Thursday, September 1, 2022

Large Spec Net Shorts Does NOT Mean We're at THE Bottom


A few weeks ago, gold and silver bugs were cheering at the silver COT report, which was showing large specs going net short silver for the first time in over 3 years.  The narrative went like this: “Last time this happened in May 2019 at $15/oz, Silver doubled in 15 months.” There is nothing false about that statement. The last time this happened was indeed in 2019 at 15/oz, and silver did double from there 15 months later hitting $30/oz in Aug 2020. The question isn’t if the statement is false, its “is this relevant to where we are today?”

 

Let me back up, as I am sure there are some people who either have no idea what COT reports are telling you or why they’re relevant, or worse, they’ve been sold on the incorrect narrative gold perma-bulls have been shouting for literally decades, about how “J.P. Morgan/Deutsche Bank/Bank of America etc, silver shorts about to be squeezed any minute now” and how that will send silver prices to the moon. (Spoiler, it’s never happened, and it never will.)

 

COT reports, or the Commitments of Traders, is a report that comes out every Fri afternoon that shows the position sizes of 3 major “groups” of traders: large specs, small specs and commercials. Large speculators are essentially hedge funds.  As a group, they are momentum chasers, meaning they have a tendency to add to long positions as price is moving strongly higher until their net longs are at very high levels at the market peak, and inversely, sell their positions as a market goes down until they, as a group, have very little longs or are even net short at market bottoms. For this reason, they are often given the nickname “the dumb money”. Small specs are retail traders. They are basically you and me (but with deeper pockets). Their positions in a market are typically not very significant and rarely important in terms of analyzing the COT report, so for the most part we are going to ignore them.

 

That brings us to the commercials. Commercials are the banks. Their positions have a tendency to be exactly inverse to the large specs, as well as price. As a market moves higher, they typically are increasing their short positions and as a market moves lower, they begin to decrease them or even go net long into major lows. This chart below of Soybeans over the last 5 yrs is a perfect example of what I mean. The large specs (green line) were net short soybeans from the end of 2018 until the end of 2019, when price was ranging between 800-1000, while commercials (red line) were net long 145k contracts in May 2019 at 800. 1 year later, price had doubled, and large specs chased it all the way up, going from net short 123k contracts at 800, to net long 250k contracts at 1600. The commercials on the other hand, were massively net short at the top.

 

Now here is where the misinformation in the gold and silver sector come from. All the talk of commercials (banks) being massively net short as price is moving higher, and a short squeeze that will send prices skyrocketing any minute now, is a fundamentally incorrect analysis on how the market operates. There is a very simple reason why we have never seen this “J.P. Morgan silver position short squeeze” and why we never will. Because the commercials are not taking a position in the market betting on price direction either way.

 

The commercials are essentially opportunistic merchants. If people want to buy, they want to be there to sell it to them and vice versa. They are not racking up a massive short position in silver because they are betting on lower silver prices, they’re short position is simply the other side of the large specs who are eager to buy. They profit from the transaction.  That is it. Banks don’t make “bets,” they invest in “sure things.” What you don’t see regarding their “massive silver short positions,” is derivative holdings that zero out all exposure to the market in any direction. If prices skyrocket, they profit and lose nothing. If prices collapse, they profit and lose nothing.

 

Wall Street is the most competitive industry in the world. The most intelligent minds on earth don’t work for NASA, they work for Goldman and Citigroup. These are organizations that have trillions in assets and the smartest people in the world managing them, with a goal to take as little risk with them as humanly possible and still profit. Why on earth would an entity like J.P. Morgan, be stupid enough to leave themselves open to blowing up their entire firm over a bad directional bet on silver? Of course those short positions are hedged! Sure, it’s not impossible that someone could leave themselves open to such a risk (Lehman Brothers), but it is not very probable and is simply not how they operate in the futures markets, or how commercial COT positions are supposed to be interpreted.

 

So, the next time you see a self-proclaimed “gold and silver expert” and “professional” in the market talk about commercials or a major bank about to be “squeezed” due to their silver or gold short positions, promptly disregard EVERYTHING they are saying. They are either ignorant of how the market works and therefore no expert or professional in any capacity, (in which case you shouldn’t pay attention to what they have to say), or they DO know better and are trying to profit in someway off of the “doom” narrative of a collapse of a major banking firm and a precious metals “moonshot” (in which case you shouldn’t pay attention to what they have to say.)

 

Ok, so where is the problem here? If large specs, or “dumb money” always chase price higher and lower and are always heavily on the wrong side at the wrong time, how is this not spelling out a major low for silver and possibly gold as well? It’s simple. Because as a rule of thumb, large specs don’t sell bull markets.

 

Yes, the last time large specs went net short silver was the last dip in 2019 down near the lows, anticipating either a retest of 14, the low from both 2015 and 2018, or a break below it. They were wrong and were forced to cover and chase price higher as it doubled over the next 2 years. But is that an accurate comparison to where we are now?

 

From 2009 to 2011, silver went from a low of $8, to a high of $50. 2 years of higher highs and higher lows, exactly what an uptrend or a bull market is. From 2011 to 2013, silver corrected from that parabolic high and consolidated between 25 and 35. In 2013, silver began breaking down, making lower lows and lower highs and this continued for 2 years until 2015, bottoming at $14/oz. From 2016 to 2018 silver spent 2 years going sideways, retesting its lows as it consolidated at a major bottom. Then, from 2018 to 2020, it spent 2 years going higher again, and from 2020 to 2022, another 2 years consolidating.


From 2009-2011 as silver made higher highs and higher lows, large specs NEVER went net short silver. From 2011 to 2013 as silver consolidated going sideways from 25-35, large specs NEVER went net short silver. In fact, for the total of those 4 years, the position size of the large specs never fell below 6k contracts net long. The first time large specs positions dropped below that (and were nearly net short) was in June 2013, as silver began making lower lows. Their position size dropped to 837 contracts, down from 41k contracts 7 months earlier.

 

Over the next 6 years, as silver continued lower, their long position sizes decreased significantly versus the previous years when silver was moving higher and consolidating after a big rise. In March 2018, they were net short 13k contracts at ~16.50 an oz. In November 2018 they were net short again by 11k contracts. In May 2019 they went net short a 3rd and final time at $14.50/oz. That is a total of 3 times they went net short during the consolidation at lows in a bear market, and one time where they were nearly net short as silver began its decline in 2013, breaking down from its consolidation and beginning a trend of lower lows and lower highs.





Today, we have a silver market that was moving higher from the lows in fall 2018 to the highs in Aug 2020. In one instance in May 2019, they were net short. They quickly flipped that wrong position and 2 months later, they were net long 64k contracts. From 2020-2022 as silver was consolidating between 20-30/oz, they were NEVER net short silver. Now, as silver has started to decline, making lower lows and lower highs, surprise, surprise, large specs have gone net short again.


So, you tell me, does where we are today sound like the final low after a long, brutal decline in price over a period of 2 years, and a long basing consolidation at those lows for another 3 years? Or does it sound more like that initial drop in long positions that large specs had in silver in 2013, that was almost net short as price BEGAN making lower lows and lower highs?

 

Yes, large specs going net short a few weeks ago is likely piled too far on the bearish side and A low is likely to occur, as it has in the past when they’ve gone net short or reduced their long positions significantly. In fact, that is exactly what happened, and I pointed out that I expected we were making A low in silver on July 13th, and that we could rally up to 21, but this low was not a good idea to go long on and a better opportunity would be shorting the rally after it occurs. Silver bottomed the next day on July 14th and 1 month later hit $20.85. That was just 2 weeks ago and we are now at 17.40, a 17% loss and a new low.

 

But much like in 2013, it was just A low, not THE low. I know many are interpreting this as the end of this decline being near, but I see it exactly opposite.

 

This isn’t the bottom or the end of the decline, it’s confirmation that we are indeed in a bear market, and likely still the early stages of it.

 

I know that’s not what people want to hear, but that is the reality, and I’ve been warning of this risk for 15 months, since June 2021. I said miner’s underperforming is a big warning sign, like it was in 2013 and it has been again. GDX has lost 36% and GDXJ has lost 42% since then. I said miner’s lead the metals and they are leading them lower today like they were in 2013 and they have continuously made lower lows, just like they did then. GDX, GDXJ, SIL & SILJ all broke to new lows long before silver followed. Gold has yet to break 1680, but I think that time is very near. I said sentiment will get very bearish and stay there for long periods like it did from 2013-2015 and it has again. I’ve pointed out COT positions in bear markets can drop much lower like they did from 2013-2015 and they have again as well. I’ve said price can get very oversold and stay there for long periods like it did from 2013-2015 and we have also seen that repeat again. All while perma-bulls accused me of “selling at the low,” shouting the most dangerous words in investing in response to my analysis: “It’s different this time.”

 

Ladies and gentlemen, there is nothing new under the sun. History doesn’t always repeat verbatim, but it does rhyme, and this time has rhymed near perfectly with 2013. The macro doesn’t matter. PE ratios don’t matter. Fundamentals don’t matter. The only thing that matters, is the human emotions of greed and fear. That is what makes up day to day price action, and that is why we can see so many similarities in price action in the gold and silver sector today, with what happened in 2013.

 

Ironically, many of the same people shouting “it’s different this time” are the ones who have shared comparison charts of the S&P-500 today versus in 2008. Was the macro not different then? Even the S&P components were different then! But human emotion is not, and we can see that play out in nearly identical price action. The Macro in the 1600s in The Netherlands was very different from the United States in the 1990s. The fundamentals of tech stocks and tulip bulbs were different as well. Yet, the chart of price action in both is identical, because price action is not dictated by fundamentals or macro-economics. It’s greed and fear. That’s it.

 

Before I wrap this up, I wanted to mention a few more things regarding the environment in the precious metals sector versus 2013.  It continues to be remarkable to me how similar the things people are saying and doing today versus back then. It truly is identical, and people don’t even seem to notice they are doing it. For those who didn’t live and trade through it, I will give you some examples of what I saw happening then. You decide how similar it is to today, and whether that is as worthy of serious concern as I have thought (and continue to think) it is.

 

First, everybody was in disbelief that it was happening. When the Fed hinted at taper in 2013, the gold perma-bulls crowed that they could never do it, that the entire economy and financial system would collapse if they even decreased their printing by even just a little. When they did, they said “they’ll reverse and start increasing their printing again within a month or 2”.  Then it was that they could never raise rates, for the same reasons, an immediate collapse. When they did, they said, “one and done” and that they’ll be cutting again (from 0.25%, lol) in months. They screamed about the national debt, and how rates at just 2% would increase our interest payments on the debt by “X” amount, and the Fed would never allow that to happen. (That was 15 trillion dollars ago). Everyone was waiting for the “pivot” that would certainly send gold much higher when it came. It wouldn’t come for another 4 years, and when it finally did, gold had already rallied 25% from the 2018 low, so the idea of buying gold when the fed pivots, was a misguided plan of action to begin with.

 

People were talking about poor sentiment that continued to get worse, sharing charts like the Gold miner’s bullish precent index at levels below 10, which MUST mean we are at a bottom. It stayed below 10 for 6 months in 2013. (Today, the gold miners bullish precent index has been below 15 for 2 straight months). Many were talking about how miners were trading at the same levels that they were when gold was 1300, but yet it was north of 1550. They thought that in the most competitive industry in the world, there was a free lunch being left on the table for any idiot who can look at a chart and see a discrepancy between miners and the metal to gobble up. Easy money buying miners here, right? Miners didn’t revert back to pricing gold at north of 1550 and have huge gains, instead gold fell to 1300. I’ve seen a lot of people saying in the last few days, that GDX and GDXJ are trading like gold is back at 1400. That does not mean an easy money opportunity, just as it wasn’t then. It’s a warning that gold is likely going to fall to 1400.

 

People were already on the edge. By the time gold was ABOUT to break support at 1550, GDX had already lost 50% from its 2011 peak. (Currently, at 23, GDX has lost 50% from it’s 2020 peak of 46, and again, gold has not broken it’s support at 1680, yet.) If history repeats from this point, we have a dark future ahead for us. Many are already on edge again today but are holding on because they know it is foolish to sell when miners are already down 50%. They’re about to witness the worst losses in a single day that their portfolio has ever suffered. When gold broke support at 1550, it was a total of $500 down to get to our final low at 1050 2 years later. Half of that $500 in losses came in just 2 back-to-back days once support broke. Major silver producers were down 20% in 1 day. Major gold producers were down more than 10%.  Jr’s got obliterated. Many suffered such extreme losses, (and later forced dilution at extremely low prices) that it rendered it nearly impossible for most investors to get back to even, let alone to ever see a profit on those investments. 


We did see a bottom about 1 month after that and a decent rally following, but then it was back to making lower lows in what ended up being a market that started as a bullet to the chest, and ended with “death by 1000 paper cuts” 2 years later, for an ADDITIONAL loss of nearly 50% from those break down lows on GDX (From 67 in 2011, to 35 in 2013 BEFORE gold broke support, to 22 in 2013 AFTER gold broke down, then to 12 in 2015 when it finally bottomed).


Being that miners had already been so weak before the breakdown in gold, everybody thought it must be a flush out, capitulation bottom. It wasn’t. They’ll say the same again when gold breaks 1680. It won’t be capitulation this time, same as it wasn’t last time. It won’t truly be capitulation until most of these talking head, perma-bulls in gold just disappear entirely. When NOBODY wants to talk about gold at all. (Here’s an example. A PM analyst I knew in 2015 left his job to go become a dentist, because the sector was that bad. THAT is what you see at capitulation lows, not moderate depression amongst an ever-stubborn group of perma-bulls. What we need is epic and total despair, and we unfortunately are not there yet.)


The break is coming, and very soon, I fear. Time is up. With a long weekend ahead of us, I wouldn’t be surprised to see gold open next week down $50-100. And then do it again the following day. No, I am not kidding or exaggerating. I think we breakdown hard and very soon. I’ve done all I can to warn as many people as possible for the last 15 months, to try and help people from making the same mistakes I saw so many make back then that bankrupted them. If you haven’t taken any actions to protect yourself, you are now at the mercy of the market. The only thing left to say is, “Good Luck.”


-Jonathan M Mergott

Wednesday, July 6, 2022

Cost


Life is funny. Last year in March, gold ~1680 and I had called for a bottom. We did bottom and had a nice rally back up to 1920 by May. The move was a little steep, but I thought after a pullback, we 'd be set up nicely for a move into the 2400 region, possibly by Aug, which is the month gold makes peaks in far more than any other month. By June, after the FOMC with the Fed dropping the “taper” bomb onto markets, things took a very different turn and it was clear that 2400 target for Aug was off the table. In fact, the whole bull market was possibly “off the table” and the reaction of metals and miners afterwards turned me very bearish, as I began having flashbacks of the 2013-2015 decline.


We declined significantly all summer and fall, and when we didn’t break down after 6 months, I got bullish again in Jan, pointing out that consolidations in gold typically break out after 18 months, and Feb would be month 18. Sure enough, we began rallying strongly in Feb and by March we were retesting all time highs. 2 days after the peak, I pointed out DSI numbers on gold and silver at 95 and 93, so a top was probably in for now, but after a month or so of pulling back and shaking out some late coming bulls, we’d be setting up a nice cup and handle from a TA standpoint with a target of ~2400 that could be achieved again, in golds favorite month to make highs, Aug.

 

Here we are again in June with a very different picture, and I will now refrain from ever calling for 2400 gold by Aug ever again. (But just know, that if it happens, I was thinking it). It seemed like we were ready to go, that the gold bugs had been vindicated after watching gold go nowhere in the face of the highest inflation since the 70s. But alas, it was not to be. We had every tail wind we could ask for. We got a retest of highs, then a collapse. That is a bad sign, and very reminiscent of gold’s final rally to 1800 in 2013 before collapsing down 40% over the next 2 years. 

 

On the one hand, I’m glad I turned bullish when I did, because it was a huge move in miners from Feb to April that was definitely worth catching. In hindsight, I had written in April about the idea of this being a “false break before the real move” and dismissed it as unlikely to me, due to the extremeness of the “false move” swing higher. A 45% move higher in GDX over just 3 months that then unwinds, losses all of its gains, and then breaks to new lows seemed like a less probable scenario. But that is exactly what happened. I wish I had given this more credibility at the time, perhaps I could have rung some warning bells sooner.

 

But what’s done is done. What matters now is, “where do we go from here?”

 

I’ve seen a lot of charts and metrics thrown around recently. Things like, “Zero miners in the GDX currently above 200 day moving average”, “Gold miners Bullish precent index at 2-year lows”, “COT reports showing lowest large spec long positions in gold in 2 years”, and anyone reading the room of gold stock investors, knows that sentiment is in the toilet right now.

 

“Buy when there is blood in the streets.” So, easy answer, right? Not necessarily.  All of these factors would make gold, silver and miners a screaming buy right now IF, and ONLY if, we are in a bull market.

 

I know there are many gold bugs out there looking around at the state of the world we live in and thinking that we are absolutely, beyond a shadow of a doubt, in a bull market. I know plenty who said the same thing in 2013, and thought they were getting a free lunch buying gold stocks at 30% discounts from where they were 1 year earlier when the price of gold had been unchanged since then. But there is no free lunch on Wall Street. The “discount” they thought they were getting because the market was being “stupid” was a warning, and a trap for those who bought it.

 

I’ve never been fortunate enough to be the smartest guy in the room on anything. I have known a few who were though and not a single one of them was audacious enough to believe that they figured something out that the smartest minds in the world, running trillions of dollars all somehow missed. (I know, Michael Burry, “The Big Short”. That’s a 1 in a million shot, and you aren’t Michael Burry.)

 

The Perma-Bull gold bugs always think it’s a low, always think it’s a bull market and time to buy, but that just isn’t the case. I know plenty that tried to blame the 2013-2015 decline on manipulation, refusing to believe it was a “real” bear market. It HAD to be some evil cartel of bankers and government tamping down on gold to keep it from going to crazy, and that is the reason for its 40% decline in 2 years. (Despite the fact that this was the fate for most commodities in the same time frame. Copper also lost 40% from 2013 to 2015. Soybeans lost 45%. Wheat dropped 50%. Corn lost almost 65%. Nat gas and oil both dropped 75%. I suppose all of those moves were normal, rational, market action, while gold’s fairly tame drop in comparison was blatant manipulation.) Since then, most accept that this period was a bear market for gold, but I have not forgotten their pathetic attempts to shift the blame of their bad calls onto some invisible entity, dead set on making them look bad. But I digress…

 

Gold would be a buy here IF we were in a bull market, but as Mark Twain said, “It’s not what you don’t know that kills you, its what you know for sure that just isn’t so.” Let me show you a few examples why. We’ll start with !GT200GDX, the index showing the amount of GDX components that are currently above the 200 day Moving Avg.

 


We can see from the chart that major lows in 2018, 2019 & 2020 were all marked by the index reading at 20 or less, with 2018 and 2020 lows at 0, where we currently are now. Might seem like a no brainer, but this chart only gives data going back to 2018, during a time when gold was in a bull market. If we compared this to the 2013–2015 timeframe, I’d bet there were a lot of times we would see it at 0, and for long periods while price stubbornly kept declining.


The 200 day moving avg is kind of a cornerstone in Technical Analysis for determining if we are in a bull market or not. When you are, price typically stays above it, or has corrections that bottom at or near the 200 day MA at their worst points. In bear markets, the exact opposite. Price stays below it most of the time and rallies typically fail near it. The very nature of a study like this one ensures that readings of 0 on an indicator like !GT200GDX will happen often and stay that way in a bear market. Inversely, In bull markets, expect to see elevated levels for long periods. From July 2019 to the end of the year in 2020, (with the covid crash as the only exception) the !GT200GDX indicator stayed above 80 for 1.5 years. I’d be willing to bet, if we had the data to go back to 2013-2015, we’d see the exact opposite, multiple hits at 0 and staying below 20 for nearly 2 years as gold stocks got decimated.

 


   

Above is GDX from 2009- 2012, a period when we were in a bull market, with the 200 day MA in red. Below it is 2012-2015, a period when we were in a bear market. See what I mean? For a VERY long period in 2013 we stayed significantly below the 200 day MA. It is safe to assume during that period, there were 0 stocks in the GDX above their 200 day MA. That in itself was not a buy signal, as we can see price continued to decline, and declined a lot. About another 50% from the initial July 2013 low at ~24 all the way to 12.

 

I’ve mentioned a few of these points before in previous articles but they are worth repeating here because we are at a crucial juncture in my opinion. Many are going to go out looking at these indicators and buy, thinking they’re catching a low on the way to new highs. In reality, I believe they are catching the “middle” of a downwards move in a market transitioning from a bull, back to a bear, that could still have a ways to go.


In regards to Sentiment, we can see the same looking at DSI reads on gold as well as $BPGDM, the Gold miner’s bullish precent index. Here are charts on them. Same situation with both. Long periods of very elevated levels during bull markets, long periods of levels at or near 0 in bear markets. In 2013, $BPGDM spent 6 months never getting above 10, all while price kept declining. I talked about this in my last article in back in May. Here is a link to it. This is an important point that’s worth reading if you missed it.





Additionally, its worth adding in COT reports. Large spec longs in gold are at the lowest level in 3 years. The last time large spec longs in gold were at these levels it was Sept 2021 and gold was 1720, on it’s way to 2100. The time before that gold was 1680 in March 2021, on its way to 1920 in just 2 months. But if we zoom the chart out to include the 2005- 2011 time period, in order to reference this with the previous bull market, as well as include the 2013-2018 bear market, we saw the same thing happen right in 2013. Gold large spec long positions hit 110k, the lowest level since the 2008 crash down to 700 (which was 80k). They were quickly on their way down to 28k, then to 16k in 2015, and ultimately 1k in 2018.

 


Ok. So, I’ve made my point. It looks to me we are likely not at a low, but in the middle of a continued decline in a BEAR market now. So, when do we know when we actually ARE at a low? There is a lot of moving parts there and a lot of factors to take into consideration as it is happening, like what other markets are doing, the state of the economy, what the Fed is doing (or isn’t doing), as well as price action in gold and miners that we will analyze day to day to try and determine that when it comes. But there is one indicator that has marked every major low in metals over the past 20 years, and given multi-bagger buy opportunities on miners in 2001, 2008, 2016, 2018 and 2020. Ready for it?

 

Cost.

 

Basic economics. As the saying goes, “the cure for high prices is high prices” and “the cure for low prices is low prices.” When prices are high, everyone producing a product is going to take advantage by making as much of it as they can to cash in. The increase of supply, assuming demand is constant and not also increasing, brings prices down. The same with low prices. If you can’t mine gold profitably when the price is $1000/oz, nobody is going to. The decrease in supply ensures price will correct back higher again.

 

Every screaming buy opportunity in gold, silver and miners in the last 20 years has been marked by the price of the metals falling to levels that were near the cost to produce them. In 2001, Gold fell to a low of $250/oz after Gordon Brown decided to sell Britain’s gold reserves at the absolute low of the bear market that was about to go 8-fold higher in the next 10 years. For the year 2001, Barrick had a “total production cost” of $247/oz. Newmont’s costs that year were similar. Two of the largest gold producers in the world at the time were mining for break-even. The same was true with silver. At $4/oz in 2001, Hecla’s total production cost for silver was $3.57/oz. A mere 40c profit per ounce produced.




Could things have gone lower? Sure. Could they have stayed low for a longer period? Of course, but for the most part, this is unsustainable for a long period, or else there just isn’t going to be gold and silver mined anymore.  If you took that as a sign that metals prices need to begin turning higher from here eventually, you had some great multi-bagger opportunities in miners that gold investors love to talk about, but most never get to see. You could have bought Barrick in 2001 as low as 13. It went to 55 seven years later, a 4.5x return. NEM was as low as 12 and went to 60 by 2006, a 5x return. HL could have been bought at less than $1, on it’s way to 9 just 2 years later, and 12 if you held on till 2008. There’s the 10 bagger “white whale” gold stock investors keep looking for, and it was right under your nose in some of the biggest NYSE listed producers. No need to search for obscure, illiquid, unknown JR’s, hoping geology, management’s competence and markets all line up perfectly to get you that coveted 1000% return.


Let’s move on to 2008. Markets were crashing and no asset was immune. Gold dropped 30% from 1000/oz to 700, and silver dropped from 21 to 8. Miners got the worst of both worlds as stocks and metals dropped, with GDX tanking from 55 to 15. According to earnings reports on NEM and ABX at the time, gold mining costs were ranging around 550-575/oz, giving them still a fairly decent profit margin at 700. (It’s important to note the calculations of “costs” at the time varied, with not all producers using the same metrics. The “All-in sustaining cost” or AISC metric wasn’t adopted by the industry until 2013. Cash costs are just the straight cost to produce an oz, but is not reflective of the costs to run a mining company. AISC account for the costs associated with exploration to replace those ounces produced as well as administrative costs, etc. Basically, all the costs of SUSTAINING a mining company long term. I mention this because 550/oz for NEM in 2008 was reported as cash costs, so actual costs were likely much closer to break even at 700 gold.)


Silver though was worse. Falling to $8/oz, it was basically at cost for most silver miners. Pan American’s total cost on nearly 20m ozs mined in 2008 was 8.76/oz. Hecla’s total production costs per oz were 8.52. Coeur mining’s costs were 12.50/oz. Clearly this was unsustainable metals prices and the market was due to correct back up higher, and indeed it did, sending miners massively higher. NEM more than tripled in 3 years, from 20 to 70. PAAS went up 4.5x from a low of 9 to 42. CDE gave you a 10 bagger, from 3.60 to 36 in the same time and HL did even better, from 1 to 11.



By 2016, metals had collapsed from their highs and miners, (who, like the basic economics example, were rushing to sell as much gold as they could at 1900, even if their costs of mining were 1400.) were frantically cutting costs as their margins disappeared. Price collapsed and costs came down. By 2014, NEM’s AISC was 1002/oz with avg realized gold price for the year at 1250. Getting close but not there yet. By 2015, price had dropped to a low 1050/oz and NEM over that year managed to reduce costs by only $3 to 999/oz. That’s about as razor thin as you get. Silver at the time was $14/oz, and costs were about the same. CDE 2015 AISC was 14.62.  PAAS was 14.92, and AG was 13.43. AG rallied 9 fold in the next 9 months, from 2 to 18. CDE was 8x, 2 to 16. PAAS 4x and NEM was 3x. Higher cost miners had better returns, as most were completely written off by investors. HMY went from 50c to $5. GSS did similar, from 70c to 5.5.




By 2018, not much had changed. Costs were about as low as companies could get them, holding at near 1000 an oz for gold and 14/oz for silver. Gold tanked in Aug from 1375 down to 1150. Not as razor thin as times in the past, but very close. Silver, once again went to 14. Again, not just thin, negative in some cases. AG’s 2018 AISC were 15/oz. HL was at 11.50 and PAAS was 11. CDE stopped reporting AISC all-together, which should probably give some insight into where their costs was in relation to their peers (higher). Many silver miners slipped a bit in 2019 from 2018 lows, but the multi baggers were still there even if you didn’t catch the exact bottom. 3 years later, AG from 4 to 22, HL from 2 (to 1.50) then to 9, PAAS from 12 (to 10) then 40, CDE from 4 (to 3) then 12.


While the 2018 to 2021 period covers the covid crash, it’s important to look at that period too. Gold fell from 1700 to 1440. Costs were still around 1000/oz so this was still a very good profit margin for gold producers, but just like in 2008, gold held its profit margin and silver exceeded it, dropping to 12/oz. AISC at the time were: PAAS= 11.40, AG=14, HL=12. (CDE in 2020 was still not reporting AISC. Interestingly, the word “cost” appears only 4x in their 131pg annual report, and in none of those 4 instances, do they actually give a per oz number, cash, AISC or otherwise) If you had missed out buying in 2018, you got a 2nd chance here with many miners dropping back to those levels or exceeding them. PAAS and AG both retested lows from ~2018. Higher cost miners like EXK exceeded them, dropping back to $1, its 2016 low. (After which it did a 5x, and then in 2020 did an 8x 1.5 yrs later.) HMY in 2020 fell to 1.7, near its 2018 low, then rocketed up over 4 fold to 7. AEM met its 2018 low at 30, then tripled. All of this in just 5 months.


Gold investors are obsessed with the idea of 5-10 bagger returns on JRs in a bull market, and they have a good reason to be, because as I’ve shown, its not only possible, its happened 5 times in 20 years even with major producers. The problem is their approach is typically to get in AFTER a massive move betting on a continued move higher and a long 10 yr bull market. Just because we had a nice decade long run in 1970s and 2000s doesn’t mean you are guaranteed one this time around.  It worked buying into gold after it ran to 700 in 2006, and again at 1000 in 2008-2009. It didn’t work at 1550 in 2013 though, and clearly it hasn’t this time either.

 

Simple fact is, as I’ve mentioned before, everything went faster this time around. Economy collapsed, Fed wasted no time printing and the govt didn’t waste time spending like drunken sailors. Gold went from “market panic crash” at 1400, to up 50% in 4 months. Silver tripled that return, from 12 to 30, a 150% return. In 2008, the Fed kept QE running with no consequences from inflation for the next 5 years. Within 1 year of starting up the bond buying this time, we were already at 5.4% inflation. For all the criticisms that the Fed waited too long to act (and they did), the time between easing and tightening didn’t give gold much to work with.


So if the way to make a killing in gold and silver stocks is to buy when we are nearing cost, what does that mean for right now? Well bad news. NEM and ABX costs as of last quarter are around 1165/oz. That’s a long way from the current price of 1730. The good news is, those costs are rising quickly, about 10% just since Q4 2021 for both Barrick and NEM. While inflation may be peaking here due to an expected economic decline, any positive number below 8.7% just means costs are increasing less fast than before. I think it’s safe to assume that unlike other recessions like 2008 and 2020, we will likely not see $20, or -$30/barrel oil like we did then. (My guess? Somewhere in the 60s. $3/gallon or less is an improvement from 5, but not the 1.xx range were used to in recessions). Being that oil is a major cost for mining, this will continue to put pressure on their bottom line.


Gold is falling apart, the lows at 1680 will likely give way so where do costs and gold begin to meet? First, there is no guarantee we’re dropping to the cost of mining, but it’s happened before so it seems possible. It’s also the best time to buy miners historically. IF we see a similar situation, I believe these roads will intersect somewhere around 1400.  If costs at 1165 for the major miners like NEM and ABX increase by another 10% over the next few quarters, they’re AISC will be about 1280/oz. At 1400 gold, that’s a pretty thin margin. (Of course, if costs rise more in a short period, that level might be closer to 1500. This is the part we kind of have to play by ear).


From a technical perspective though, we can see a lot of significance with 1400. A trendline from the lows in 2006, 2008, 2016 and 2018 line up right at 1400 currently. Additionally, 1400 was the “ceiling” of the entire bear market. From a TA standpoint, a breakout and retest of that bear market ceiling area would not be an uncommon thing to see. It’s also the 38% Fib retracement from the 250 low in 2001 to the recent highs at 2100.



The problem is that’s down 20% from here and knowing how silver and miners trade in relation to gold would spell out some devastating losses. If silver dropped inline with gold (It won’t, it’ll drop more) that would be 15/oz (13.30 if it’s a 30% drop). (As of Q1 2022, PAAS AISC is at 13.30, AG’s shot up to 20, which will likely come back in line ~15-16 soon. But that looks like a logical level for silver) If these things occur, expect miners to revisit 2018 and 2020 lows. Currently a 30% drop here in GDX sends us to 18 again. If you’ve been invested in PM miners for more than 1 day, you know that expecting a 30% drop in miners with a 20% drop in the metal is incredibly wishful thinking.

 

Right now we may be setting up for a pause in the bleeding. The only 2 times gold has been lower than it is now in this consolidation, were the 2 times it tested 1680. Silver is testing the 61% Fib retracement from the 2020 low to the high at 30/oz. Additionally, this area near 18.50 was support from 2013-2014, then resistance from 2017-2020, so it should offer some support testing it again this time.

 


GDX is testing ~25, which is the 23% retracement from the 2011 high to the 2015 low. This area was also resistance from 2017-2019, then provided support in 2019. Weekly RSI is the lowest its been since the 2018 bottom, but as we can see from that reading at 21, while we are currently at 31, we can go a lot lower. GDXJ looks similar, just worse. After already losing 50% from Aug 2020 highs, its now testing the 78% Fib retrace from the 2020 low. This level ~30 also coincides with support, as we can see many instances of lows and bounces from 2013-2019 near this level.

 




I suppose it’s worth mentioning the pitiful performance of SILJ, now closing in on the 23% retracement from all time high to low, again an area it bounced at in 2013 and not too far off now from 2018 lows at 6.84. Just another 20% down to erase all its gains for the last 4 years.



We may get a bounce here, but I wouldn’t try to play this long. It MIGHT be worth taking some liquid, in the money protection out by buying puts, but we’ll cross that bridge when we get there. Don’t try to go long a bull market.


One more point I want to note. People have said how I haven’t posted as much here or on Twitter, or done very many interviews recently. Truth is, I spent all of last summer screaming the warning signs that I thought were coming in gold. I thought what we’re seeing now would begin unfolding then. I got an incredible amount of backlash and ridicule for my opinions by permabulls (who have been largely quite recently). People who scoffed at the idea that gold would be weak due to taper fears and bottom when the fed began hiking when I said it in June, finally began accepting that as the likely blueprint by Jan, which was of course, too late. Everyone shouted the same words I heard 1000x before, the most dangerous words in investing, "It'S dIfFeReNt ThIs TiMe", only to now watch miners drop almost identically to how they did in 2013.


It was tiring. It burned me out and I kind of lost interest. Since then, been trying to focus on other things. Gardening and hiking have been nice hobbies. With the help of a friend, I’ve been stewing over some business ideas as well that I may wish to launch in the future. For now, the trend is down so if there’s nothing to do in your portfolio, do something else, and I have been.


If there’s something important to say, I’ll be there to say it. As I did in Jan right before gold turned higher. As I did in March when DSI numbers were signaling a top. When I think we reach that multi-bagger, near cost, buying opportunity in gold, believe me, I’ll be on Twitter and on here saying it. My goal has always been to help the smaller PM investors navigate a volatile market, while trying to cut through the Perma-bull crap and conspiracy theories to get to the stuff that actually matters, like how to ACTUALLY make 1000% in miners by buying when price is near cost, not because Basel 3 is a game changer that will send gold to 10k by next week. I’m not going anywhere. I’ll be there screaming when the time is right. (Perhaps it can be done on an better platform in the future?)


Remember, leverage kills. You won’t go broke picking a few bad stocks. You go broke picking 1 bad stock with leverage. If you have leverage, get out. Live, learn, move on. This is a bear market and your only goal here is to survive it.

-Jonathan Mergott

Wednesday, May 25, 2022

Quick Update

I'm about to head out on vacation for the next week, hiking around the Blue Ridge Mountains, and will likely have spotty service so I wanted to post a quick update on gold before I leave.

 

Gold is up almost 100 from its low 1 week ago, managing to not have a daily close below 1800. We ran right up to resistance ~1870, that we failed at in Nov last year.  It is also the 23% Fib retracement from the 2018 low and is currently right where the 30 day EMA sits. Now it appears we are weakening a bit.

 


I am not enthused about this price action. Gold chugged higher after an extreme drop and being very oversold but only managed to claw back less than 100 of the 300 its lost in the last 3 months. I would have hoped to see closer to 1900-1920 before a pause and pullback. This weak price action I think is a warning here to proceed with caution. Very oversold conditions have pared off a bit, and while this might be slowly building a low, it equally could be getting ready for another drop.

 


Although the price action in Gold is not enthusing to me, I am even less enthused about silver and miners here. For 2 years, Silver consolidated above 22. There were only 2 times it traded below that level, Sept 2021 and Dec 2021 and in each instance, it bounced back above within 24 hours.  It’s now been 2 weeks that we’ve held below 22 and have now bounced back to test that level, and we are beginning to roll over. Support becomes resistance, resistance becomes support. This is not a good look for silver right now.

We can see something similar in SILJ as well. The area around 11-12 has held as support at the worst parts of the correction that began last June, and now we have broken below and held below for a substantial period of time. We have bounced to retest that previous support area and are failing here, which is also right near the 13 Day EMA, (substantially weaker than gold which was able to claw back to the 30 day). Additionally, we have 2 big gaps down from this plunge. The nearer of the 2 is at 11.50 to 12. The last few days we have topped out near 11.50, unable to fill the first gap. There is virtually nothing on this chart that is instilling me with the confidence to buy right now.



GDXJ is similar. Although it was able to bounce back within a few days of breaking the major support it held after last summers weakness, it too has 2 gaps to fill, the first at 40-41 and is stopping dead at that level, unable to find buyers over 40.



GDX looks the best simply because it did not even flirt with breaking support near 29-30. But on the flip side, the 1st gap in GDX at 33.50 to 34 it still has not reached unlike GDXJ and SILJ which are at least ATTEMPTING to fill them. This price action in miners is almost identical to what we experienced last summer to winter, except then it took 4 months for GDX to drop 30% from its high of 40, and this time around we had a 30% loss in just 4 weeks. If I am being honest and objective about my analysis, and following the same rules and cues that made me cautious last summer, then there is little difference in price action today to make me wildly bullish right now.



I’m not here to tell you what to do, simply to point out what I see, how I interpret that, and what I myself am doing. So from that standpoint, I don’t think this is a good time to be trying to buy producers, and I will be holding off on doing that for the time being. There are a lot of Jrs that have gotten very cheap recently that are worth nibbling on here, but I am not trying to spend all my cash reserves just yet as I have a feeling all markets will continue to get worse and it may last for a good amount of time.

Markets are overleveraged. If SPX continues to grind lower, it WILL affect PMs and miners, as well as crypto, commodities, etc.  Best case scenario is a crash. In that event, we all know what to do, we have been conditioned by it from witnessing what has happened post 2001, 2008 and 2020. That being said, the fact that everyone is waiting for a crash to buy is a major reason I think we may not see one. Instead, we may actually see a bear market for the 1st time in 40 years, and by that I mean, grinding lower while everyone tries to pick a bottom and is forced to bail as we break to new lows over the course of maybe a few years.

Everybody has an opinion on the economy here and looking at price action in markets, I think it supports mine, and that is this: The biggest factor contributing to the weakening economy right now is inflation. I know many have expected 1970s style inflation peaking into double digits, but the fact of the matter is that since 1977, cumulative inflation is ~370%. At the same time, adjusted for inflation, median income in America is down 5% and household debt is up 35%. The middle class simply have no room in their paychecks and no room on their credit cards to continue to pay higher prices for the same goods and services. The result is a decrease in spending and a contraction in the economy.

Everyone seems to think Powell is going to rush to print again as the economy contracts because that’s what the FED does, but when the economic contraction is caused by inflation which was a result of printing, more printing now will do more harm than good. He royally screwed up by not acting fast enough and now he must maintain his course continuing to tighten while the economy takes a nosedive. The problem is we now have a similar situation to 1980. When inflation peaked at near 20%, the Fed had to hike aggressively to 20% to fight it. But it didn’t just go away because of that. 2 years later, inflation was still 6% and the Fed funds rate was 9% all while GDP was -1.8%. I think it is likely we can still see presistant inflation, a weak economy, and higher interest rates then we have been use to over the last 15 years for some time. After a decade of inflation in the 1970s that hurt the middle class and benefited the rich, we had a decade of high interest rates in the 1980s that hurt the middle class and benefited the rich. The result of which is the massive wealth gap we see today. And now we’re doing the same thing again.

I fear the policies we enacted after covid were America’s nail in the coffin. The economy will never recover fully, debt is too high, and we are now destined for a stagnant economy with little to no growth and at the very least, low but persistent inflation that we will never recover from. Essentially, we are embarking on the path Japan has been on for decades now.

But I digress. Let me wrap this up with something positive. Sentiment in Metals has taken a major turn from overly bullish, to very bearish over the last 2 months, and that is very positive from a contrarian standpoint. Additionally, COT reports on Silver and Gold have seen large specs rush to sell their longs which is something we typically see at major bottoms. The issue here with these 2 things is that sentiment and COT positions are relative to whether we are in a bull market or a bear market. I shared the chart below on twitter before, showing Gold DSI and how it differed in it’s peaks and lows when gold was trending higher and when gold was trending lower. Bearish sentiment is not always a buy. You can see that DSI levels went to near 0 bulls many times, had small bounces then right on to new lows when gold was in a bear market. Below that chart is the Gold miners bullish precent index which shows the same thing. Currently now it is ~20, which has basically marked all major lows since the bull market began in 2018. IF we are in a continued bull market, it is likely this is also a major low.







However, if we are transitioning into a bear market, it’s likely we can continue to see sentiment drop with price for long periods of time. Long term, I am a gold bug at heart and therefore bullish, but short term, price action is not encouraging. I THINK this is likely pressure being put on gold that is related to all markets which are experiencing selling across the board, due to an oncoming recession. But I would be remiss if I didn’t take into consideration the similarities in the economy right now to what we saw occur in 1980 when inflation peaked and the long and difficult battle the Fed had hiking rates to fight inflation while the economy contracted. In THAT situation, gold had already peaked and was grinding lower and would continue to for a significant period of time. (20 years actually, which I do not think will be the case this time around, but we could see a stagnant period like from late 2016-2019.  After the massive rally in gold and miners early 2016, we corrected from those highs significantly and just grinded sideways for over 2 yrs, dropping 1 more time in 2018 before we began moving higher. This also occurred during a Fed tightening cycle.)

To sum up, I’m looking here to add small amounts to cheap Jrs with good assets and good management who will be able to expand those assets and shareholder value, regardless of the direction of the metals. Producers I will not be buying till they can “show me” something good here. I’m in no rush to spend all my cash as I expect either a crash to buy heavily into, or continued grinding lower for some time where I can keep picking up small amounts over the coming months. There are some positives with metals here, mainly in sentiment after a brutal drop, but I will repeat something I said when this happened in June. Violent moves down like this are rarely isolated incidents that just reverse back and break to new highs shortly later. If the lows here do hold, we likely have a few months of back and forth range bound action till we’ve shed off every hopeful long that we can, and then we can resume moving higher.

There is a lot up in the air right now in markets and the economy. No matter what your view on a market is, it’s a good time to be skeptical about everything and consider opposing points of view. Times like these, uber bulls or bears can get wiped out, Cash is a good thing to have so don’t be too quick to dispose of all of it.

 

-Jonathan Mergott