A Bearish Tilt to the Gold and Silver Market – A Great Risk-Reward Setup

A Bearish Tilt to the Gold and Silver Market - A Great Risk-Reward Setup

A Bearish Tilt to the Gold and Silver Market – A Great Risk-Reward Setup

With analysts at most public gold and silver websites now turning decidedly bearish, with the summer doldrums staring us in the face, with the new rate hike raising interest rates (on paper making gold less desirable as it provides no yield), and with the gold seasonals suggesting that “sell in May and go away” was the play, there is a definite bearish tilt to the sector right now.  That’s why (among other things) we have a great risk-reward setup staring us in the face.

Pining thinks it’s a great place to go long (with stops)!  Let me give you a few reasons why, then I’ll outline the trade:

Sentiment:

A quick review of 7 popular and publicly available precious metals analytics/trading sites, and a glance through the comments on those sites, made clear to me that there is (at least roughly) a general consensus in the metals complex right now: after failing to break through 1300, and first pushing through then falling back below the long-term downtrend line in gold, the summer doldrums are upon us and consensus sentiment has turned bearish.  The two most likely scenarios I saw discussed were either (1) we languish and churn lower for the next few months following typical gold seasonals pattern into a July or August low, or we cascade from here into an earlier low, perhaps late June or early July.

I like this widespread bearishness very much.  This is precisely the type of setup the metals love; wrong-foot the investing public, going against well-known patterns (because it’s never that easy in the metals) and making sure the majority of retail is not on the train and has to chase price. That’s also why the so-so COT doesn’t bother me much, that pattern has been a bit TOO clear recently and has been becoming a little too easy to trade, so I think it’s due for a wrong-foot.  In fact it is this “juking the crowd” and subsequent chasing of price on the way up that provides the fuel for the best runs in the metals.  This is an excellent setup from a sentiment standpoint.  Just ask yourself, when was the last time the majority of retail sentiment was dead-on correct and on the right side of the trade in the metals?  Thought so.

GDJX rebalancing is behind us

Regardless of where you stood on the whole GDXJ/JNUG issue, the fact remains that it is now largely in the rearview-mirror.  This means a genuine, significant source of instability in the sector is now largely behind us, removing some of the unpredictability which had been a drag on both price and sentiment.  Additionally, it is likely that money managers who may have previously been hesitant to allocate funds until this nonsense was sorted may now be prepared to put that money back to work, thus bringing an unexpected tailwind that could help things to the upside.  If instability was a negative, then stability should be a positive.  Bullish!

Crossing over of the 50,100, and 200 DMA on the Gold Daily chart:

Don’t look now, but for all the wailing and gnashing of teeth, gold is about to see the 50 DMA above the 100 DMA above the 200 DMA.  This golden cross setup is seemingly timed to catch people off-guard given the poor sentiment we see now, yet will trigger buy signals for technical traders and algos.  With about 60% of stock “market” volume now quants, this is not immaterial.  With a massive turnover in shares last week, especially the huge volume on Fed day last Wednesday (see black arrow on chart, look at that volume level) and follow-up churning, there has been a significant rinse in the complex. Lots of longs have been spooked out of their positions, and some shorts have covered profitably.  This actually looks good to me, with Quad witching just passed on Friday, and particularly the Thursday and Friday follow-on action- no waterfalls, just tons of repositioning.

The tinfoil hat wildcard, but worth a mention: Is the Fed schizophrenic or working a plan?

Traditional analysis says that when the Fed raises rates, gold price craters.  Yet during this recent cycle, when the Fed raised rates Gold took off.  And guess what? The Fed just raised rates.  Short version-  Bullish!

Long version:  I actually think there is a reason for this counter-intuitive recent action in gold when the Fed has raised.  Traditionally, why did the Fed raise rates, and when did they do it?  They raised when the economy was getting hot and genuine fears of inflation were taking hold, and they did so to cool-off inflation and that hot economy by sucking liquidity into bonds through higher yield.  So with better options (yield) available, gold (which produces no yield and is an inflation hedge) went down.  But recently, the Fed has raised with (1) no real signs of inflation, and (2) and a genuinely poor economic picture.  So gold didn’t do what it usually does, and in fact one could argue that gold was simply performing another of its traditional roles- that of the Safe Haven in times of uncertainty- since raising rates into a poor economy is quite possibly a recipe for a stock market crash (given that the market is in a highly overvalued position historically).  In this context, gold rising (insurance) when the Fed (stupidly) raised rates actually makes perfect sense.

Tinfoil Hat version: Has the Fed decided to become as part of “le Resistance” like so much of the Washington establishment has, and is this the sign?  Before you dismiss me as a nutter, answer this simple question: After 8 years of keeping what was initially billed as “extraordinary measures that are historically unprecedented and temporary” in place for nearly a decade now, why has the supposedly ‘data-dependent’ Federal Reserve suddenly just hiked rates AGAIN at a time when economic data just missed so badly? Again? And yes, the previous sentence showed how what the Fed once described as temporary is now permanent, what was once extraordinary is now standard, and how “data dependent” means ignoring the data no matter how bad it is.  This is sheer Schizophrenia. Or, you know, Central Banking.

The most recent miss inspiring our data-driven Fedsters to hike more was so big it was the worst miss in six years!  In fact, the last time economic data disappointed by this great a margin the situation was considered dire to such a degree that Bernanke unleashed “operation twist”… back in August of 2011. So how is this rate hike in any way logical for a “data-dependent” Fed, absent the deliberate intent to muck things up?

If the Fed were truly making policy as economic data dictates, they wouldn’t be doing this.  So why keep hiking rates into a dumpster-fire of an economy when they know could easily lead to a major stock market correction, crash, and/or recession at some point (maybe soon)?  Occam’s razor suggests: because they’ve decided that’s what they want!  If you do A, knowing it will probably cause B, that strongly suggests you desire B as an outcome.  Simple. Call me crazy all you want, but that explanation seems quite consistent with the tone and behavior I’ve seen coming from the rest of the DC/government establishment for the last half year, so I don’t see why the Fed would be any different. When the feeding trough is threatened, some folks ‘resist’, some folks leak, some folks hike.  Potato, po-tah-to.

And if you think the market won’t be allowed to drop because it’s never allowed to drop, ask yourself WHO has not been allowing it to drop for the last 8 years?  The PPT/Fed.  And what are these rate hikes suggesting they might want now?  Ummm hmmm.

Regardless, don’t totally sleep on the long-shot catalyst folks; the SP finally heading south as a possible catalyst for gold…

Trendline test, rise above, and rejection:

One of the lessons I’ve learned the hard way in the metals is that trend lines are not what classical trading theory says they are.  In classical trading theory, a trend line should act as a psychological level of support or resistance, and when (for example) price rises then bumps up against it then breaks through, it is supposed to trigger a new wave of buying as other market participants (seeing the strength of price in breaking through the barrier) join in the buying, driving price higher (or of course, in some cases rejecting price and sending it back down).

But all that supposes free and fairly traded markets among participants of equal standing before the law.  And these are the metals. HAHAHAHAHAHAHA!!!!!  So here, trend lines are places where, when resistance is breached, once price breaks through and attracts new buyers, THEN the market “makers” crush price with an avalanche of paper to harvest all that new money that just came in. Ring the register, bank the bonus.

So the way trend lines work in the metals is that price bumps against resistance or trend lines, and if it goes through bringing in new longs, THEN it gets smashed back down below, and only when everyone who just got run has either been cleared out or turns bearish will price finally be allowed the possibility to rise back up through that line at some point.

In other words, in the metals, trend lines are only valid indicators after the gang-rape has occurred there.  We’ve now had that in gold (twice, actually), so in my book, we are finally clear for a rise up through 1300.  Strange?  Yeah, but that’s how it works around here.

The Bottom Line: Risk vs. Reward

In the end, all of the above is just food for thought, or fun speculation.  As the wizened sage of the trading pits atlee once said, “That’s a nice story.  Ms. Market doesn’t care about your story, she will go where she wants.”

This is a basic range-trade with well-defined risk vs. reward.  You take the known trading range, buy-in near the recent low of that trading range, and use that as your stop- it’s a simple play, regardless of whether any of the above winds up being a catalyst or not.  Right now, GDX is just above the recent lows of May, so we have a very clear and recently defined low. We need to make a higher low above this level if we are going to continue moving up, so there is your well-defined stop-loss level.  GDX is around 22, and 20.75 would be my stop-loss for this trade… we go below that, the trade is busted, so get out (FYI, I find that gold and silver are gamed so much day to day that setting stops, entries and exits via GDX is much more reliable and predictable, even if the vehicles I am trading are gold and silver).  A tight, well-defined 5-6% stop-loss if you’re wrong is acceptably low risk IMO.

But the reward… if this takes off like I think it could, we would at least revisit the highs of GDX 31.5 of last summer. The safe play would be to take 50% profits near that point, then wait for market action to decide further, but I suspect it’s possible that the momentum generated by a rise from 22 to 31 would mean that bull might very well keep running until we hit the 36, and possibly on the outside the 40-42 range. But let’s stay conservative (recent range-bound) in our calculations and stick with the 31.5 figure- that would be an unleveraged gain of 43%.  Put another way, that’s a risk/return ratio of 7.7 to 1 on this trade.  (Best Borat voice) Verra Niiiiiiiice!!!! And if it keeps rolling to 36 or even 40? Ka-ching!

.     .     .

So you can have your summer doldrums, your new lows, and your gold seasonals.  This parrot, with disciplined stops, is going long. – Pining 4 the Fjords

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