It’s bitter medicine, but having lived through the aftermath of a few hurricanes I can tell you that the old adage is true: What doesn’t kill you makes you stronger, explains Brien Lundin, editor of Gold Newsletter.
And after living through more than a few massive booms and busts in the markets, as well as far more intra-year seasonal cycles in gold than I’d care to remember, even a hard-head like me has learned a few lessons.
And one of these is that massive washouts like the one we’re experiencing in gold right now are the fathers of subsequent rallies.
Also, those who learn to view these situations as opportunities instead of catastrophes can make a lot of money in these cyclical markets.
So am I still, truly, enthused about what gold represents right now after another month of declines? Is this really an opportunity, or is it actually a catastrophe after all?
It seems like this is always the way it works with gold. Rather than touch on support and quickly rebound like other markets seem to do while in a longer-term uptrend, gold tends...sadistically...to break support more convincingly — to punish the bulls and shake out all but the strongest holders.
Just as an example, we all know that the 200-day moving average is a key support level that’s closely watched for most commodities and asset classes.
In gold, however, I found that the 400-day moving average was much more useful as a support line during the metal’s long climb from 2001-2008. Gold wants to hurt you just a little more, test your convictions a bit more harshly, than other markets. Again and again.
Yes, gold has tested our patience over and over, for years. And it’s doing so right now, yet again. But as I said, the other lesson it’s taught us is that buying at these bottoms, when everyone’s giving up, is the key to maximizing your eventual gains in this cyclical asset.
It’s tough to do, to divorce yourself from the emotional swings of the gold market. But as the most successful speculators in the space have taught us, doing so can open the door to tremendous profits over the intermediate and long terms.
The downside risk at this point is minor in comparison with the upside potential if, indeed, gold rallies as we expect. Therefore, if gold breaks to $1,200 from current levels, that would represent a loss of about 2.4%. If it breaks to $1,150 (God forbid), that would be a fall of 6.5%.
I consider those numbers to be our realistic downside risk at this point, considering the level of political uncertainty in today’s world, coupled with the monetary certainty of rising price inflation and currency depreciation.
Granted, the junior mining stocks are leveraged to gold in both directions, but when they bottom out like they have at this point, their illiquidity actually works in our favor. In other words, their downside is limited because there’s no one to buy them from the sellers.
So let’s look at the potential upside from here. To get to the $1,372 level that represented gold’s high point of 2016 and recent ceiling, the metal would have to gain 11.6% from today’s price.
As a point of comparison, gold bottomed right around this time last year and then took off on a rally that culminated the first week of September with a gain of 11.2%. But that’s doesn’t represent our upside by any means. During last year’s late-summer rally, the Gold Bugs Index of gold producers rose 24% — or about 2.5x leverage to gold.
The juniors, though, offer much more leverage in a rising market. If gold gets back to the $1,370 area, I’d expect the top juniors (particularly those with large, established gold and/or silver resources) to at least double from current, dramatically oversold levels.
So, roughly a 5% downside risk in gold balanced against a potential upside of 100% or more in top-performing juniors. That’s the kind of risk/reward dynamic that I like.
Once again, it’s hard to be patient these days. But if we can bide our time and pick up some of the many enticing bargains out there right now, history says it will pay off generously.
Of course, our thesis will be wrong if gold doesn’t begin turning up soon. The good news is that evidence is growing that the price is bottoming now and poised to rally. Let’s take a look at some of the indicators worth watching.
The latest Commitment of Traders report from the CFTC shows that the large speculator category (again, money managers and hedge funds) had gone net short in gold for the first time in years.
This is important for a couple of reasons. First, the large speculators as categorized in the COT reports are almost always wrong on market direction.
Now, the lines have been blurred as to who’s a speculator and who isn’t in these reports. For example, many of the large bullion banks, which are amongst the most active traders in the market, are included in the “large commercials” category thanks to their hedging operations on behalf of some customers.
Still, whatever their true constituencies may be, the record very clearly shows that whenever the large speculators dramatically reduce their gold long positions it is a sign that the market is about to turn higher. The speculators, in other words, are usually wrong in their price prognostications.
Conversely, the large commercials are typically correct in their forecasts, and whenever this sector dramatically increases their short positioning in gold it is a sign that a downturn is in the offing.
Some analysts say that the commercials actually cause the downturn by dumping shorts hand-over-fist until the price craters, and I won’t disagree with this view. Regardless, the facts are the facts. And the large speculators have not only reduced their longs, but actually gone short.
That brings me to my other point: The last time the large speculators went net short in gold was January 2016 — just a couple of weeks after gold had reached its major, long-term bottom. The rally that followed this previous event was extraordinary — gold soared over 19% and many of the junior and senior mining stocks multiplied in price.
Pardon me a bit of repetition here, but the big picture story for gold is exceptionally bright. For one thing, the U.S. Federal debt is so large today that it demands a very significant depreciation of the U.S. dollar.
There’s simply no other way to address it. But every developed economy is in the same boat, with debts so massive that they can’t be managed through any fiscal means. The only solution is to debase the underlying currency.
And with every major currency forced to devalue, the only winner in the scenario will be gold. That’s the long-term inevitability. Over the more intermediate term, we’ve seen the Dollar Index bump up against solid resistance at the 95 level and, once again, fail to decisively break through.
The failure this time was due to jawboning by President Trump, who broke from tradition by decrying the Fed’s program of rate hikes. Of course, the Trump administration is demonstrably in favor of a weaker dollar and easier monetary policy. But whatever the cause, the fact remains that the dollar just hasn’t been able to break through its ceiling and gather any consistent upside momentum.
This supports my view that the dollar is mired in a longer-term bear market, with the rise of the past few months representing a brief countertrend rally.
With the dollar and gold maintaining an historically strong inverse correlation over the last couple of years, this infers that gold’s recent weakness is merely a correction within the major uptrend. Of course the markets will tell us if this is correct in due course.
