In our opinion short positions (half): gold, silver, and mining stocks are justified from the risk/reward perspective.
The entire precious metals sector declined yesterday, even gold. Has the situation changed enough to double the short position? Let’s take a closer look (charts courtesy of http://stockcharts.com).
Miners once again moved lower by more than 1% and the volume – while still not huge -- was higher than on the previous day. Increasing volume during a downswing is a bearish sign, especially that the day before the decline started we had seen a move up on tiny volume.
Miners moved below the October 2013 high, but they did not move below their previous local low (the most recent one) and back below the 50% Fibonacci retracement level. The situation is bearish, but it doesn’t look that it deteriorated.
Gold moved lower on relatively high volume, which is a bearish sign. We also saw another sell signal from the RSI and Stochastic indicators. The situation on the above chart has clearly deteriorated, but the move lower has not been significant enough yet to make the situation extremely bearish.
Yesterday, we wrote the following about the Euro Index:
The situation on the currency markets remains unchanged. The Euro Index is likely to decline based i.a. on the long-term declining resistance line that was recently reached, but not broken.
Even if we had assumed that there was a small breakout above the declining resistance line, it would have been invalidated yesterday. The short- and medium-term implications are bearish for the Euro Index and for the precious metals market. They will become stronger if we see continuation of the decline in the former.
Next page: The situation in the dollar
As one might have expected, a decline in the Euro Index meant a move higher in the USD Index. That’s not a surprise as the US Dollar was right at the medium-term support line and was likely to move higher once again shortly. Quoting Tuesday’s alert:
The medium-term USD Index chart suggests that we are still likely to see much higher USD values. The index is right at the long-term (or medium-term depending on one’s approach) support line and after a breakout. It’s an index just waiting to start a big rally. A rally in the USD Index to the 85 level or so would likely have a devastating effect on the precious metals market and this type of rally could be seen based on the above chart.
If the USD really rallies and gold refuses to decline, then we will be happy to conclude that the medium-term decline in the precious metals market is probably over. It simply doesn’t seem to be the case just yet.
The above remains up-to-date.
In Monday’s alert we commented extensively on the juniors’ outperformance and its implications. We summarized that it was not necessarily a bullish sign and that the last 4 years’ performance suggested that we were approaching a local top. We also wrote that the sell signal from the Stochastic indicator would be an important event – we wrote that a sell signal from Stochastic could actually trigger a decline on its own in the current state of the market.
We have just seen this signal, so the situation has further deteriorated from this perspective.
Last but not the least, we would like to discuss the situation in the silver market. We previously wrote about the 50-week moving average that was likely to keep the rally in check. Yesterday, silver invalidated a small, unconfirmed breakout above this resistance and at the same time moved back below the 2008 high. The bearish implications of these events will be much stronger if silver closes the week below these levels, but the outlook deteriorated somewhat based on yesterday’s price action anyway.
Also, please note that the volume is already quite significant for this week even though only 3 trading days have passed. Silver is declining this week, so this is a bearish indication.
All in all, we can summarize the situation by writing once again what we wrote yesterday: with the currency market being a major (!) threat to the precious metals market’s rally and indications that this market will move lower at least in the short run, we think the short positions are justified. The situation has deteriorated somewhat based on several signals, but it doesn’t seem to become extreme enough to justify doubling the short positions just yet.
To summarize once again:
Trading capital (our opinion): Short position (half): gold, silver, and mining stocks.
GDX ETF: $28.9
Long-term capital (our opinion): No positions
Insurance capital (our opinion): Full position
Please note that we have started to include the insurance capital on the above list in order to avoid the impression that we suggest being entirely out of the precious metals market. Those of you who have been with us for a long time are well aware of this, but since a lot of new subscribers have joined us recently, we though a quick reminder should be useful.
Next page: Portfolio example...
We have expressed our opinion regarding being out with one’s long-term investment capital, but being in as far as the insurance capital (physical precious metals holdings) is concerned. You will find details on our thoughts on gold portfolio structuring in the Key Insights section, but in short, it depends on your approach and experience. Below you will find a “portfolio” that we created for Eric -- the fictional character that we use to illustrate suggestions (not investment recommendations) for beginning investors. More precisely, this was the portfolio before we suggested moving out of the precious metals market (so, before April 2013).
Click to enlarge...
Now the “investment” category would be 0%, but the insurance remains at 44.1%. Please note that the average size for the trading position (we provide the netted amount in the above points regarding positions / trades) is just 1.4% of the entire capital in this case, so half of the position means using just 0.7% (11.8% is kept in cash / dedicated to trading but only a part of it is used for each trade). The entire portfolio report provides also 2 other fictional characters and their “portfolios”. John being the proxy for an experienced investor is the other extreme (Eric being the beginner). He “has” 17.6% in insurance capital and the average size of his trading position is 31.6% (half of which is 15.8%).
The bottom line is that if you assume that precious metals have much further to go (beyond 2011 highs) like we do, having just some money in the sector might appear as being out – and opening a small speculative short position in addition to it might seem as betting against it. When one looks at it from a “fresh perspective” without any assumptions about the gold bull and reads about shorting, they might get the impression that we suggest being entirely out of the market, which is not the case. Actually, the netted effect of small speculative short positions is simply hedging the insurance capital to a smaller or greater extent. It might be more than that if we suggest doubling the size of the short position, but that’s not the case just yet. Of course the above is not an investment advice and consulting an investment advisor before taking action regarding your portfolio is encouraged.
As always, we'll keep our subscribers updated should our views on the market change. We will continue to send them our Gold & Silver Trading Alerts on each trading day and we will send additional ones whenever appropriate. If you'd like to receive them, please subscribe today.