Is the Correction in Gold and Silver Over or Just Beginning?

This week we have seen precious metals and mining stocks peak, just as I've indicated previously. In the summary of last week's update I wrote that "Although prices of gold, silver and mining stocks are reaching their own resistance levels, such a correction will most likely be caused by some kind of catalyst, probably a strong move in the U.S. Dollar, or in the general stock market". It turned out that the catalyst was in fact the U.S. Dollar, however I will get back to this issue later in this update.

I will start explaining my opinion on the current situation on the precious metals market, by covering one of our indicators (from the Charts section). It has been particularly useful in determining bottoms during the big comeback of the precious metals sector (approximately since October 2008). The SP Short Term Gold Stock Bottom Indicator has signaled virtually every important local bottom in the previous 8 months, and thus it is definitely worth including in this update. Please take a look at the chart below for details.

For those of you, who are not yet familiar with the Charts section - the buy signal is given, when indicator is below the dashed line and starts to rise (when value of the indicator has been falling for 3 consecutive days and then the next day is higher). It is based on data from more than one market (it's much more complex than ratios).

It was at the end of March 2009 when this indicator flashed the last "buy" signal. The reason that I mention this indicator today is not because of what it has just signaled, but because of the fact that it did NOT signal anything so far, and this situation is likely to change in the near future. Naturally, just as this indicator's name suggests, I have designed it to help us determine particularly favorable moments to add to our long- and / or close / limit short positions in PM stocks. Since this indicator's performance has been so impressive in the recent months, it makes sense to take a closer look at the way it works.

As I mentioned above, the first condition that needs to be met in order for this indicator to signal a speculative buying opportunity is that it needs to be below the dashed line. This line corresponds to the 0% level in the right vertical axis. Once the indicator goes below the dashed line, it will flash "buy" as soon as it turns up. Right now we have just seen this indicator break below the 0% level, so the "buy signal" is rather near. Of course, it may continue to fall for an additional week or two, but the history shows that it turns up rather quickly after going below the dashed line.

The implication of the above analysis for anyone interested in PM stocks is that we may soon have a favorable buying opportunity, as this indicator turns up. Naturally, many factors need to be considered (definitely more than one indicator), but given the extraordinary performance of this particular technique, one should not ignore it.

A similar thing can be said about physical metals, as they usually move together with the mining stocks (usually lagging behind them, but there are many exceptions from this general rule). In other words - gold and silver are positively correlated with mining stocks.

USD Index

Last week I mentioned that USD Index is in the oversold territory and bound for a quick bounce. This week that pullback materialized.

USD Index briefly touched the 61.8% Fibonacci retracement level and bounced. The question here is whether this was the ultimate bottom (unlikely in my view), a correction that is already completed (more likely), or the beginning of a several-week correction (even more likely).

For more detailed signals we need to consider a short term chart.

The short-term chart gives us additional resistance levels that might stop this rally, but none of them provides one decisive resistance level. Rallies that begin with a fake breakout tend to be stronger than those who begin in a different way, so I expect this rally to continue in the following days. It's too early to say where exactly this rally will end, but nonetheless I've marked the most probable topping area with a red ellipse. This corresponds to approximately 82-83 level.

In sum, the USD Index appears to have put a local bottom. It is too early to say where and when this rally may end, but short-term factors suggest that it will go above the 82 level. Analysis of USD Index from a long-term perspective provides us with additional details.

Gold

This week gold has moved lower along with rise in the value of USD Index. As I mentioned above, U.S. Dollar is likely to move higher in the following days / weeks, we may see gold move even lower on a short-term basis. This is confirmed by the high, negative correlation between USD and gold, and the way volume shaped during the previous week.

If you looked at the volume from a broad perspective, you would not see anything extraordinary - the average value of volume has been neither exceptionally high, nor low. However, once you consider details, the outlook becomes rather bearish in the short term. The point here is that volume has been declining while gold has been rising and it rose along with declining gold price. Volume usually confirms the direction in which the market is headed, and this time it points to lower prices in coming days. Naturally, a day or two of pause are possible (and also quite likely), as gold is currently just at its support level, but still - it is likely that gold will move lower in the short term.

Silver

Similar analysis can also be applied to the silver market.

As mentioned above, from the short term point of view, the situation in the silver market is currently similar to the one on the gold market. Moreover, the volume gives much clearer signals, as the difference between days when price of silver rose and days when it fell, is even more evident. Therefore, the silver market may also experience a correction from here.

Summary

The USD Index has just bounced after having declined for a month, which led to lower values throughout the whole PM sector. Taking into account dollar's previous correction and the technical situation in gold, silver, and mining stocks, we may expect this correction to continue for the next few days / weeks. Once this "breather" is complete, we will probably have a favorable buying opportunity, which will most likely be confirmed by indicators from our Charts section.

Naturally, the long-term situation still remains bullish for the whole PM sector, as the fundamentals are favorable.

Disclosure: No positions

Comments

[enngee:]

Really helpful article.

Jun 09 08:48 AM

[Mr_Nick:]

I appreciate the way his articles are well structured (beginning, middle and end). The story is told in a logical and well described manner. I can follow the thinking and understand the conclusions. Very good.

Jun 09 09:29 AM

[DONE_SONZ:]

Fundamentals trump technicals.Inflation,debt defaults,0% interest rates,debt monetizing,currency crisis looming,gold hoarding,gold cartel playing with fire, to name a few.Yeah,go ahead and bet on the dollar .Nice try.

Jun 09 10:51 AM

[Larry House:]

How many people actually trade in and out of gold? Just buy gold and silver bullion and hold it.

Jun 09 12:08 PM

[bowman711:]

I hope you are right. I bought $15 (in the money) puts yesterday morning to cover all my SLV holdings.

To Larry house - you don't need to trade in and out, but you can hedge with options to (hopefully) profit from the ups and down in your precious metals holdings. I suppose I could have sold calls, but then you run the risk of some world calamity happening, gold and silver shooting way up . . . and having to sell your holdings way below their then value. [With puts, all one would lose is what you paid for them, in my case, $1.65/share.]

Jun 09 12:48 PM

[silverwood:]

In brousing about the internet I have read many articles from technical traders about gold/silver and US$ current situation. My take on this is this $1000 level or gold making a new higher high is being fought by those forces opposed to gold. These forces must defend the US$ for that is their strength. They have the ability to steer markets in whatever direction they need on a short term basis. This in turn paints the charts for technical traders using them to support their direction. Also some well placed media spin will be used to support all this. If one is nimble enough you could play this with various paper gold/silver instruments. Meanwhile I am patiently waiting for gold's new higher high which just matter of when and not if. Stay long all physical gold/silver position.

Jun 09 01:00 PM

[Przemyslaw ...:]

Fundamentals are the thing that matters the most in the long term and I couldn't agree more that they are favorable for the precious metals sector.

Still, in the short run, fundamentals will not help you to determine the best time/price level for your trades in any market. Short run is determined by investors'/speculators' emotions and this is where technicals become useful.

Of course, one should use the methodology that best suits them and their risk preferences, however my research indicates that using both: long- and short-term approach leads to best resutls. Please refer to this essay www.sunshineprofits.co... for details.


On Jun 09 10:51 AM DONE_SONZ wrote:

> Fundamentals trump technicals.Inflation,debt defaults,0% interest
> rates,debt monetizing,currency crisis looming,gold hoarding,gold
> cartel playing with fire, to name a few.Yeah,go ahead and bet on
> the dollar .Nice try.

Jun 09 02:17 PM

[Spartacuss:]

I have been exposed to the "technicals" over the last 30 years and have seen several of my friends going "technical" in a big way and have lost their shirts. In statistical analysis, one finds that a thing cannot be a function of itself, period.

However, that is not to say that if most traders are "technical" then we get the self fulfilling prophecy effect in which case this mantra becmes dejour and one tends to pay some attention. However, I firmly believe that the fundamentals are the key to good long term investment along with trend. Unfortunately, the market is perhaps more driven by emotion than reason and that factor provides substantial risk especially in a stress environment such as we have now.

And then to make things even more spicy for the metals is the nice government men who do not want to see an avenue of escape for those who want out of the dollar, and, I suspect that the nice government men are going to find more ways to prevent you from getting out of the dollar, even to the point of outright confiscations disquised as "new" taxes.

For G and S, buy the dips and hold but don't trade.

Jun 09 02:40 PM

[Donald Ingram:]

The markets will swing back and forth like this for the doldrum months of the Summer. Come the Autumn they will likely make an upswing before the trap door opens and they go zooming down right on past the March lows.
The bounce will create a "last gasp" rally post Christmas into early Spring before totally capitulating at Dow1450. Just my opinion and the way I see it unfolding, and am planning on just such an outcome.
Keep your shorts up! Have gone long gold and silver holding the physical. Prices will go astrophysical.

Jun 09 05:16 PM

[Robert Nabloid:]

I only pay attention to the short-term to find great opportunities to make purchases on long-term assets. Long-term gold/silver have GREAT prospects, certainly better than the dollar.

Buy land, gold and silver. Hold. At least they'll retain their value better than holding dollars in a bank account. The dollar is in the hospital and has been given a grim prognosis: Cancerous Tumours that are growing at an alarming rate. The dollar is dying. Some people refuse to acknowledge the obvious. It's easier for outsider's to see the dollar is dying.

Jun 09 05:23 PM

[Mad Hedge F...:]

I go for a long term up. Brace yourself for the impending gold shortage. Gold shortage? Yup. Last year, South Africa suffered its steepest decline in gold production since 1901, falling 14%, to a mere 232 tons. It now ranks only third in global production of the yellow metal, after China and the US. Severe electricity rationing, a shortage of skilled workers, and more stringent mine safety regulations have been blamed. Choked off credit has frozen the development of new capital intensive deep mines, as it has for everybody else. Rising production costs have driven the global breakeven cost of new gold production up to $500 an ounce. In the meantime, the financial crisis has driven flight to safety demand for gold bars and coins to all time highs. Last year, the US Treasury ran out of one ounce $50 American Gold Eagle coins, now worth about $980. Competitive devaluations by almost every central bank, except Japan, mean that currencies are not performing as the hedge that many had hoped. It all has the makings of a serious gold shortage for the future. Could last year’s downturn be a blip in the eight year bull market? When we break $1,000, which could happen any day now, watch out above!

Jun 09 06:54 PM

[Przemyslaw ...:]

Well, actually there is a phenomenon called "autocorrelation" (statistical models should be "autocorrelation-free"), but I don't think this is the place to discuss it.

Fundamentals ARE key to long term (!) investment, but I already wrote about it in my previous comment. Self-fulfilling prophecies and other mechanism that are often used to "explain" technical analysis (survivorship bias etc.) are one thing - but - without getting into more detailed discussion - just take a look at a trend line that holds several times (it will be easy to find one) and try to explain that it's not there. It is and it works.

I realize that there is a large assymetry between rates of return that traders achieve (not many people gain enormous amounts of capital, and many lose), but that is no proof that the technical analysis does not work - "if you can't dance, don't blame the dancefloor".

Getting back to statistics - when applying statistical tools to any market (including precious metals market), one needs to be careful, as almost all popular models assume the normal distribution of returns - which is not true. I've developed several models that are available on my website, and I always emphasize which parts can be used directly, and which rather only on a comparative basis. You will find them in the tools section: www.sunshineprofits.co...


On Jun 09 02:40 PM Spartacuss wrote:

> In statistical analysis, one finds that a
> thing cannot be a function of itself, period.

Jun 09 07:06 PM

[xxxx:]

All the assumptions made rest on if the S&P corrects. if wall street ke4ps manipulation the S&P the dollar will rise so much and commodities will only fall so much. I correction has been in the picture a long time, but not allowed to happen the dollar rose for a few days, the s&P did not fall the way it should have. (see stick save at end of day monday). see what is happening today.

If you aren't going to see the manipulation and use that as a way to giude your trading you will loose a lot of money.

silver should go down to about 13.75 before moving up again. that isn't what is going to happen because of manipulation.

Jun 10 08:49 AM