Is the Time Right for the Precious Metals?

Back during those March lows of last year I wrote a post suggesting that it might be a good time to buy the Dow Jones index as it was sitting around some very strong support levels. This has proven correct, as the Dow has gone on to virtually double in price since then. However I was a little more reticent with the precious metals as I wrote at the time.....

There are some reasons to think that the precious metals have bottomed. With the exception of gold itself, silver and the miners have been hit hard and the charts are in oversold territory. However there are a few things nagging me. 

1.     Firstly, it feels like gold has benefited from a safe haven status (this is not surprising) and that some of that still needs to be washed out.

2.      The panic is not over yet, and forced liquidations should affect gold the same as everything else.

3.     The COT positions are still bearish despite some improvement.

4.     Despite being oversold, the technical indicators are not severely oversold which I would would expect to see at a major bottom.

5.     The 2015 low. It never felt like a true bottom to me. There just wasn't enough panic and liquidation for my liking. I may be wrong and we may not reach those levels on this move, but before going long I definitely want to see more downside, and I think the US dollar rally might be the trigger that causes it.

For the time being I'm happy to watch and wait with respect to the precious metals.

Unfortunately, my reticence was misplaced, with both metals proceeding to rally strongly, confirming that the corrections from the 2011 highs are over and that a new bull market has begun. Whilst missing the bottom is always frustrating, the good news is that now a bull market is confirmed we can look for a price correction to give us the opportunity to enter long positions. Which brings us nicely to the here and now.

Below is a weekly chart of the Gold price showing the collapse of March 2020, the subsequent bounce and the corrective wave since August of last year. We can see that the correction has now lasted for some time, that the technical indicators are all at the lower end of their ranges, and that gold is now around an area that has provided support in the past.

I have often used the Commitment of Traders reports in the past to give insights as to how the professionals are positioned relative to the speculators that tend to just follow the trend. If we look at the chart below we can see that the positioning has been pretty stable in the last year, with the professionals (known as commercials and represented by the red bars) maintaining a short position until the last few weeks when they have started to buy back their short position as prices have fallen.

The chart isn't yet compelling but it is reassuring, as if the commercials are now in the market buying gold on any weakness, this will act as a support to the price and likely reduce the magnitude of any further falls in price.

Lets now move on to the mining companies themselves. As we know, the miners tend to magnify the movements in the underlying metal by some margin, so are often the best place to take advantage of any price moves.

Below we can see the weekly chart of GDXJ, an index of some of the smaller gold mining companies. It unsurprisingly looks similar to the gold chart above, with a long correction, oversold technical indicators and price now close to areas of support.

So having outlined the bullish case for gold and the miners, what could go wrong?

Firstly is the fact that these corrections often take time to form a base, with a number of selloffs and rallies taking place in order to exhaust selling pressure and provide the basis for a sustainable rally. Therefore, just because the price reaches an area of support does not mean it just stops and rockets higher. The basing process can be a roller coaster, but this is where the charts come in. They give perspective, allowing us to see where the price is relative to any support levels and how oversold it is relative to previous corrections. Seeing the price with an historic context shows us that by previous standards, this seems a good entry point.

Secondly, whilst I've outlined many time previously why I am so bullish on US equities in the longer term, they have had a very good run recently. I don't think there is a crash coming, but there could be a short-lived selloff that should it occur would put downward pressure on the gold miners.

Lastly, the US dollar. Most of this last year it has been buffeted by the political circus going on in the US which has driven it down to its 100 day moving average as we can see in the chart below. However the recent uptick in bond yields in the US has got everybody worried about the likelihood of rising rates. This prospect of higher rates has been dollar positive and the price now seems to have turned with the technical indicators moving up from oversold levels, meaning it will likely resume its long term uptrend from 2014. 

Normally, a rising US dollar is bad news for any US$ based commodity, with their trends often inversely correlated.  And at this early point of the change in trend for the dollar, any strength will probably be taken as gold bearish and will put pressure on the gold price. However, we are living in anything but 'normal' times, and I expect to see both a rising dollar and rising commodity prices in the months and years ahead.

So if and when gold does rally, how do you get the best bang for your buck?

As I mentioned earlier, the miners tend to outperform gold itself, and the smaller miners tend to outperform the majors . There are numerous companies to choose from out there depending on your preference and risk profile, but one way of obtaining exposure whilst avoiding the 'eggs in one basket' problem from buying an individual share is by buying an exchange traded fund (ETF) of one of the gold mining companies indexes. These indexes are comprised of a number of underlying companies, with their profiles differing depending on what they are trying to achieve. 

One of the largest etf's is the VanEck  Vectors Gold Miners ETF (GDX). This contains some of the largest gold mining companies around and has traded for some years. An alternative is the VanEck Vectors Junior Gold Miners ETF (GDXJ). This contains some of the smaller companies and is therefore more volatile but with greater leverage to gold. Another to consider is the Sprott Junior Gold Miners ETF (SGDJ), which is also more focused towards the smaller companies with more volatility and more upside potential.

In conclusion, whilst the negative gold sentiment might continue a little longer and the price could well be buffeted accordingly, I think we are at or around a level where there is some good upside potential. It is always hard to buy when the price is falling and sentiment is rotten, but in bull markets they are the best opportunities, even when they don't feel like it at the time.

Lastly, you might be wondering why I haven't mentioned Silver. I am tremendously bullish on Silver in the medium to long term, but the price got taken up and over-extended on the recent Gamestop and Bitcoin frenzy and it has yet to fully correct. Historically, Silver is much more volatile than Gold and I expect there to be more downside before we reach a buying point. I will be doing an update on Silver shortly as that is one rally I don't want to miss.