Smart Money Is in Precious Metals, But a Local Top Is Close

by: Przemyslaw Radomski, CFA

At Sunshine Profits we’re holding gold and we find ourselves in very good company with some of the world’s biggest players. The smart money is definitely in.

Central banks are net buyers of gold for the first time in 22 years.

According to a report by precious-metals research firm GFMS, for the first time since 1987, central banks around the world bought more gold in the second quarter than they sold. India recently bought 200 tons of gold from the IMF and it won’t surprise anyone if China steps in to purchase the other 200 tons offered for sale.

Some of the world’s most successful traders are in gold.

John Paulson’s hedge fund holds a massive gold position in the SPDR Gold Trust (NYSEARCA:GLD) and large positions in gold miners.

Star hedge fund manager, David Einhorn, who predicted the fall of Lehman Brothers, used to stay away from gold for personal reasons. His grandfather was a gold bug who held on to his gold position for 30 years waiting for the U.S. greenback to collapse and for inflation to run amuck. Apparently Einhorn now thinks that grandpa may have been right all along but just had his timing wrong. He initiated positions in gold for his fund.

“Being a patient investor is one thing. Being 'wrong' for three decades is quite another,” wrote Einhorn in a letter to his investors. “To everyone's dismay, we believe that some of Grandpa Ben's predictions are playing out.”

The smart money is in, but it’s clear to me that the real fireworks will start when Main Street catches gold fever. The gold market is small. The market cap of all the gold stocks in the world is less than that of Microsoft (NASDAQ:MSFT) or Walmart (NYSE:WMT). So, when the public finally rushes into gold... Well, that’s when we’ll be very glad that we got in early.

Speaking of getting in and out of the market, there are times (during before local tops) when it makes sense to be in and out of the market at the same time. I believe that a word of additional comment here would be useful, as I get the feeling that it might be perplexing to read that it might be useful to do one thing (enter the market) with a part of one’s capital and do the opposite (wait/sell) with the other part.

Generally, the action that one is supposed to take depends on their risk tolerance - and consequently their portfolio structure and attitude toward money management. Risk-averse Investors should have more capital invested in PMs also during corrections, while risk-loving Speculators might be inclined to monitor market closely on a daily basis to catch even the small moves in the price of gold and silver. Therefore, depending on your preferences, you will need to monitor prices of metals in different time frames, and you will define different moves as “small” or “big”.

From the long-term point of view even $50-$100 downswing is really small - think about a chart with gold's rise from $250 to $5000 - a $50 move is barely visible. On the other hand, the geo-political situation is tense and the risk of a meltdown in the financial markets is relatively high - meaning that a single event can cause gold's price to rise $100-$1000 or so - for instance if the Chinese officials decided to dump their dollar reserves on the market. This is not likely to take place in the near term, but given the enormous effect it would have on the price, I believe it is better not to be totally out of the PM market with a large part of one's capital (long-term holdings).

Conversely, if it is the short-term speculative capital that you want to focus on, please keep in mind that trading means using rather limited amount of capital for each trade. After all, there is a certain amount of capital that you should use at most, and if you use more than that, you can lose money on average (!) even if you are mostly correct in predicting moves of PMs - I wrote about this phenomenon in the past. Therefore, if you use a small amount of your short-term capital anyway, you don’t need to worry about a single big event that would drive gold’s price very high (you are covered, thanks to owning bullion, and using a part of your capital for long-term investments), and focus on what is probable in the short term. Here, a $50 move is very often a difference between a winning, and losing position, so focusing on such moves and exiting positions once a correction is looming, might be profitable.

Having said that, let's move to the analysis of the current events on the precious metals market. This week I will provide you with my thoughts on silver and PM stocks - charts courtesy of

Silver reached its long-term resistance line, which means that further gains might be postponed. On the other hand, should gold rally from here - and that is the likely outcome - silver's rise may be stopped by at its previous highs of $19.55 or $21.44.

Generally, much depends on the gold market, so once we get exit signals from it, it will mean that might be a good idea to close one's silver speculative (!) positions as well.

Silver often tops in the form of a double-top pattern, so it would not surprise me to see silver decline a bit, only to re-test its recent highs and decline afterward.

The precious metals stocks are also near their resistance level.

Gold stocks are very close to their old 2008 high, and given the strength of the current momentum it is possible that this level will be touched during this rally. I have used the word "touched" intentionally, as it seems the PM stocks would need to take a breather before they break into new highs.

Currently, the HUI Index is trading near a less significant high (marked with a thin vertical line on the chart), which may also stop this rally, if gold is to decline from here. However, based on the above analysis of gold charts, this is not a likely outcome so PM stocks may also move higher before topping. Based on information available today, I've marked the probable topping area with a red ellipse. Let's see if the short-term chart confirms the above analysis.

I've used the GDX ETF as a short-term proxy for PM stocks, as it allows me to analyze volume. The latter has been decreasing recently, which is an early sign that the rally is slowly running out of steam (buying power is drying up). The value of volume is not at a dramatically low level that would cause me to send out a Market Alert, but it certainly suggests that if mining equities are able to move to their previous highs, this is likely to mark a local top.

Naturally, the key question is "when?" As always, "now" is the most difficult time to invest, but once again the cyclical tendencies help us put the daily price swings into proper perspective. In the past, the red vertical lines were very close to local extremes (tops or bottoms), so it might be the case also here. This time, the next vertical line suggests top/bottom in early December, possibly in its second week. This may correspond to the top, at which the HUI Index reaches its 2008 high.

Summing up, apart from points raised in my previous essay, additional signals pointing to looming correction come from silver and PM stocks. The momentum is strong, so the correction may not materialize today or tomorrow, but based on what we see today, it seems that the temporary top will be reached within the next few weeks. The full version of this update is about 4x bigger than the free version and contains many additional charts and analysis with critical implications to you.

Disclosure: I own gold and silver.

About this article:

Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here