Deja Vu for the Precious Metals

Deja Vu for the Precious Metals

The precious metals sector has been through quite a rollercoaster ride since we last talked about it back in May of last year. At the time of that post http://kiwiblackers.blogspot.co.nz/2013/05/a-dead-cat-bounce.html , gold had crashed through important support levels around $1530 and plunged as low as $1321 before staging a weak rally. The question at that time was whether or not gold had bottomed and would continue to rally or would the bounce soon peter out to be followed by more weakness. In that post I clearly outlined the reasons why I felt that the rally was a 'dead cat bounce' and that gold and silver still had a long way to fall before reaching a true bottom, I also mentioned a price projection in gold showing a downside target of $1070.

Subsequently both the metals resumed their descent, reaching new lows in July last year of $1179 in gold and $18.17 in silver, after which they again rallied before falling to test these levels of support once again in December. At this point the support levels held, forming a 'double bottom' chart pattern, reinforcing that level of support and allowing the metals to once again stage a rally. 

We can see this double bottom illustrated in the chart below.

 In this chart we can also see the rally that carried prices up to a high of $1392 in gold before topping out and suffering a sharp correction over the last couple of weeks.

So here we are again with the metals at a point of indecision-  Will they recover, resume their rally and finally end the correction that has been ongoing since mid 2011, or will they once again crash through these support levels and carry on to new lows?

To find the answers lets take another look at some of the factors that influenced our decision the last time around, our answers then and how it currently looks.

• At a genuine low we should expect the rebound to be strong with good volume as buyers return to the market and chase the price higher. Whilst this could still occur, thus far the recovery off the lows has been relatively weak with low volume. 

This time around the volume was once again unremarkable, and certainly not the surge in volume that would suggest a sustainable rally.

• As was discussed in 'Gold Revisited' the move through the long-term support level in gold has triggered a downside price objective of $1070 and whilst this might not eventuate, it is far from a positive development.  

This downside target still exists and has not been altered by the bounce from the double bottom, in fact it would need a rally up to around $1800 to invalidate the signal. Although we must remember that these targets are not always reached, it is still a bearish sign.

• On a price move as violent as we witnessed I would have expected the 'commercials' to have aggressively covered their short positions, but the latest COT data below shows that although they have bought back some of their 'shorts' it has hardly been dramatic, suggesting to me that they expect another bite at that cherry.  

 Lets look at the current Gold COT picture below.
 
 

You will recall that the red bars signify the net long/short position of the commercials, who for want of a better description we can think of as the professionals, the people that know what they are doing. We can see that the commercials did reduce their short positions substantially, reaching there lowest in July and December, the two periods during which the double bottom occurred, what a coincidence! However, since those December lows their short positions have expanded rapidly, and recently reached there biggest levels in almost a year. This does not paint a pretty picture for the bulls.

If we look at the Silver COT chart for confirmation, the situation is even more pronounced.

• Lastly, we are entering the weakest period of the year for precious metals. Traditionally gold prices enjoy three bullish periods within the calender year driven by demand for physical gold, the first of which is the buying induced by the Chinese New Year celebrations around January/February. The second period is around August/September when Asian farmers harvest their crops and invest the profits into physical gold, and lastly the Indian marriage season that lasts from September through to November which creates the biggest demand spike of all, as gold is a hugely important part of most Indian wedding ceremonies in its form as a dowry. This May to July timeframe is absent of any drivers of physical demand so we often witness weakness in the precious metals during this period.

This seasonal affect still holds true although it can be over-ridden to an extent by other more powerful factors in some years, but absent of something abnormal we should expect the precious metals to under-perform through this May to July timeframe.

All of these factors seem to point towards further weakness in the precious metals, however we should also expect this bearish outlook to be mirrored in the  outlook for the share prices of companies in the sector. A good proxy for the sector is the Market Vectors Gold Mining Index or GDX, so let's have a look at a point and figure chart to see if it gives us a target price.

 This seems to confirm the bearish outlook and gives us a downside target of $19.62, almost a 20% drop from current levels.

When we combine these factors it looks increasingly unlikely that we have seen a sustainable bottom in the precious metals, and as a consequence I still expect that $1170 price target in gold to be reached in due course. 

When and if it is, expect it to be accompanied by a chorus of calls declaring the end of gold and silver as an investment, experts suggesting the next stop is $600 in gold, and investors throwing in the towel swearing they will never touch the shares or metals again. This will be the anecdotal evidence we need to tell us the end of the correction is finally here, and the beginning of the rally that will take the precious metals back to their old highs and beyond has arrived.