Briefly: in our opinion, full (300% of the regular position size) speculative short positions in junior mining stocks are justified from the risk/reward point of view at the moment of publishing this Alert.
Let’s start today’s analysis with a question that just hit our inbox, as it provides a good intro to today’s technical discussion:
Q: I really appreciate your services and technical support. Do you think the Pelosi/Taiwan news is giving gold and junior miners a bump? If so, how long will the bump last? It looks like Biden might be lifting China tariffs in exchange for Pelosi’s visit to Taiwan. What effects does lifting China’s tariffs have on PM and junior miners?
A: The bump is probably over – the visit had already started and there were no military repercussions.
If Biden is going to lift China’s tariffs, it’s likely to contribute to further declines in the precious metals sector. Why? Because it means greater cooperation and peace in general. Geopolitical conflicts tend to cause gold to rally, at least temporarily. Consequently, when conflicts de-escalate, it’s likely to remove some of the safe-haven appeal that gold (and the rest of the sector) has.
Please note how remarkable it is that technical tools can provide us with insights as to what’s likely to happen even before we get to know what the direct reason for a given move is.
How could that be the case? Because it is not the news itself that drives the price, but rather the news that is filtered through what people want to react to based on emotional/technical grounds.
You know what, let’s make today’s issue a bit more interactive.
In order to show you how the above works in practice, let’s do a quick exercise (no worries, you won’t have to even change the position in which you are at the moment of reading these words, and it will take less than 2 minutes).
Okay, please take 20-30 seconds or look around the room/space you are in right now and memorize all items that are red – as if you had to list as many as possible shortly.
I don’t want you to see the following part of the exercise yet, so I’ll put many dots below. Please scroll down only after you complete the above part of the exercise and you have memorized as many red items as possible in 20-30 seconds.
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Now, for the second (and final) part of the exercise, immediately after finishing this sentence (don’t look around again), please close your eyes, and check how many blue items you can recall (yes, blue, not red).
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So, how was it?
Most people say that it was difficult to recall items in a different color because when they focused on one color, everything else was out of focus and was more or less ignored.
It’s the same with pretty much anything – including how the markets react to news.
When markets really “want” to move in a certain direction because of emotional/technical/cyclical reasons, it’s as if they were focusing on the “red items”. If a piece of news comes out that confirms this narrative (it supports the original expectation = “it’s red”), then the markets will react strongly. However, if they see something that contradicts it (against the narrative = “blue”), then they either react only a little, or not at all, or only briefly.
By the way, that’s why it’s a good idea to practice gratitude – one’s brain is then focused on noticing good things, and thus life becomes more beautiful and pleasant.
Yesterday’s news resulted in price moves that were likely to happen, not because of “magic”, but because these reversals (or something similarly bearish) were likely to happen anyway. The news just happened to fit.
However, since it’s not as simple as “gold reverses on Pelosi visit,” the majority of people writing about markets won’t be able to forecast the reversal beforehand.
Here’s what I wrote about the USD Index previously:
This move is in tune with what we saw at previous local bottoms. The RSI moved slightly below 50, and it’s the turn of the month – this combination was enough to trigger rallies in the U.S. dollar index.
Let’s keep in mind that the latter tends to form important bottoms close to the middle of the year.
So, the scenario in which the USD Index bottoms shortly (or that it just bottomed) seems quite likely.
There’s also the possibility that the USD Index keeps declining until it reaches the very strong support at about the 104 level – the previous long-term highs. Right now, it’s at about 105.5, which means that it could decline by another 1.5 index points or so. It doesn’t necessarily mean that gold, silver, and mining stocks would need to rally substantially if the above materialized. Conversely, since gold might now be reluctant to react to the USD’s lead and miners might be reluctant to react to gold’s lead, it seems that the possible upside for junior miners is very limited.
In other words, even if the big decline really picks up in a few weeks, I think that the risk-to-reward ratio already favors being on the short side of the precious metals sector. In particular, on the short side of the junior mining stocks.
That’s exactly what happened.
The USD Index declined quite visibly yesterday, almost reached its 50-day moving average, and then rallied back up – very close to the turn of the month.
Was that the final short-term bottom? It might have been, but it could still be the case that it moves to 104 in order to bottom there. However, even if that happens, it won’t change the fact that gold didn’t want to react to lower USDX prices recently, and thus the additional decline in the USDX would only be likely to trigger back-and-forth movement in gold, not a profound rally.
The above gold futures chart doesn’t fully show the extent of yesterday’s decline (the data will likely catch up after today’s session), but it does tell us that gold just verified the move back to the neck level of the previously broken head and shoulders pattern. A decline from here will have profoundly bearish implications because, based on this pattern, gold is likely to decline to at least $1,540.
While the GLD ETF declined by 0.59% yesterday, the GDXJ ETF – a proxy for junior mining stocks – declined by 1.34% (in terms of the daily closing prices).
After moving to the 23.6% Fibonacci retracement level and above the neck level of the previously broken head and shoulders pattern, the GDXJ declined, and ended the day 1.34% higher, thus making our short positions profitable.
The stochastic indicator flashed a sell signal, and there were only a few times this year when that happened, while the RSI was very close to the 70 level. That was at the March, April, and early-June peaks. These were all important tops, and the two most recent ones were followed by significant short-term declines. It seems that we’re likely to see one once again.
This means that my previous comments on the above chart remain up-to-date.
What’s also quite interesting on the above chart is the similarity between the recent upswing and the one that we saw in May and early June. In fact, even the timing relative to the days of the month is similar.
The previous rally started right before the middle of May, while the current upswing began just before the middle of July. The previous one consisted of two smaller rallies, which I marked with blue dashed lines and copied to the current situation. The first part of the move that we saw in July was not as big as in May, but the timing of the reversals was almost identical.
The second small rally is also aligned – at least so far. If this self-similar pattern is to continue, junior mining stocks are likely to top any day now, and the same goes for other mining stocks, silver, and gold. In fact, perhaps they have just topped.
Having said that, let’s take a look at the market from a more fundamental point of view.
Fixing Mistakes
While risk assets remain relatively elevated due to hopes of a dovish pivot, I warned on Aug. 1 that fundamental realities suggest investors shouldn’t hold their breath. I wrote:
The PMs rallied on Jul. 29, as Powell’s pain is commodities’ gain. However, with the Fed chief undoing weeks of inflation progress with his poor communication, don’t be surprised if Fed officials ratchet up the hawkish rhetoric in the days/weeks ahead. Because if not, a hyperinflationary collapse may greet the U.S. in 2023.
To that point, with Fed Chairman Jerome Powell’s dovish press conference on Jul. 27 loosening financial conditions and suppressing real yields, I noted that the developments make his inflation fight more difficult. However, with his deputies making the rounds on Aug. 2, they attempted to put out the dovish fire.
For example, San Francisco Fed President Mary Daly said on Aug. 2:
“People are still struggling with the higher prices they’re paying and the rising prices. The number of people who can’t afford this week what they paid for with ease six months ago just means our work is far from done.”
As a result, she shares our belief that pausing rate hikes amid 9%+ annualized inflation is a recipe for disaster.
Please see below:
Source: CNBC
Furthermore, with the futures market pricing in rate cuts in 2023, market participants’ addiction to stimulus has clouded their judgment. To explain, I wrote on Jul. 26:
With the futures market expecting Powell to pivot, the front-running is in full swing.
Please see below:
To explain, the light and dark blue bars above track the market-implied rate hikes on Jun. 13 and Jul. 25. If you analyze the height of the light blue bars, you can see that investors had priced in rate hikes through March 2023 (the final bar that reaches 25 bps).
However, the dark blue bars highlight how those expectations have materially decelerated. For example, market participants now expect the Fed to be done hiking by December 2022 and to begin cutting rates in 2023 (the negative dark blue bars).
However, Daly said on Aug. 2: “That’s a puzzle to me. I don’t know where they find that in the data. To me, that would not be my model outlook.” Thus, while it often takes time for investors to digest the ramifications of fundamental reality, Fed officials realized that looser financial conditions impede their goals.
As further evidence, Chicago Fed President Charles Evans said on Aug. 2: “We want to get a little restrictive expeditiously. We want to see if the real side effects are going to start coming back in line (...) or if we have a lot more ahead of us.”
As such, he said that a 50 or 75 basis point rate hike is prudent in September.
Please see below:
Source: CNBC
Making three of a kind, Cleveland Fed President Loretta Mester also delivered a dose of reality on Aug. 2:
Source: Reuters
Thus, while I’ve warned for many months that the Fed’s war on inflation will be one of attrition, loosening financial conditions and suppressing real yields only worsen the situation. Therefore, investors’ expectations of a 3% U.S. federal funds rate (FFR), 2023 rate cuts, and 2% inflation are pie in the sky.
In contrast, the Fed will need to push the FFR materially above 3% (likely ~4.5% or higher) to curb inflation. Moreover, even that’s a conservative estimate given that nearly 70 years of data shows the FFR needs to meet the year-over-year (YoY) percentage change in the headline Consumer Price Index (CPI) at or near its peak. As such, with a 9%+ CPI already on the books, meeting the metric halfway is likely the Fed’s best-case scenario.
Higher for Longer
While I've been sounding the rate hike alarm for many months, and the liquidity drain has helped upend gold, silver, and mining stocks, the former should have more upside, while the latter should have more downside.
For example, Charlie McElligott, head of Cross-Asset Macro Strategy at Nomura, told clients on Aug. 2:
“The Fed's problem is simple: the market has reflexively built-in a message that not just 'Peak Fed Tightening' is behind us already, but that we're about to cut Rates in early '23, as evidenced by U.S. 10Y Real Yields collapsing 70bps in two weeks – which has then dictated a wholesale risk-asset explosion higher from Equities to Credit to Long Duration, as U.S. financial conditions then impulse ease in an extremely counter-productive dynamic for the Fed's ‘inflation fighting’ mandate.”
Moreover, as another dose of reality, he added:
“Inflation is simply in no position to return to the ‘old world’ of 2% without a further escalation of FCI hawkishness from the Fed.”
Please see below:
Source: Bloomberg/Zero Hedge
To explain, the black line above tracks the Bloomberg Financial Conditions Index (FCI). For context, the basket tracks the direction of variables like the U.S. dollar, stocks, interest rates, and credit spreads. Moreover, when the black line falls, financial conditions tighten, and when the black line rises, financial conditions loosen.
If you analyze the right side of the chart, you can see that the FCI has risen sharply recently. However, showcasing a clear technical downtrend, the FCI has made lower highs and lower lows since late 2021.
Therefore, it’s no surprise that Fed officials were on the hawkish prowl on Aug. 2. Furthermore, while I wrote on Aug. 1 that tighter financial conditions are required to reduce inflation, the bond market heard Fed officials’ message loud and clear on Aug. 2:
Source: Investing.com
Rising Rents
With the Shelter CPI accounting for more than 30% of the headline CPI’s movement, rent inflation is material. Moreover, with Apartment List releasing its National Rent Report on Jul. 27, the results showed that rents increased by 1.1% month-over-month (MoM) in July.
Please see below:
In addition, the report stated:
“Rents increased this month in 87 of the nation’s 100 largest cities (…). In the seven months of this year, our national rent index has increased by 6.7 percent, well below last year’s 12.0 percent increase over the same months. However, this year’s pace is also still notably faster than that of the years prior to 2021. For comparison, rent growth from January to July totaled 4.0 percent in 2017, 4.5 percent in 2018, 4.1 percent in 2019, and -0.4 percent in 2020.”
As a result, 2022 seven-month rent inflation is nearly 2x and 3x the annual figures from 2018 and 2019.
Please see below:
On top of that, the report revealed:
“Our national vacancy index held steady at 5 percent this month. Our vacancy index has been gradually easing from a low of 4.1 percent last fall, but that easing now appears to be leveling off at a rate that remains well below the pre-pandemic norm. This may be at least partially attributable to spiking mortgage rates, which can contribute to tightness in the rental market by sidelining potential first-time homebuyers.”
Remember, higher interest rates make mortgages less affordable and decrease the loan amounts that applicants can obtain. As such, while higher interest rates are needed to cool overall inflation, they stimulate rent inflation by reducing the supply of homebuyers and, therefore, increasing the supply of renters.
Likewise, the relationship is not a gimmick that Fed officials can ignore. For example, the Shelter CPI hit a 2022 high of 5.61% YoY in June. However, the S&P/Case-Shiller U.S. National Home Price Index hit an all-time high of 20.63% YoY in March. As a result, if we swappes rent inflation for home price inflation, the headline CPI would be much higher.
Therefore, the former is playing catch-up, and further interest rate hikes should increase rent inflation’s ascent over the medium term. Thus, the dynamic is bullish for the Shelter CPI and the headline CPI.
Apartment List concluded:
“As we enter the fall and winter months, rental activity tends to slow, and we are likely to see rent growth continue to cool. However, there are no signs that prices will actually fall in a meaningful way, meaning that American renters will continue to be burdened by historically high housing costs.”
The Bottom Line
With reality returning to the financial markets on Aug. 2, the GDXJ ETF underperformed the S&P 500. Moreover, with Fed officials knocking some sense into the bulls, my comments from Apr. 6 continue to prove prescient:
Please remember that the Fed needs to slow the U.S. economy to calm inflation, and rising asset prices are mutually exclusive to this goal. Therefore, officials should keep hammering the financial markets until investors finally get the message.
Moreover, with the Fed in inflation-fighting mode and reformed doves warning that the U.S. economy “could teeter” as the drama unfolds, the reality is that there is no easy solution to the Fed’s problem. To calm inflation, it has to kill demand. If that occurs, investors should suffer a severe crisis of confidence.
In conclusion, the PMs were mixed on Aug. 2, as gold closed in the green. However, with the USD Index and U.S. Treasury yields rallying sharply, the PMs’ main adversaries showcased their fundamental might. As a result, more downside should confront gold, silver, and mining stocks over the medium term.
Overview of the Upcoming Part of the Decline
- It seems to me that the corrective upswing is either over or about to be over, and that the next big move lower is about to start.
- If we see a situation where miners slide in a meaningful and volatile way while silver doesn’t (it just declines moderately), I plan to – once again – switch from short positions in miners to short positions in silver. At this time, it’s too early to say at what price levels this could take place and if we get this kind of opportunity at all – perhaps with gold prices close to $1,600.
- I plan to exit all remaining short positions once gold shows substantial strength relative to the USD Index while the latter is still rallying. This may be the case with gold prices close to $1,400. I expect silver to fall the hardest in the final part of the move. This moment (when gold performs very strongly against the rallying USD and miners are strong relative to gold after its substantial decline) is likely to be the best entry point for long-term investments, in my view. This can also happen with gold close to $1,400, but at the moment it’s too early to say with certainty.
- The above is based on the information available today, and it might change in the following days/weeks.
You will find my general overview of the outlook for gold on the chart below:
Please note that the above timing details are relatively broad and “for general overview only” – so that you know more or less what I think and how volatile I think the moves are likely to be – on an approximate basis. These time targets are not binding nor clear enough for me to think that they should be used for purchasing options, warrants, or similar instruments.
Summary
Summing up, it seems that the corrective upswing is over (or close to being over), which means that the powerful medium-term downtrend can now resume.
Last week, we closed yet another profitable trade in a row. This year’s profits are already enormous, but it seems likely to me that they will grow even more in the following weeks and months. Making money on corrections during powerful trends is a difficult feat, but you managed to do just that – congratulations!
Moreover, please note that it’s not only the profits on the long positions that are so great about this success – it’s also the ability to get back on the short side of the market at more favorable (higher) prices, thus increasing the likely profits from the current trade. Congratulations, once again!
Also, please note that I will be updating the targets for the leveraged ETFs as we move closer to them, as their prices will depend on the path prices take to reach their targets.
After the final sell-off (that takes gold to about $1,350-$1,500), I expect the precious metals to rally significantly. The final part of the decline might take as little as 1-5 weeks, so it's important to stay alert to any changes.
As always, we'll keep you – our subscribers – informed.
To summarize:
Trading capital (supplementary part of the portfolio; our opinion): Full speculative short positions (300% of the full position) in junior mining stocks are justified from the risk to reward point of view with the following binding exit profit-take price levels:
Mining stocks (price levels for the GDXJ ETF): binding profit-take exit price: $20.32; stop-loss: none (the volatility is too big to justify a stop-loss order in case of this particular trade)
Alternatively, if one seeks leverage, we’re providing the binding profit-take levels for the JDST (2x leveraged). The binding profit-take level for the JDST: $29.87; stop-loss for the JDST: none (the volatility is too big to justify a SL order in case of this particular trade).
For-your-information targets (our opinion; we continue to think that mining stocks are the preferred way of taking advantage of the upcoming price move, but if for whatever reason one wants / has to use silver or gold for this trade, we are providing the details anyway.):
Silver futures downside profit-take exit price: $12.32
SLV profit-take exit price: $11.32
ZSL profit-take exit price: $79.87
Gold futures downside profit-take exit price: $1,504
HGD.TO – alternative (Canadian) 2x inverse leveraged gold stocks ETF – the upside profit-take exit price: $19.87
HZD.TO – alternative (Canadian) 2x inverse leveraged silver ETF – the upside profit-take exit price: $49.87
Long-term capital (core part of the portfolio; our opinion): No positions (in other words: cash)
Insurance capital (core part of the portfolio; our opinion): Full position
Whether you’ve already subscribed or not, we encourage you to find out how to make the most of our alerts and read our replies to the most common alert-and-gold-trading-related-questions.
Please note that we describe the situation for the day that the alert is posted in the trading section. In other words, if we are writing about a speculative position, it means that it is up-to-date on the day it was posted. We are also featuring the initial target prices to decide whether keeping a position on a given day is in tune with your approach (some moves are too small for medium-term traders, and some might appear too big for day-traders).
Additionally, you might want to read why our stop-loss orders are usually relatively far from the current price.
Please note that a full position doesn't mean using all of the capital for a given trade. You will find details on our thoughts on gold portfolio structuring in the Key Insights section on our website.
As a reminder - "initial target price" means exactly that - an "initial" one. It's not a price level at which we suggest closing positions. If this becomes the case (as it did in the previous trade), we will refer to these levels as levels of exit orders (exactly as we've done previously). Stop-loss levels, however, are naturally not "initial", but something that, in our opinion, might be entered as an order.
Since it is impossible to synchronize target prices and stop-loss levels for all the ETFs and ETNs with the main markets that we provide these levels for (gold, silver and mining stocks - the GDX ETF), the stop-loss levels and target prices for other ETNs and ETF (among other: UGL, GLL, AGQ, ZSL, NUGT, DUST, JNUG, JDST) are provided as supplementary, and not as "final". This means that if a stop-loss or a target level is reached for any of the "additional instruments" (GLL for instance), but not for the "main instrument" (gold in this case), we will view positions in both gold and GLL as still open and the stop-loss for GLL would have to be moved lower. On the other hand, if gold moves to a stop-loss level but GLL doesn't, then we will view both positions (in gold and GLL) as closed. In other words, since it's not possible to be 100% certain that each related instrument moves to a given level when the underlying instrument does, we can't provide levels that would be binding. The levels that we do provide are our best estimate of the levels that will correspond to the levels in the underlying assets, but it will be the underlying assets that one will need to focus on regarding the signs pointing to closing a given position or keeping it open. We might adjust the levels in the "additional instruments" without adjusting the levels in the "main instruments", which will simply mean that we have improved our estimation of these levels, not that we changed our outlook on the markets. We are already working on a tool that would update these levels daily for the most popular ETFs, ETNs and individual mining stocks.
Our preferred ways to invest in and to trade gold along with the reasoning can be found in the how to buy gold section. Furthermore, our preferred ETFs and ETNs can be found in our Gold & Silver ETF Ranking.
As a reminder, Gold & Silver Trading Alerts are posted before or on each trading day (we usually post them before the opening bell, but we don't promise doing that each day). If there's anything urgent, we will send you an additional small alert before posting the main one.
Sincerely,
Przemyslaw K. Radomski, CFA
Founder, Editor-in-chief