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After what happened on Friday many Precious Metals sector investors are
naturally concerned about the effect of further heavy losses in the broad
market on the sector. Let's now review Friday's action, starting with the
broad market itself, before moving on to consider the likely impact on the PM
sector.
After almost two months of quietly drifting sideways, the ground opened up
beneath the broad market on Friday, as we can see on the 6-month chart for
the S&P500 index below, it gapped down at the open and plunged by 2.45%,
heading ever lower as the day unfolded - there was not even the customary
bounce in the last hour of trading. This was predicted on the site back on
1st September when we had correctly identified what kind of pattern was
forming, in the article COMPLACENCY RIFE AS
VERY DANGEROUS PATTERN COMPLETES IN S&P500, a Dumpling Top, although
at that time it was not known what sort of collateral impact this would have
on the PM sector. This was a severe and decisive breakdown and there was
almost no place to hide - most everything tanked, with the exception of the
dollar and some obscure paper of the Czech Republic, I believe. Bonds plunged
and yields rose, and it is thought that this may mark, at long last, the
start of a rate tightening cycle, necessary to the survival of a number of
banks. Of course, the rate rises, should they occur, can only be miniscule,
otherwise the entire system will implode. If it does mark the start of a tightening
cycle then bonds and stocks are in for a really rough ride.
 
The decisive breakdown in the stockmarket on Friday probably marks the
start of a severe downtrend. How far will it drop? It should drop, in short
order, at least to the 2030 - 2040 level, where there is support, and could
easily continue lower to the next support level in the 1990 - 2000 area. This
latter objective is made more likely by the top pattern also having the
attributes of a Tower Top, where the sharp rise out of the June lows to form
the left side of the tower is now mirrored by a precipitous decline to
complete the right side of the tower. This drop, should it occur, will
probably be the curtain raiser on a long and brutal bearmarket, that has been
kept at bay for years now by Fed and government meddling.
If such a drop occurs in the broad market in coming weeks what will be the
effect on the PM sector? We have already seen the PM sector suffer quite
severe collateral damage during yesterday's mad scramble for the exits. While
it doesn't look all that much on the 1-year chart for GDX shown below, partly
because the PM sector is much more volatile, the losses in the PM sector were
double the losses in the broad market, not a good sign - while the S&P500
Index fell by nearly 2.5%, the PM sector fell by over 5%. This means that it
is reasonable to expect further steep losses in the PM sector if the broad
market continues to tank as expected. How far will it drop? - probably to the
zone of strong support on the GDX chart in the $21 - $22 zone. While that
might not look all that much from the current $26.4, it will involve a good
many stocks showing further heavy losses. With this move the correction
should end, and here it is important to note that such a drop would not cause
any technical damage, since GDX (and PM stock indices) would only be dropping
to their rising 200-day moving averages - on the contrary, by rebalancing
sentiment and shaking out the weak, it will set it up for the next big upleg.
After a big plunge the stockmarket will probably grind lower in a more
measured manner, whereupon the PM sector is likely to go contra-cyclical and
rally. This correction now appears to be taking the form of a classic 3-wave
A-B-C correction as shown on the chart, and the C-wave to the support should
mark the end of it.
How should holders of PM stocks handle this correction? Most important of
all is realizing first off that it is only a correction, and having an idea
of where it is likely to end, as set out here, should help. There are several
ways to handle it depending on what type of investor or trader you. One
approach is to sell holdings now, assuming the sector doesn't open heavily
down on Monday, with the aim of buying them back when GDX drops into the
support zone - this approach risks being left stranded if the sector turns up
from here. Another is to sit tight and tough it out, in the knowledge that
prices will recover again, once the next major upleg gets started, but
perhaps the best approach for those set up to use this strategy, given that
we have a good idea of the downside target, is to insulate your positions
from loss using Puts. If the Puts are sold for a profit once GDX drops into
the support, and the sector subsequently recovers as expected, so that there
are no losses in the stocks, the Puts will have provided a windfall profit.
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