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Gold surged to a new
record on Wednesday, propelled by the possibility of a third round of
quantitative easing in the US. Already rallying hard on the back of fiscal
concerns in the Eurozone, gold jumped to within reach of $1,600 an ounce
after Fed Chairman Ben Bernanke said the central bank could take further
steps to prop up the US economy if needed (read that as QE3). Gold rose as
much as 1.4 per cent on Wednesday to touch a new peak of $1,587.46 an ounce.
That surpassed the previous peak of $1,575, reached on May 2. Looking back we
see that gold rallied about $270 an ounce between Bernanke’s first
mention in August of last year of a second round of quantitative easing
– or “QE2” – and the end of the program in June.
Every time gold takes off we are asked if it is too
late to enter the gold trade. Gold has gone from $300 to well over $1,587 in
a decade. That is a 400% gain compared with effectively no gain for the
Standard & Poor’s 500 Index (SNC:SPX).
Some investors feel that gold is already too high and anyway, how much higher
can it go.
Our answer is short and sweet for the long
term—higher—much higher.
For those who still have their doubts, here are just
3 reasons why we believe gold and silver will vault forward in the long run.
Anyone not in a coma can see that from an economic point of view we are
living in historic times. Black swans are circling as we grapple with fallout
from the all-too-recent meltdown, the ominous and even frightening
possibility of sovereign-debt defaults, and political uncertainty across the
globe. It is in times such as these that people look for a safe haven, and
the one that makes most sense is gold.
So, here is our very short list, in no particular
order.
1. If investors are not already nervous enough, the
recent U.S. deficit-reduction debate has surely raised concern about a U.S.
default; destruction of the U.S. dollar; and even the possibility of a global
recession or depression. Moody’s placed the US triple A rating on
review for a possible downgrade as fears mounted that Washington will fail to
raise the federal debt ceiling by August 2. The Moody’s warning came as
Ben Bernanke issued his most explicit warning yet on what would happen if the
debt ceiling is not raised, a recession on the scale of 2008 would be
“certainly conceivable” and that it would have “a very
adverse effect very quickly on the recovery”. If there is no increase
by August 2, the US could only spend incoming revenues, leading to default on
some obligations.
2. Inflation is rearing its ugly head in China and in food prices around the
world. That gives support the price of gold as paper assets lose purchasing
power. Gold is a hedge against inflation under the current financial system.
3. As we have been reporting, central banks,
particularly Russia’s and Mexico’s, have become large buyers of
gold and will likely purchase more this year, increasing worldwide demand for
the precious metal.
With everything that has happened with precious
metals this week, let’s not delay any longer and let’s take a
look at the current situation in the mining stocks. However, first
let’s briefly examine the latest events in the main stock indices. We
will start with the long-term chart of the S&P 500 Index (charts courtesy
by http://stockcharts.com).
 
In the medium-term S&P 500 Index chart this
week, we see that stocks have reversed after a failed attempt to move back
above the rising resistance line. This was followed by a decline last week
and another this week as well. In last week’s Premium Update we wrote that
if stocks decline from here, the possibility of a bearish head-and-shoulders
pattern developing will be quite likely. In this scenario it would be quite
likely that a decline similar to what was seen in the middle of 2010 takes
place.
We have previously seen a number of situations where
the bearish head-and-shoulders pattern has been invalidated before forming.
Nonetheless, this pattern could very well complete if stocks continued to
decline. The result of a head-and-shoulders pattern completion could be much
lower S&P 500 levels, possibly to or slightly below 1200.
The bearish case does not stem from the above chart
alone. It’s also confirmed by the financial sector.
In this week’s XBD Broker-Dealer Index (proxy
for the financial sector) chart, we see the index has reached new 2011 lows,
moving below the lows seen last month. Since this is a leading indicator for
the general stock market, the situation does not look good for stocks in the
short term.
Let’s see what it
means for the mining stocks.
As you may see above the 0.63 correlation
coefficient number between HUI and S&P 500 in the short-term (based on
the last 30 trading days) column, it is unlikely that mining stocks will
continue to outperform gold if stocks in general plunge.
Moreover, in the medium-term column, we see
significant negative coefficients for precious metals and the dollar.
Therefore if the USD Index confirms its breakout and rallies in the medium
term, lower prices will likely be seen for gold and silver over this time
frame.
Moving on to the mining
stocks, the HUI Index does not look too bullish at this time.
Namely, in this week’s HUI Index chart, we see
a sell signal based on the RSI which has reached an overbought status. This
took place while the HUI Index itself was moving to the rising resistance
line. Therefore, a short-term decline in gold mining stocks appears quite
likely.
In this week’s short-term GDX ETF chart, the
gold miners have corrected 61.8% of the previous decline and therefore the
trend remains down unless this level is taken out. Although it is a
possibility, indications are that a decline is more likely. This is consistent
with the signal received in our analysis of the long-term HUI Index chart.
Another - quite reliable - sell signal comes from
the analysis of the Gold Miners Bullish Percent Index.
In fact, we see a situation which indicates that a
top appears to be quite close. Both the RSI level and Williams %R are overbought here and this has been a reliable tool
for predicting local tops in the past few years. Of course, a local top is
synonymous with a sell signal for short-term Traders
Summing up, gold and silver mining stocks have rallied
significantly recently but numerous indicators yield a bearish outlook for
the short term.
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Thank you for reading. Have a great and profitable week!
Przemyslaw
Radomski
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