Gold Tailwinds: Don't buy a Bear Market and Don't sell a Bull

Quick update on metals here, because there are a few things worth discussing.  First of all, it’s worth noting the impressive weekly candle on gold here. From the amount of the drop Sun night to a reversal closing at highs for the week, its very hard to find a comparison of anything like this gold has done in the past (In a similar magnitude that is.) One of the closest, (on a weekly scale) I could find was Nov 2014, when gold reversed from a low of 1130 to close the week at the highs at 1179.  The next 2.5 months gold gained an additional $120 from there.  From a technical standpoint, this is definitely bullish.

Additionally, it proves the point I made in my last article that I published Sunday morning, Aug 8^th, BEFORE the plunge occurred later that night when futures opened. I wrote, regarding those who always use the manipulation argument to explain away their bad calls, trades and investments:

“Yes, all markets are (manipulated), in the short term. But if there was overwhelming demand to buy gold at 1850, investors wouldn’t pass up the opportunity. We wouldn’t be sitting here $100 lower. There are people whose sole job is arbitrage. They will buy 50m in Euros from a seller knowing they can offload it to a willing buyer 10 seconds later for 1/1000 of a penny higher and keep the difference. If gold was mispriced, they’d be buying it.”

When futures opened, gold dropped $80 from 1760 to 1680. Within 5 days investors saw the value in gold being “mispriced” and bid it back up to 1780, $20 higher than we started. Regardless of the reason why behind the drop, it was a complete BS move, plain and simple, and the market recognized that. In this instance, the crowd screaming manipulation was right, and it was proven by the reaction in gold in the days that followed. But beware, because they will scream manipulation on every drop and that won’t always be the case. This is what they did all the way down into a bear market from 2012-2015 that saw the GDXJ lose 90% of its value from the 2011 highs.

There are 2 other major tailwinds for gold right now, the first being COT positions, and the 2^nd being sentiment. Regarding the last COT report, we can see that large spec positions in gold are at their lowest in a year. These are about the same levels as the March lows as well, which is a good sign. A quick note on COT reports for those who may not be familiar:

Large specs are hedgefunds, essentially. Small specs are you and me, (retail investors), and commercials are the producers and hedgers who act like merchants to the large and small spec groups. If you look at COT reports, what you will find is, (Not always perfectly, but within reason) the large specs are essentially trend trading, momentum chasers. They buy what is going up. They typically, as a group, have their position sizes increasing as an asset moves higher, meaning they are most long at market tops, and least long or sometimes even net short at market bottoms. They’re positions move mostly in line with the underlying asset. Small specs often mimic this as well.  Commercials on the other hand are the ones selling to the large specs and small specs who want to buy. As a result, their positioning is typically INVERSE to the underlying asset. So, they are most SHORT at market highs and least short, and sometimes net long at market lows. This is why they are looked at as the “smart money”.

Below is an example of what I mean with current OJ futures. Notice how at the decline in price in Oct last year, Large specs (green line) went net short, right at the lows, while commercials (red line) were net long. OJ rallied and large specs chased price back up, then sold as it declined again. Now with OJ at 52 week highs, it should be no surprise that large specs have their largest long positions in it during the same time frame. Retail is also the most long in one year.

An important note though. Although they are typically wrong at major turning points, large specs are the group that drives markets higher. If you want to see a strong uptrend in an asset, you want to see large specs continuing to increase their positions as that asset moves higher. Without them, you rarely get good trending moves. So, in the situation with gold, we want to see them selling and have their positions dropping going into a low, and then increasing steadily as we begin moving higher, ideally continuing to increase to new highs on their positioning.

The tailwind for gold here is that large spec long positions are the lowest in 1 yr, and about equal in size to their long positions during the March low. This is a good first step to marking a low. From here we want to see their position sizes continue to increase as the market moves higher, indicating that they are buying strongly.

Here’s where it is problematic. While on surface value, “lowest large spec long positions in 1 yr” is bullish, digging a bit deeper as to the “why” behind that raises some concerns.  For instance, looking at large spec positions in gold over the last year we can see their positions near highs have been steadily decreasing, meaning they have been overall, less long than they have been previously, which indicates they are losing interest in buying this market. We can see the same looking at the small specs as well. The problem here is this, as a basic general rule of investing and trading,

Don’t buy bear markets and don’t sell bull markets.

And the reason behind that is simple. If you buy into a down trending bear market, expecting to nail the low because a rally should be coming soon, you will often find the asset continuing to head lower and by the time the rally comes, you are lucky if you are break even. Same with selling bulls, don’t sell expecting a top and a correction, because by the time it comes, you very well could be higher than you were when you sold. In short, don’t make things harder for yourself by trying to swim upstream. Stick with the trend, buy dips in bulls, sell rallies in bears.

This is why “lowest long positions for large specs in 1 yr” isn’t necessarily wildly bullish in the medium & longer term.  Here is a picture of gold and the COT positions from 2007-2016. The first thing of note here is that large spec long positions (green line) near the end of 2011, began declining to the lowest levels since 2009. There was a bit of a lack of interest by the large specs while gold was consolidating here.  The final rally to test that 1800 level saw a bunch of large specs “suckered in” right before the bear market decline started. You can clearly begin to see a “downtrend” in their long positions and thus, their interest in gold, prior to the downtrend and bear market in gold itself. During the 2013-2016 timeframe, large spec longs were SIGNIFICANTLY lower than during the bull market timeframe from 2009-2011. Even after big rallies higher, large spec longs peaked at less than half the number of contracts they had held at previous highs during the bull market.

So, the worry here is that “lowest long positions in 1 yr” may not just be a mark of a low in gold, but instead a complete lack of interest in the asset by the group that is very important for driving prices higher. The warnings to look for here would be if a significant rally were to happen in gold, and in turn we see much lower long positions for the large specs, indicating their continued lack of interest. They follow that simple ideology of “don’t buy a bear market and don’t sell a bull market” which is why long position sizes dropped significantly as gold moved lower. So, this is not what we want to see repeat itself if our bias on gold remains that it is in a bull market.

The other tailwind here is sentiment. Aside from the die-hard gold bugs, very few people are enthused about gold right now, and again, its large institutions buying that drive prices higher, so their interest is needed for a trending bull move.  Our opinion as retail investors, is of little significance if we are standing in front of billions in institutional money that is looking to sell. The daily sentiment index for gold (DSI) hit 8 this past week. That is incredibly low, possibly the lowest I can recall seeing, even in the 2 major lows in the bear market, 2016 and 2018. From a contrarian standpoint (and we all SHOULD be contrarians in the market if we expect to survive) this is INSANELY bullish. I believe the DSI for gold hit around 15 at the lows in March, so this would indicate nearly no one is left long in this market.

Now sentiment is not the most accurate indicator for price or timing. Incredibly low bullish sentiment like this can continue for a while and price can continue dropping for a while, but within reason, accumulating quality positions for the medium term when you see sentiment like this, is almost guaranteed to be rewarded. But the problem here that arises is basically the same issue we have with the COT reports.

Months ago when I was very bullish of gold and silver I was expecting a consolidation-breakout-consolidation type move. In moves like this, we see sentiment reach extremes during peaks, then slide downward as bulls get frustrated with the consolidation. So, for example, a fast rally in gold could see 90+% bulls at the peak, then slide for a while till bulls are more like 30-40% at worst, then repeat. You don’t want to see extreme low levels like this because it indicates everyone has left, and in a situation like that, you don’t see a resurgence of bullish momentum return at the drop of a hat. Usually, it is a long grind higher and consolidation that exhausts the bears and makes people begin to take notice again. That’s what occurs in a BULL case of seeing incredibly low sentiment.

In the BEAR case, we could easily see extreme lows in bullish sentiment on gold provide a fast rally that sends shorts scrambling.  Bulls jump in, getting excited and we could be much higher in a few weeks. After say, a $200 rally from lows, DSI could return to a level near 60…

And then see the selling resume.

Just as the long positions in large specs do not return to levels they were at in the bull market, because of lack of interest, we can easily see bullish sentiment peak at much lower levels as well, and stay declining at extreme lows that in a bull market, would be considered screaming buy indicators. DSI at 15-25 might be a great buy point in a bull market, like it was in March where we rallied $250 from the lows in 2 months. But in a bear market, a DSI at 15 could just be on its way to 8 again, and there could be a huge loss between those 2 points.

RSI is the relative strength index. It is not a sentiment indicator, so this might not be the best analogy, but on one hand, sentiment is a strength indicator in a way. RSI provides a reading of “Strength” on a scale of 0 to 100 which in that sense, is similar to bullish % sentiment indicators, so I believe it works for this illustration. Obviously, levels at 0 or 100 are rarely if ever seen, but in general, readings below 30 mean oversold, and readings above 70 mean overbought. But it is not as simple as saying “its oversold therefore we should rally soon.” In bear markets, oversold conditions STAY oversold for long periods. Bad can get worse, and buying a bear market because its oversold is usually a losing trade. The same is true in bull markets. Selling a bull market because its overbought will more often than not, see the asset keep going higher and remain overbought before a meaningful correction.

This can be especially true on longer term charts. The SPX monthly chart became “overbought” with RSI above 70 in Spring of 1995. RSI stayed above 70 for 3 yrs until a correction in Summer 1998, took it back below that level.  At the bottom of that correction, the SPX was still 100% higher than when it first became “overbought.”

Here are 2 examples of RSI that I had posted before in an article a few months ago but I am going to use again to illustrate my point on sentiment as well as COT long positions of large specs. One of a bull market and one of a bear market. 

Below is Macy’s chart from 2009-2016. Notice how as it rose from a low of $5 to a high of $75 in 2015, that in addition to maintaining the uptrend line, dips in RSI did not go below 40, and “overbought” conditions above 70 stayed there for a few weeks at times. In 2015, the uptrend was broken and RSI went “oversold” around sept at a price of 50/share. It stayed “oversold” for weeks while price dropped 30% down to 35, a more than 50% loss from the high. Rallies afterwards saw RSI top out near 60 then continue lower. Ultimately, by the low in March 2020, Macy’s was right back to 2009 lows at $5/share.

 

Next is Ford from 2013 to 2021. It peaked at 18/share in 2014 and began trending lower. RSI topped out at ~60 as it trended down and peaks in price were pushed back by the downtrend line. In early 2020, it was “oversold” at $8 a share and stayed there for over a month while it lost an additional 50% to $4/share. As it has rallied since then, pullbacks in price have been accompanied by much higher RSI levels which have not fallen below 50.

 

Focusing on the F chart, we can see a few occasions where oversold RSI saw a bit of a bounce, and if you timed it perfectly, you could catch 10% upside before it began rolling over again, but overall, this chart was better suited to be selling rallies where RSI pushed up to ~60. We can see the opposite with M. Buying dips near 40 was very profitable and trying to sell when “overbought” was far less profitable. It simply depends on correctly identifying if you are in a bull market or a bear market and not fighting the trend.

I saw somebody had posted the Gold miners bullish percent chart recently on twitter.  (Didn't see who and can't find it now. Not trying to call anyone out, just using this to prove a point.) While this is actually a breadth chart, it is often cited to give an idea of sentiment. It also works on a scale of 0-100, like DSI and RSI. It is currently at 33, which for reference, is higher than at the March lows when it bottomed at 24. So I did a little digging into this chart in the past and what it looked like in the bear market, and lo and behold, it EXACTLY proves my point regarding sentiment that I was attempting to illustrating with the Macy's and Ford RSI charts.

When miners began dropping in 2013 the Gold miners bullish percent started at about 33. Same as it is right now. It then hit lows at EXTREME levels near 0-5 as the HUI fell from 450 to 200, a 55% loss. On every rally afterwards, it never got past 60, and mostly topped out at 50 while the HUI spent 2.5 more years dropping ANOTHER 60% down to 100. A total of a nearly 80% loss from the time when the Gold miners bullish percent started at 33 and LOOKED like miners were a good buy due to "Bad sentiment" given the fact that we were in a bull market. (Which we weren't).

Don’t buy bear markets and don’t sell bull markets.

In essence, this is my fear with Gold, silver and miners here, and longer term I am not seeing any indication that this is changing. I think it is a very real possibility that we rally strongly, see sentiment improve, see large specs begin to increase their long positions a bit, then top out at lower levels on all of these things and head right back down again.  As I write this at 1pm NY time on Monday, Gold is up $10 at 1788, trying to push back above 1800. Silver is flat at 23.78 The GDX is down 1%. The GDXJ is down 1.3%, and the SILJ is down 2.3%.  Remember the formula we want to see in bull markets I wrote about last week.

JR Silver > Major Silver ≥ JR Gold > Major Gold ≥ Silver > Gold

It is still exactly backwards, with gold outperforming all right now. Early last week I had mentioned on twitter that I was beginning to buy in small amounts as the risk reward here looked good. I bought a few Jr silver miners, closed my GDX puts, and bought the following calls:

GLD 160s Oct expiration

SLV 21s Oct expiration

GDX 33s Oct expirations and

SILJ 13s, Nov expiration.

The results so far after almost 1 week are interesting and disappointing, but understandable given my longer-term expectation that we are likely in or entering a bear market in metals and caution should be taken here.  My GLD calls are up over 65%. My SLV calls are up 9%. GDX calls are up 4% and my SILJ calls are up 3.5%. My Jr miners are a mixed bag, some up a little, some down a little. Overall, pretty much a wash.  Silver and miners are not performing even in line with gold, let alone outperforming, and Jr miners are lagging majors. Gold is up over $30 from Wednesday’s highs and the GDX is down 50c from there.

On Nov 30^th a made a point of saying on Twitter that I think we were at a bottom in gold. We were, to the day, and we rallied $200 over the next 6 weeks from there. On March 2^nd, I said the same, that we likely hit a major low. We headed about $20 lower from that point over the next 6 days and bottomed at 1680, but it was the low to the day on the GDX. 2 months later we were up $250. On Tuesday, after being VERY cautious about metals and miners for 2 months and voicing my concerns of a possible bear market coming in multiple articles I’ve written and an interview I gave as well, I QUIETLY mentioned I was buying here simply because of the risk/reward being beneficial. I didn’t “call” a low this time and make a point of voicing that opinion loudly like I have in the past and there is a very good reason why.

Because I didn't want people to hear that and think "buy."

I don’t want people to read my “calls”, remember I was right calling the major lows in gold twice before and buy now thinking we're in the same situation, because I don't think we are. Don’t buy bear markets and don’t sell bull markets, and I’m increasingly believing this is a bear market. (I know, I just broke that rule on Tues, but 1) I bought very small amounts, and 2) I am well equipped to handle the risk, and bail if I need to whereas a less experienced investor might screw this up and have big losses.)

If you are looking at the markets here and you’re beating your head against a wall, frustrated at the fact that silver is still underperforming and miners are not following the metals higher, you need to revisit the points I have made in previous articles. Wall street is the most competitive industry in the world. There are more rocket scientists working for Goldman than there are at NASA. People who manage billions of dollars are selling. Do you really think they’re all wrong? Do you honestly believe you’re the smartest person in the room? You think they can’t do the same basic Cash Flow analysis you are, the same that every college student majoring in finance learns their freshman year? Perhaps the answer is that you need to stay humble, and not stubbornly dig your heels in on your thesis, but instead HONESTLY and without bias, examine where you could be wrong.

Past examples can offer some clues here. As the saying goes, buy the rumor, sell the news. If the news is bearish reverse that, sell on the rumor, buy on the news. Gold declined SIGNIFACANTLY on the RUMOR of a taper coming. By the time it was announced in Dec 2013, gold finally saw some relief and bounced 17% over the next 3 months, only to continue heading lower on the expectation of a rate rise.  By the time we got a rate rise, of a whopping 0.25% in Dec 2015, that was the bear market low. The rumors of a taper are here again, and gold has been getting whacked significantly. The Fed has talked about raising rates in 2023, about 2 yrs from now. The similarities in the precious metals markets to 2013 are too significant to ignore.

As I’ve said before, I think this rally we’re getting here will offer us a lot more clarity on the overall direction of precious metals. If we begin to see buyers coming in strongly on dips, that will be a good first sign. If silver begins catching up and outperforming, that will be another plus in the bull’s box. And as always, we want to see miners outperform relative to the metals, so we want to watch out for that.

Inversely, if silver continues to lag, if miners continue to underperform metals and not “believe” this rally, that would be a very bad sign. One that we have seen in the past from 2012-2013. Miners underperformed and trended lower while gold consolidated. The miners broke down first, and anyone thinking they were smarter than the market and bought into that believing they were undervalued, and the market was missing something very basic and fundamental here, saw a 70% decline from those levels in the GDX.

Listen to what the market is telling you. My view here could be wrong, and I continue to hold out hope that this is a consolidation in a longer bull market that has just gotten started, but I would rather wait to see some confirmation from these indicators before I buy, then to try and catch a falling knife. I will happily pay more for assets I want to own if we get this confirmation. It’s like paying for insurance, and it will help me sleep at night. I will be paying attention to sentiment, watching the miners, waiting to see if we get a resumption of our bull market formula, looking for a good increase in large spec COT positions on this rally and waiting to see if buyers come in on dips, or if sellers begin overwhelming us again. But for now, patience.

 

-Jonathan Mergott