Gold Miners ETF (GDX) to a low of .48. Currently, from the high of .62 on December 7th, 2010, to .44 (as I write today), GDX has experienced a correction of 15.7%. So if this is your first rodeo, hold on tight!
Let's cover some of the talking points on why gold is falling, or what market pundits, newsletter writers, and the Street attribute this correction to:
- The Commodity Futures Trading Commission (CFTC) raising of margin requirements on precious metal futures contracts.
- As the economy strengthens, the Federal Reserve Bank may need to cancel its QE 2.0 project.
- Daniel Shak's million hedge fund held gold contracts valued at more than 0 million. Monday he liquidated and returned money to his clients. That's more than 10% of the main U.S. futures market and the equivalent of South Africa's annual gold production.
- Fears that the world central banks will raise rates enough to stifle inflation.
My belief is that precious metals stocks fell on three things alone: it was an extended run, there was excessive bullishness, and technical (i.e. psychological) supports were broken. Selling begets more selling. Even Daniel Shak's sale is more a reaction to the correction than the cause of the correction. "Daniel Shak told the newspaper that the trade had been profitable for him for years, but it stopped working" – Huge U.S. gold position liquidated by fund - WSJ.
**I apologize in advance if some of the discussion ahead lies in a different, financial language than many understand, but the reason for it is due primarily in my belief that we are merely going through a technical correction, a reversion to the mean correction, and one that is healthy for this bull market.**
Looking at the chart on the Gold Miners Index (GDX), momentum clearly slowed in December when the index failed to reach new highs. This also occurred in the last rodeo of January 2010. When momentum fails to support higher prices, the commodity beast unleashes its full arsenal of twists, bucks, and spins to jolt the precious metals investor off this bull. As traders become more convinced that a reversal is in the making, they sell and go short the commodity.
Breaking below support and the 50-day moving average on January 4th was a significant technical marker (key break above) that gave sellers and short-sellers the green light that a reversal was at hand; even more so when the index failed to rally above that price level on January 11th, 12th, and 13th when sellers resumed control of the near-term trend down. However, we’re at a price level now that was previously a source of major supply in December 2009, May 2010, and July of 2010. The same supply level gave way in September of 2010. Sellers who have missed the rally since September are likely wanting to buy back in at the same price level they got out. That’s how resistance becomes support on charts.
To emphasize how important this price level is for the index, here is a 4-year chart showing the index's prior all-time high back in 2008, which we surpassed late last year.
For the trend in precious metal miners, it is pivotal that we maintain above this zone. Not only are we sitting on the 200-day moving average (a long-term psychological trend indicator) but also on the 3-year resistance zone that was broken last fall. If GDX fails to remain above these levels (and it is possible that GDX could briefly trade below these levels, which would trigger stop-loss selling and capitulation of selling pressure) then the breakout above this price level will have acted as one very large bull trap. Naturally, through the course of mass psychology, price levels are typically retested. We're currently doing that now. The direction the Gold Miner Index trends over the next week or two, from here, will very much affect the long-term trend for precious metals in 2011.
The precious metal industry was a top performer in the second half of 2010. For 5 months, the bull relentlessly charged forward to higher highs; however, over the past two months, the bull noticed us riding him and has now gone through the bucks, twists, turns, and kicks of a rodeo to throw us off. This is our 46th rodeo. As such, there have been 46 corrections in precious metals that PFS Group has ridden since we began investing in precious metals in 2002. The long-term fundamentals haven't changed for this theme. The intermediate-term trends may shift a couple of times a year (i.e. safety trade, risk trade, risk-off trade). This week should be significant in telling us gold’s intermediate-term trend. Rallies at the 200 DMA have been found in many individual miners here. $28 is a key level for silver to get above. We’ve been telling our clients since 2002, “buckle up because it’s going to be a bumpy ride” – and we weren’t joking! So don your cowboy hat, put on your leather chaps, your leather gloves, and spin your spurs because you're riding in a gold rodeo.
