Gold and Silver In Period of Low Volatility and Disinterest while Juniors and Silver Stocks Show Relative Strength
Published in April 27, 2012on
Gold and Silver have been correcting multi-year advances. In this article we illustrate what ultimately develops as these corrections progress into consolidations. Namely, volatility declines, general interest in the market evaporates and this produces sentiment that is conducive for an important bottom. Because these are long-lasting, sustained corrections, the bottoms take time to develop. There are many fits and starts and as a result, most bottoms are not obvious until months after the fact. We provide some charts to help understand what is currently taking place and what we can expect going forward.
Let’s start with Gold. At the top we plot the average true range (ATR) indicator which is a helpful volatility indicator of sorts. When it becomes stretched or rises too high on the chart, we can expect a reversal in trend. Note that the ATR indicator often hits a low prior to or soon after the start of an impulsive advance. This occurred with every major move with the exception being 2008 when volatility peaked during the financial crisis which sent Gold down 30%. Also, the yellow shows what was an uncorrected two year advance from $900 to $1900. This 25-month advance has been followed by an 8-month correction. Using Fibonacci retracements implies a “time” correction of 9.5 months, 12.5 months or 15.5 months. This indicates that Gold should correct (in terms of time) for at least few more months.
Next, we look at the commitment of traders report (COT) for Gold. The bottom rows show the commercial short positions as well as open interest. Note that the commercial short position is essentially near a three low which implies very limited speculation in the market. Moreover, open interest has declined since late 2010 and sits at a multi-year low. Traders are leaving this market en masse.
Turning to Silver, we find a similar situation. Periods of low volatility have coincided with the start of major moves in Silver. The examples are 2005, 2007, 2009 and 2010. Silver advanced from $8 to $49 in about 29 months. The market has been in a correction for 12 months. Applying Fibonacci analysis, we’d expect the correction to last 11 months, 14.5 months or 18 months. Thus, Silver could continue to consolidate for several months.
Moving to the COT, we see that commercial short positions are at 26.5K contracts which is relatively close to the 10-year low seen at the end of 2011. Open interest has begun to climb higher but it remains well below the peaks seen from 2009-2011.
Markets cycle between periods of advance, correction and consolidation as well as periods of high volatility and low volatility. In the case of Commodities, these states tend to be magnified. Advances can be sharp and fast and the same goes for corrections. Because of this, multi-month consolidations are often required to digest these big moves. When the market finds an equilibrium, which occurs at low volatility, the primary trend can reassert itself.
The point is, Gold and Silver made major moves in recent years lasting 25 months and 29 months. Such moves are not corrected and digested in a period of only a few months. As we should know by now, it takes many months. As the market gets deeper into these corrections and they become consolidations, volatility falls, bullish sentiment recedes and general interest abates. These are the conditions that precede important lows.This isn’t manipulation or conspiracy.This is how markets work.
It appears to me that Gold and Silver could have a few more months of consolidation before the next big move can develop. Summer is naturally a period of low volatility when these metals make lows so be patient and keep your eyes out for bargains and a potential low in the summer. The catalyst will clearly be further weakness in the S&P 500 and economy that prompts more action from the Fed and ECB.
While the precious metals sector has consolidated and struggled to find a bottom, an important development has taken place. First, lets harken back to 2007-2008. Large cap mining stocks peaked in March 2008, yet the speculative sides of the sector “gave out” far earlier. The juniors and silver stocks actually peaked in April 2007. That was about a full year ahead of the large gold stocks. As the 2007-2008 crisis unfolded, juniors and silver stocks led the way down and displayed extreme relative weakness even as metals prices were firm.
Today, we have an entirely different and bullish development. As you can see in the chart below, the speculative areas of the sector have been outperforming the large gold producers (GDX). If this were really an end to the bull market or another collapse, the juniors and silver stocks would not be showing this kind of relative strength. In fact, the silver stocks have actually managed to hold near their 2010-2011 lows even as gold stocks have broken to new lows. We also see that the CDNX has been outperforming GDX since October while GDXJ has been outperforming since December.
Given the recovery of the past few days, we are likely witnessing the start of the next cyclical bull market for the gold and silver stocks which have essentially been in a cyclical bear or correction since December 2010. The above analysis implies that the more speculative areas of the sector, the juniors and silver stocks will be the leaders.
The reemergence of the bull market will mark the inception of the third and final phase of this bull market. The stealth phase took place from 2001 to 2007 while the wall of worry phase has been in place since 2007. The wall of worry phase consists of muted gains, subdued sentiment and improving valuations resulting from rising profits but stagnant stock performance. During its final phase, a bull market experiences widespread participation, increasing valuations and increasing speculation. The current relative strength in the speculative areas of the sector (juniors and silver stocks) is a harbinger of things to come.
The reasons for such outperformance are simple. As a bull market progresses, speculation will naturally increase. A move in Gold above $1900 will increase the appeal of Silver which always outperforms during an uptrend. Moreover, many producers are generating record cash flow and profits. Given the market’s desire for growth and the current values in quality exploration and development companies, it is only a matter of time until we see increased takeovers and mergers and acquisitions. Such action would obviously ignite the junior space.
We personally continue to focus on 1) producers with strong development projects that can become mines and 2) exploration companies with strong capital structures operating in the best jurisdictions.
Jordan Roy-Byrne, CMT
THE DAILY GOLD