Saturday, January 9, 2021

Riding the Gold Bull in an Algo-driven Market Tsunami

Yesterday was bloody in precious metals.  Silver tanked 10% at the worst point of the day and many miners were down 10% or more.  Gold bulls on twitter suddenly got quite as virtually everyone was analyzing the market, their portfolio, and trying to see "what went wrong."  Looking at it, and I think it is clear this was a dump.  But it shook a lot of people, so I want to write a bit on what is in store for the future here and what we can expect trying to ride a volatile gold and silver bull in a market driven by momentum chasing algos and how to not get bucked off the ride until you’re ready.

I responded to a comment on Twitter yesterday and said this regarding the metals dump and one person’s panic:  Step 1: Analyze the fundamentals of the situation.  Is our analysis on a much higher gold and silver price flawed somehow?  Step 2: Look at the technicals.  Do they confirm the fundamentals?  As I like to say, “watch the miners” for clues as to the next move in the metals.  Do the miner charts look bearish?  Step 3: Analyze your personal situation.  Are you leveraged too much?  Did this correction shake or hurt you to the point where you cannot stand to see another one?  Are you risking more money than you can afford to lose?  (I mean this both literally and psychologically).  If the answer to these questions is all “No”, then proceed to Step 4: Turn off the screen and go fishing.  It’s not time to buy, it’s not time to sell, there is nothing you can do here sitting by your computer other than shake your own resolve, so get up and leave.  I want to break down these points in more detail.

Is the fundamental analysis correct?  You should always know what you own and why you own it.  This seems obvious, but you’d be surprised.  Why do we own gold?  For wealth protection, historically.  That is why people buy gold.  But what drives people to seek the protection they find in gold to begin with?

A little about myself for those who don’t know me well.  I like to say I was raised by old school gold bugs.  My father, my grandfather, my great-grandfather were all PM investors at different times in different decades.  My father had been a gold and miners investor from the late 90s through the bull market from 2001-2011.   My grandfather and great-grandfather worked together investing through the 70s bull market.  Prior to it, my grandfather was a broker, back in the days before call waiting, when 2 brokers sat at a table with 6 phones on it.  The other broker at his table was Jim Sinclair, who for those of you that don’t know, famously called for gold to go from $50/oz in about 1972 and hit $900 by 1980 and he ended up being off by a whopping $13 when gold topped at $887.  I worked with Jim Sinclair as an investor relations consultant from 2011-2015.  I managed a primarily gold and silver investment fund from 2008 through the metals peak in 2011.  I currently manage a non-profit investment trust my great grandfather began 65 years ago.  (We are primarily invested in gold and silver miners). 

I’m mentioning this because I have had the pleasure and fortune of working with them, their colleagues, and rubbing elbows with well-known and lesser-known great minds in the gold industry who collectively have centuries of wisdom and experience.  So, getting back to the question of why people seek the protection of gold to begin with, you can get a lot of opinions and I’ve heard some of the best analysis for a bull case in metals that’s out there.  But I think most arguments are missing one important factor.

There are those out there calling for higher gold because they believe we are headed into a depression.  There are those calling for a bull market because of looming inflation.  Then there’s the stagflation argument, a mixture of the two.  Economic deflation coupled with rising prices, the worst of both worlds for everyday people.  It seems from some people’s arguments, that you can buy gold for a looming depression/deflation or for incoming inflation, which seems contradictory.  Basically, buy gold because it will always go up in either situation, which we know is not true.  But we can point to the great depression and claim deflation.  We can point to 20% inflation by the 70s bull market peak in 1980 and claim inflation.  We can point to the fed’s balance sheet, and massive debt from 2008-2011 (and still really) and claim its debt or QE.  All these things are not inaccurate, but they are symptoms or byproducts of the greater reason why people invest in gold and what drives bull markets. 

 

Gold goes up when people lose confidence.

 

The one common theme in all bull markets in gold is a loss of confidence.  In the depression, a loss of confidence in the economic system.  In the 70s it was a loss of confidence in currency after ending Bretton Woods and seeing relentless inflation and dollar devaluation.  In 2001-2011 it was a loss of confidence that we will ever pay back our debt.  It was also the repeated bubbles and crashes that made many lose faith in the economy and the markets.  A bull market in gold is a sign of a loss in confidence in the economic system, markets, currency and the ability of government to fix it.  A loss of confidence in government itself. 

This is our fundamental case for higher gold and silver prices.  So, in the course of yesterday’s trading session, was anything done to garner any confidence in government?  What about the Fed’s management of inflation and the economy?  If anything, people’s confidence in EVERYTHING is continuously hitting all time lows from what I see.  Three days ago, people stormed the capital because they have lost confidence in our election process.  In 2009, people were shocked at our first trillion-dollar deficit in one year while our debt hit 10 trillion, only to see 10 years later for the deficit to balloon to 3.1 trillion and the debt to nearly 3x what it was a decade ago. Does anyone think we will ever pay this back?  Does anyone have any confidence in any aspect of our government to set us back on the right path? To do ANYTHING right?

People are dying, losing jobs, and homes.  No one is coming to their rescue.  The government is offering $600 of checks helicoptered out to the country.  They have no plan.  This is the most slip-shot, thrown-together “stimulus” I’ve ever heard of.  And why?  Probably because they’re too busy intricately planning how they will throw billions to bailout airlines to even waste any time with a thought-out plan on how to help you.  In the meantime, the fed pumps their balance sheet propping up corporate bonds and forcing down interest rates while the market soars to new highs after crashing 30% in 6 weeks only 9 months ago.  Tesla shares are up 1000% since then, closing in on joining the world’s biggest companies like Amazon in the 1 Trillion club, on only 20 billion in revenue…1/10 of Amazon’s revenue.  Oh, and grocery costs are going up.

I don’t want to digress into politics because I firmly believe it doesn’t matter.  The die is cast.  Whether your right wing, left wing - no one can fix the problems we’re facing and none of them care about anything other than themselves.  It’s a big club and we’re not in it. 

The world has gone mad.  Everyone is losing confidence in everything.  I lived through the last bull market.  I haven’t had the experience of living through the depression or the 70s stagflation, but I’ve worked with and heard stories from people who have.  This is the most bullish scenario for gold I have ever seen or studied.  We are going much higher before this is over.  How high depends a lot on how fast we get there.  I’m expecting gold between 3500-8000 before this is said and done, with the median target at 5000.  The point is: Our fundamental case for gold is sound.

     Now let’s look at technicals.  I posted a lot of charts on twitter yesterday, so I am not going to repeat them for the sake of time.  Take a look at the posts on my profile @Jmergz1985 to see them.

I posted a lot of silver miners yesterday, but left out SILJ, so I’ll do that now.  If I removed prices from the chart and you just looked at the picture the candles were painting, there would be no concern whatsoever.  The previous high, as well as a long-term downtrend line are right at 17.  It tried breaking above this and couldn’t quite muster the strength and fell back.  Sure, that’s a sharp red candle there, but I can see about 6 other red candles that look about equal to it on this chart.  This looks like it’s forming a cup and handle consolidation right at its highs which is very bullish. 

From a textbook chart pattern definition (use with a grain of salt, nothing is textbook) the handle should bottom about 50% of the depth of the cup.  So being that the high is near 17, the low of the cup is near 12.50, the depth is roughly 4.50, so the handle shouldn’t drop much below half of that difference (2.25), which works out to be about 14.75.  Honestly, we could drop back to the 23% retracement at 14.30 and test that level and I wouldn’t see anything bearish about this.   I should also add, silver was 30 when SILJ first hit 17.  Now, silver is 20% away from its recent highs at 30 and SILJ is 6% away from it’s highs at 17.  The miners are leading the metal as they typically do in bull moves. This isn’t just not bearish, it is incredibly bullish.

Next up let’s look at NEM. Newmont ran up about 15% from the Nov 30 low, tested near the 23% Fib extension around 66.46 and dropped.  Yesterday we tested the convergence of the 20 day and 39 day moving averages, bounced decently from the lows and closed at the 23% Fib retracement from the Aug high and March low.  Gold miners have been underperforming silver miners, but this was expected, the same as we expected juniors to outperform majors.  There is certainly a big difference looking at this, the biggest gold miner versus the SILJ, but it is not at all bearish, just slow. 



Let’s look at Gold and Silver too.  Gold got pushed back from the 1960 level a few days ago.  This was the same level we were at when vaccine news started pounding the metal 2 months ago and we closed at nearly the same level yesterday too.  It was a nasty drop, but we tested the broken downtrend line and bounced.  We were able to close the week above the 1844 level, which is both the 38% retracement of the move higher from March to Aug, as well as the 23% retracement of the move lower from Aug to Nov 30th.  Again, this isn’t explosive looking but not bearish either.  What will matter most is how we bounce from this.  I think we will melt higher slowly in a boring way and make our way back to 1960.  What we don’t want to see is gold regain about 50% of what it just lost and stop cold and reverse.  That may mean we are in for a deeper correction.  So, watch the area right near that fib retracement at 1891, as well as the psychological 1900 level for a failure.

 


                Looking at Silver it’s a much better picture than gold and that is what we should expect in a bull market.  We dropped from about the 28 level in Sept after an explosive move.  We managed to get back to that level and retest it a few days ago before yesterday’s plummet.  Again, if I could take prices off the chart, you’ll look at the candle and see about 6 more like it - after we plunged from 30, the drop to 22 in Sept, the vaccine news...  In mid-December we fell just short of 28 and reversed on the day then dropped the following day strongly.  We basically got those 2 days in one yesterday.  We started and ended at about the same levels. We came back off the lows nicely.  We closed above the consolidation from 22 to 25 we spent the entire fall in.  Again, this looks like a possible bowl-like formation that may mimic some form of the miner’s many cup and handles I am seeing.  (The target here would be 34 roughly).  Not a bearish picture, just a sharp pullback.

 


I could go on.  Some charts look amazingly strong.  The worst of the bunch look “meh”.  Not too great, not too bad.  Most look at the least very solid.  So, the technicals confirm our fundamental view.

        Next up, leverage and psychology.  Have you talked to your portfolio about using margin?  Do it now before it’s too late.  If you didn’t blow up your portfolio, get forced out of positions, or suffer such emotional discomfort that you sold, then congratulations, yesterday was a gift.  Why do I say that?  I think I probably lost more on paper yesterday than any other day I can remember.  Felt like a punch to the gut at first.  After some analysis, some personal analyzation of my portfolio, and a few beers last night, I realized that’s a good problem to have.  I’m certain I have had equal percentage losses, but if this was my largest dollar drop in a day than I have more money then I use to, so I’m doing something right.  Gold and Silver aren't at all time highs, the GDX isn't either.  So I've done well building a portfolio of miners that have outperformed the funds at Van Eck and elsewhere.

I didn’t sell or blow up my portfolio.  I have the same amount of ownership in the same companies I had before, they’re just worth less now than they were on Thursday.  And if you didn’t either, than its a gift because we got a test run of what’s to come without actually suffering any irreversible damages.

There was one chart I posted in a comment to a post by @TheLastDegree, which I will repost here (For those who aren’t following @TheLastDegree, I highly recommend you do.  I have seen very few, if any people not only nail timing, price, and strategy as accurately and as many times as he has but also nailing stock picks that have unbelievably outperformed their peers in the gold and silver sector.)



This is the Silver chart from Oct 2010- April 2011.  Going over the chart, I calculated 5x in 6 months that price moved intraday 6% or more.  One of those times, like yesterday was a 10% move, and there was also a 15% decline for about 3 weeks in January. Silver ended January near $27 (only about 5% higher than where we are now) and practically doubled only 3 months later. 

This was exactly 10 years ago.  For context, the Dow was 12,000, oil was 90 and Tesla was $5.  Volatility has increased immensely since thenPrices move far more drastically in far less time in all asset classes.  From top to bottom, the 2008 financial crisis bear market in stocks lasted about 18 months and lost a little over 60%.  The Covid-19 bear market lost 30% in just 4 weeks, then broke to new highs 5 months later.  This is what you get when momentum chasing algos make 90% of the trades on the NYSE.  EXTREME volatility.  It’s not going away.  It will only increase.  In already volatile assets like gold and silver, this means we will see extreme moves in the future, more than even yesterday’s move. 

That’s the bad news, we will see more of this.  The good news is it will be followed by 10% up days in the future as well.  The other bad news is that the next step will be 15% down days.  As the saying goes, bull markets take the stairs up and the elevator down.  It’s what keeps it going, people panic, selling on big down days than chasing prices higher.  If yesterday put you over the edge, consider your personal situation and strategy in order to keep your portfolio in harmony with your psyche.  Here is what I advise:

  • Do not invest any money you may need for expenses in the future, or a possible unexpected large expense. 
  • Do not invest any money you are not prepared to lose.  Right now as we speak, some Fortune 500 company is cooking their books Enron style and no one has any idea until it blows up and goes to 0.  This can happen to any stock, anytime, it is always a risk.  If it’s too much, don’t do it.
  • Do not use stop loses on your long-term gold and silver positions.  If your stop is too tight, you WILL get stopped out in volatile swings often and usually end up buying back higher.  If your stop is too loose, you will see volatile swings that will stop you out at terrible prices and it will ultimately prove a pointless endeavor that doesn’t actually offer you any “protection”.  In short, you’ll get bucked off the bull before you want to.
  • Do not use margin.  You might think a small leverage of 5% is fine, and theoretically will not result in a margin call even in a crash but consider the mental anguish of the volatility on days like yesterday.  Also even a 99% chance you won’t blow up your account means a 1% you do and walk away with nothing.  If you are going to use margin at all, make sure you can pay it off immediately on the spot if need be, in full without selling your positions.
  • If the mental anguish was too much yesterday, consider keeping a portion in cash or completely unrelated assets, like the SPY fund.  (And always remember, in a crash everything will go down.  When the margin calls come, if you can’t sell what you want, you sell anything you can.  This is why gold reverses it’s bull moves in major market crashes.  No one wants to sell their AAPL stock, so they sell their gold hedge, and then usually have to sell their AAPL anyway) If you suffered a bloodbath in call options on metals and miners, consider converting some percentage into stock, at whatever level will help you sleep at night if this happens again.
  • Prepare to see this again.  Prepare for worse.  Prepare for the fact that at $100 silver on it’s way to $150 or higher we will likely see a swift, brutal, 30% drop in a short period of time.  Prepare for how much more your portfolio will be worth then and how many paper dollars you would lose in that situation.  If your doing something right, it will be a lot more than whatever you lost yesterday.  Think about the exact amount you could lose, 30k, 50k, 250k.  Really think about losing that kind of money in a few weeks.  Then when it happens, you’ll be prepared, you were expecting it.  (No guarantee it doesn’t still feel like a punch to the gut though)

     So the fundamentals are sound, the technicals back us up and we’ve got our financial house and our minds in order for what’s to come.  There is no need for alarm here.  It hurt, its done now, the bull market is not over yet.  Let’s watch some of these key levels and prepare for a possible reversal on the relief rally, worst case scenario.  Crashes can happen anytime.  Know what you want to do in that situation and how you’re going to do it.  But for now, all is well in Gold and Silver land.  Nothing here is unusual or has suddenly turned bearish. Now let's bring on Monday.

-Jonathan Mergott

10 comments:

  1. J - It's a great write up at the hour of crisis. Measured and Frank. Thanks

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  2. Outstanding article which will help a lot in this community. Thank you very much !

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  3. Thank you for the timely reminder about why we are in the previous metals, especially after yesterday's attack on the price.

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  4. I needed that - merci beaucoup!

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  5. Regarding margin, what about no margin on leveraged ETFs?

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    1. Don't use leveraged ETFs. Time decay does you no favors on either the bull or bear side and I've seen too many blow up entirely. (Look up the chart of XIV from the 2018 implosion. From $120 to $4 in 1 day, then delisted). As I said, "Nothing worse than being 99% right and having nothing to show for it." On that note, story time... In late Feb 2020 I was expecting a looming liquidity crisis with COVID surging. (The Fed's sudden REPO moves in Nov were a clue that all was not well.) Bought the VIX and DUST expecting all assets to plunge and to use the panic opportunity to hedge my long term gold holdings, as well as to raise cash to buy with while everyone else panicked and dumped. What happened next was exactly what I thought. Everything crashed, VIX soared, Gold tanked. Everyone was panicking to raise cash. In 3 days, DUST went from 200, to 450, to 100. A few days later, Direxion announced DUST and NUGT were being reformulated to track the GDX at 2x instead of 3x. In the end, what I made on VIX was eliminated by my loss on DUST. I was 99% right on everything except the way I chose to play it. I called the biggest liquidity crisis and market crash in a decade perfectly and didn't make a penny off of it. Learn from my mistakes, it's a lot cheaper than making the same ones yourself.

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  6. Thx, for this view.Kind regards, The critical mind on Twitter

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