Bull State of Mind

Jan FOMC played out exactly the opposite of the Dec FOMC meeting. In Dec, gold was breaking down, silver was hanging on to the 21 area by a thread and GDX was threating to break to new lows again. We got a strong reversal that flushed out some bears and gave metals and miners time to pause. Fast forward now to Jan FOMC, and gold is at 1850, testing the downtrend line its failed at 6 times before, silver gets a jolt of energy, surging up to nearly 25, and miners start looking like they want to join the party as well, shooting up quite a bit in just a few days.

But alas, it was just a dream.

Miners unwound pretty quickly while gold held in and silver still looked fairly bullish. If you’ve been following me for a while and reading my articles or listening to interviews, you know I put a higher weight on the performance of miners vs the metals. The fact that miners unwound while metals stayed looking pretty decent was more likely a bearish sign then an opportunity for miners to “catch up.” 

After any major move up or down, we want to watch the counter move afterwards. Do we lose all our gains, or see buyers come in strong at a higher low? Does a move down from highs rip back upwards, or begin to fail at a lower high, indicating an opportunity to short? Miners couldn’t hold their gains on a pullback, so that is that. No legs to that rally.

In June I advised caution in precious metals and miners, citing the Fed’s hinting of a tightening cycle and the similarities to the gold market in 2013 as my reasoning. We’ve talked for months about hedging risk on investment positions in Jr miners by buying puts on ETFs like GDX & GDXJ. Of course, my analysis was ridiculed by perma-bulls who screamed about buying every dip because “this is it.” That the Fed couldn’t taper, or the world would implode. That they would never raise rates in the face of 7% inflation because it would kill the economy and explode the national debt.

They tapered, they accelerated the taper, they’re going to be done with tapering entirely in 2 months, and nearly everyone now is certain of a rate hike in March. They’re even already talking about reducing their balance sheet by selling assets back to the market, possibly beginning this year. In that time since June, GDX and GDXJ broke to new lows in Aug, again in Sept, and are breaking down again to new lows as a write this. GDXJ has now lost 1/3 of its value just since June.

Folks, there was ample opportunity to protect your investments from downside risk over the last few months by buying hedges that could have mitigated your losses, as well as providing you with cash to buy with at lower levels. (If you had only LISTENED to what the market was telling you!) If you did this, congrats you’re sitting in a much better place then you would have been right now. If you didn’t, sorry to say but you missed the boat.

I have been greedier than most in the gold market. While many have been buying every dip along the way, we have remained hedged, nibbling only slightly on a few names for long term holdings while expecting a significant amount of more downside than most have been looking for and waiting patiently to make much larger purchases then. So far, that has paid off quite well, and will likely continue to for a brief period of time. But there is an old saying in the market, “Bulls make money and bears make money but PIGS get slaughtered.” I’m not trying to be a pig here, and I definitely am not trying to get slaughtered.

At this point, risk/reward on the short side is not appealing anymore. That is not to say we won’t go lower, or that it might not be painfully lower. (The last 15% of a 50% correction has a tendency to hurt more than the first 35%) We can certainly have a fast flush out that could be very painful. But at this stage of the game, looking at risk/reward and the probability of further downside versus infinite risk to the upside after an 18-month correction, considering the time left for further selloffs to continue, it feels to me that both from the perspective of time and price, that ship has sailed. 

Many are finally coming around to the idea of Fed tightening being the driver in PM weakness and to expect some harsh drops coming soon. (Where were they 6 months ago?) I prefer to stay ahead of the crowd. We have been so far. So now is not the time to plan for the drop, as many now think is inevitable, it’s the time to plan for what comes after.

Which means it’s time to get back into a BULL state of mind. Let’s take a look at why.

March FOMC is 6 weeks away. The Fed is GOING to hike. So far, history has rhymed quite well, with the change in control in the gold market shifting to the bears as soon as taper fears began both in 2013 as well as in 2021. Gold bottomed on the fed rate hike announcement in 2015. While history may not repeat exactly, it is reasonable to expect something similar. This is not a lot of time to start making a wish list and a LOGICAL plan to execute it. 

We probably have more downside from here, and we might even trail lower after the rate hike is announced, but in my opinion, we are nearing a point soon that I think will be a very attractive place to take positions for the intermediate and longer term. If you missed out on making a plan to protect yourself to this downside risk, make sure you do not miss the opportunity to make a plan for adding to your long-term investments that is likely coming very soon.

After 18 months of consolidation in gold, its time to make a move. I say this because in the last 15 years, Gold has had 4 major consolidations: 2006-2007, which lasted 16 months and broke higher for a 90% gain from the correction low. 2008-2009, which consolidated for 18 months and broke higher for a 180% gain from the correction low over the following 3 years. 2011-2013, which lasted 19 months and broke lower beginning the bear market that didn’t bottom for another 2 years. And then there is today. 2020-2022 which in February is an 18-month consolidation from the Aug 2020 highs. Gold, now at 1800, is currently 7% above its “floor” at 1680. Historically, we are reaching a point in which consolidations in gold begin to resolve. 

While I’m not ruling out a break of 1680 still, I’m beginning to think the odds that it happens are far less than what I thought they were over the summer. Even if we do break lower, I was never expecting the magnitude and duration of a “bear market” this time around like we had in 2013-2015 low.  So, a break of 1680, will likely be limited in both time and downside potential, assuming we don’t have an all-out market crash that takes everything down, like in March 2020.

Here are some charts a shared on Twitter. While there are many aspects of this consolidation that are similar to 2013, it also is starting to look very similar to 2006 as gold began drifting higher towards the end until it broke out. If you are of the belief we are still early in this bull market cycle for gold, this might be a more logical analogy.

Let’s look at an example of what I mean regarding a LOGICAL plan. Below is weekly GDX. Currently down 35% from the Aug 2020 high. It is struggling to hold on to this area near 30 that was the ceiling for the entirety of the bear market. The next major area of support is near 25, down an additional 15% from here. That would make it a 45% correction from the high. Could we go down 55% to support at $20? Or 60% to $17, the 2020 crash low as well as the 2014 and 2018 low? Of course, it is certainly possible, but that much of an extreme is likely not PROBABLE. (Remember, we’ve been right to be greedy and bearish, but we don’t want to be a pig.)

Now let’s take a look at Abbra Silver, as it’s a Jr many people like and one of GV’s top sitfolio holdings. If the floor gives way on miners and GDX suffers a 15% loss from here, the Jrs will be a mixed bag. Some will likely plummet; some will barely budge. Some may simply decline in line with GDX. A lot in terms of a “plan” will have to be constantly updated as markets change and a bit played on the fly as it happens, but assuming a 15% drop in GDX, a 20% drop in a volatile small cap silver Jr is a conservative and probable expectation. 

Looking at OTC (ABBRF), Abbra hit a high of 68c, not in Aug 2020, but May 2021. (The Aug 2020 high of 35c was equal to last week’s high, actually. Again, I think this speaks clearly to the aspect that the change in control from bulls to bears in metals happened in June, as that was the high in many jr's that were bucking the trend of the majors and metals up until that point). Since June, it is currently down 60% at now 27c. A 20-25% correction from here puts us at support right near 20c, which would be a 70% correction from highs hit only 6 months ago.

Could we go to 15c? Sure. 10c? Of course, but its far less probable and too greedy an expectation in my opinion. Keep some cash in case it happens, market crashes are always a risk any given day. But start looking at these names that you like, placing a REASONABLE expectation of a range in price they may fall to in the coming weeks, then decide based on your own conviction, what you are willing to pay for them and how much capital to commit when they get to those levels. Most importantly, don’t forget to execute when we get there. Everyone likes to talk about buying the correction, until it comes, then they worry they’re catching a falling knife.

Speaking of “catching a falling knife”, something important I want to note. I’ve mentioned before that I tend to weight the market’s price action greater than macro analysis. The simple reason for this is that there can be varying opinions on the interpretation of current underlying factors, and even more interpretation of what future underlying factors will be and how the markets will react to them (because markets are forward looking, so what the data is now is already irrelevant.)  I have my ideas about what’s driving a market. Some will of course disagree and have their own ideas. We can spend weeks debating what the key drivers are in a market and never reach a conclusion, or we can just look at price action.

Put more simply, I put a higher weight on what the market IS doing vs what I THINK the market SHOULD be doing.

In line with that thinking, I generally wait for the market to give me some indication of a turn before diving in to buy on declines. Along with other criteria I use, a big factor is miners outperforming and turning higher ahead of metals. This method has worked very well in the past and allowed me to nail the Nov 30^th 2020 low in gold to the day by watching the miner performance (which turned and bottomed 4 days earlier). It also was a major factor in calling the low in early March, which was 1 day early to the exact low on the GDX. (it dropped another 8c from the previous day’s low). It also caught us a nice rally in early October.

Many who have criticized my “watch the miners/miners lead the metals” thesis, often cite the 2016 low as an example where that wasn’t true, and they are right. At the bear market low, miners consolidated and broke lower while gold maintained. Miners were not giving us any clues as to an impending further breakdown in metals then, they were just absolutely capitulating. Within days though, they turned and turned HARD. In 3 weeks’ time, gold was up 10% and GDX rallied nearly 40% off its low at 12.50. While there were no clues as to the low, the relative outperformance to the metal soon came and even buying then at around 17 on GDX left you with a nearly 100% profit 8 months later.

I mention this because it is very possible to see something similar when we get to the final low. Buying into declines from here may feel a lot like catching a falling knife. It’s important to remember a few things. First, we are buying longer term investment positions. Those are the type you want to buy when they are cheap and declining. Secondly, don’t bet the farm all at once. Plan for multiple “tranches” of buying and expect to do so over a period of a couple of months perhaps. Also, leave a little cash left over in the event things go lower than we expect, or take longer. The last bit can be deployed as we begin to get confirmation we are turning higher.

Adding LEVERAGE to our positions when things begin to start cooking, THAT is when we want to wait to see miners lead and outperform metals. By leverage, I’m talking about any position you put on in addition to your investment portfolio to make a little more as we start to run. Typically, I do this with calls on the ETFs and some producers.

Whether you want to use options or just buy the stock is up to you, but I feel this is an important aspect of taking advantage of prices moving higher. We wouldn’t be buying jrs if we didn’t believe an explosion in metals prices will send them soaring, but it is also due to their own building of their assets. Some do better than others at times then rotate their outperformance. 

Producers on the other hand, are simply leveraged bets on metals directions. If gold begins trending higher for a period of time, so will the GDX, that is a guarantee. A jr may not if say, they have a poor drill result or do a financing. Everyone wants to find the jr that’s going to give them a 5-10 bagger, but the fact is GDX in the money LEAPS will give you a 5 bagger too if we return to Aug 2020 highs at 45 in the next year. And there are a lot less variables with a basket of established, major producers if gold is moving strongly higher than trying to increase the market cap of an explorer by 5-fold.

Another point on producers. For the duration of this decline, we have been holding our Jr investment positions and additionally the highest QUALITY gold stocks we can find. To me that has meant 1 producer, NEM and the royalty companies. That’s been a good call as an equal weighted basket of NEM, FNV, WPM, and RGLD has outperformed GDX since June by 10%, and GDXJ by 20%. But as things begin to bottom and turn higher, the biggest profit is in the LOWER quality companies.

I’m not saying go all in on a high-cost producer with mountains of debt. But for example, that same equal weighted basket of FNV, RGLD, WPM and NEM got smoked by HMY coming out of the 2016 low, which outperformed them by 325%. The same with CDE which outperformed by 275%. The simple fact is, if a producer like HMY is producing at a cost of 1400/oz when gold is 1400/oz, investors know there is no profit here until gold turns, and it gets dumped, hard. The moment that starts to turn, the pendulum swings back in the other direction with equal force. GDX rallied 170% from its 2016 low by Aug that year. Both CDE and HMY went up 10 fold from their lows, all in just 8 months. Higher costs equal higher leverage, and have a tendency to scream when coming out of major lows.

Many people have asked me what Jr’s I like for when things turn higher, and I’ll be the first to say, stock picking jrs has not been my strongest suit. I’ve mentioned before, there are a lot of guys who I think have done a great job picking quality jrs with great 5-10x potential, and there are also a lot of guys who done a great job on timing and direction. These are two very different things and being good at one doesn’t make you good at the other. I’ve seen almost nobody who has done an exceptional job at both timing and direction in metals, as well as nailing the best 10 baggers.

I have done a lot better in terms of timing and direction myself. One isn’t necessarily better than the other. Everyone is looking for the stock with a 5 fold potential over a few years, but by simply timing and positioning correctly in GDX puts and calls over the last 6 months, multiple major swings higher and lower have netted us the same 5 fold return on our leverage and hedges while most 5 bagger potential Jrs have been stuck in the mud. (Something to keep in mind.)

If you are trying to research the best jrs to begin buying in the near future for long term investments, there are a few great people who have done some quality research you can start with by piggybacking on the free information they have shared and the due diligence they have already done themselves.

The first is GV’s Silver Sitfolio and Gold Fever portfolio, available here https://www.goldventures.org/. Additionally, there is great write ups he has provided that are shared on twitter and the Wallstreet Silver subreddit.

Another must follow for his picks in my opinion is Erik Wetterling, aka The Hedgeless Horseman. You can read his website here https://www.thehedgelesshorseman.com/ . Don Durrett is another who has done quality research and is a must follow on twitter as well. His website is https://www.goldstockdata.com/

Everyone now is focusing on a downside break in miners, so we’re going to look a step ahead at the bullish potential coming out of this. Like most of the market, their realization came too late, and the expected poor performance they think is coming will likely hit a pinnacle in despair and bearishness right when its time to buy. I know that investing in precious metals and miners the last 18 months has been like going through Hell, but you know what they say to do when you’re going through Hell, right?

Keep going. 

We’re almost there.

-Jonathan Mergott