Sid Klein Global Strategy
JUNIOR PRECIOUS METALS STOCKS:
GDXJ vs. GDX and GOLD
March 31, 2010
The XAU and related precious metal indices are in secular bull markets that will take them much higher. However, the timing is not fortuitous now.
This report looks at the Philly Gold & Silver index (XAU), as well as the Market Vectors Gold Miners (GDX), including the junior precious metals version of same, (GDXJ). All are optionable; both GDX products are ETFs.
The March 14, 2010 report examined the short term for the XAU, as well as the possible decline in the precious metals during the Dow's first phase of its resumed secular bear market.
The report gave a 60% - 40% probability for a new short term high in the XAU.
Last week's report for Gold-Eagle mostly examined the case for gold. Taken together, these reports clarify the appropriate strategies now, in the context of the short, intermediate and long term possibilities for the gold and silver stocks.
While the preceding focused mostly on the precious metals, here, we look at gold and silver in the context of interpreting their relationships to the timing and performances of the equity indices that are covered in this report.
Briefly, the gold and silver stocks declined in 1929 and partook of the major post-'29 rally that concluded in 1931.
When the crash resumed in 1931 (before bottoming in 1932), the precious metals dropped again, but then divorced in mid-stream, as Homestake rallied from $20 to $200. (See 2009 report: bottoms in New York and Japan).
Upshot: Recently, the XAU has too closely mirrored the stock market for me to not be concerned about a final wave-C decline to the 120 - 140 area (per charts below), dragged there by a broader market that could be peaking around April 6.
With the Yen leading the way, the USD will resume its secular bear market, perhaps after another quarter of correction in the foreign currencies.
The next great buying opportunity in the XAU could look like this, then:
The 2010 countertrend rally in the USD will have ended, while growing fear of the precious metal stocks coincides with the Dow heading toward completion of a 20% decline.
The background could include silver at $12.00, gold at $1,000 and their ratio at 62 - 63.
After that, there will be an amazing buying opportunity in the gold and silver stock ETFs, as well as the precious metal indices, in general.
The following charts and their interpretations conclude that:
Gold and silver stocks (XAU) definitively outperform gold. Therefore, their present underperformance suggests sizeable profit potential.
Similarly, at the highs and lows, in each direction, junior gold and silver stock prices go farther than their larger counterparts. This simply reflects the reality of fear and greed, setting up windfall profit potential for alert timers, therefore.
Chart #1 is a 30-year monthly overlay chart of gold versus the XAU:
The chart below clearly illustrates a massive reverse (bullish) shoulder-head-shoulder pattern and, just as clearly, reflects the outperformance in the XAU versus gold, except at extremes when the XAU takes off. Except this time,…
They came together at the 2008 peak, and I conclude that the corrective phase is not yet complete, based on the XAU's ongoing underperformance.
The correction in the precious metal stocks will end once the performances come into line again. Then, wave-C will end with all systems a "go", as bulls relent.
With the added support, resistance and trend-channel lines drawn in, the notion of a decline to the 120 - 140 area does not even appear to be a big deal.
The Dow's last leg of its bull market took place in the first decade of this century. Meanwhile, the XAU was putting in its first leg of its secular bull market.
A look at the 50-Year charts of gold and silver in last week's Gold-Eagle report make clear that the low at the beginning of this decade was merely a Wave-2!
Still, the tree must shake, bulls must change their plans and margin calls must dominate. Same old, same old.
Chart #2 presents the 10-year weekly gold versus XAU overlay chart:
On the 50 and 30-year charts, we see that the 1st decade merely marked Wave-1; the correction, which began in 2008, is only a Wave-2 within a dramatically larger, multi-decade advance.
The 10-year chart below shows how gold's continued strength versus silver continues to mask its true wave count (silver and XAU overlay charts below).
Gold moved to 1200, even as silver and the XAU made lower highs at the end of last year. When gold eclipsed the prior year's high by around $150, technicians did not figure the move to be countertrend.
The a-b-c breakdown of Wave-2 is shown here, as is the XAU's continued and atypical underperformance of gold, suggesting ongoing correction in the equities.
Chart #3 presents the 2-year daily gold versus XAU overlay chart:
The longer term charts and their respective analyses leave little doubt as to the enormous potential for profit in the precious metal stocks.
However, investors talk themselves out of the bull markets they believe they are prepared for, by engaging in strategies that do not best serve their psychology.
Simply, when looking at shorter term support, Elliott and other levels, one can easily doubt the longer term charts. My purpose here is to make clear how much psychological and price risk there is, once the Dow starts to head toward 8800.
Now, the reader's psychology may even have reviewed all of this report's charts and concluded that my target of 120 - 140 may even be insufficiently conservative. Indeed, at the lows, the fear of XAU-100 will be palpable.
Chart #4 looks at the 30-year XAU versus silver chart overlay:
Plainly visible are their bullish reverse shoulder-head-shoulder formations, replete with neckline and proximate 50% retracement level of the XAU's 2009 advance.
As well, the XAU remains in an ongoing sell mode, as it continues to underperform silver.
Above all, note the XAU's similarity to silver.
Again, this century's 1st decade represented Wave-1, of a multi-decade bull market. (See 50-year chart gold and silver charts:
Chart #5 below looks at the 10-year weekly XAU versus silver chart overlay:
The 5-wave patterns are plain, just as are the corrective a-b-c declines, though I have added parallel lines to this chart, which define the targeted 120 - 140 zone.
Again, we see that the corrective period began once the XAU's performance was no longer superior to that of the metal (this time silver, as opposed to gold).
The XAU's underperformance suggests an ongoing corrective period, I wish to remind.
Chart #6 looks at the 2-year daily XAU versus silver chart overlay:
As with chart #3, here we look at a breakdown of the larger Wave-2, including its a-b-c correction.
Whether there is a final move to complete wave-b, or whether there is an additional 3-legged breakdown (up) within this correction's correction, the point is moot.
Either way, as expressed earlier, the upside potential, in terms of either price or time, remains so limited as to bring the investor to the same strategic conclusion.
A sharp move up into next Wednesday….and any XAU positions should be liquidated.
In fact, when the Dow will be collapsing toward a level under 9000, analysts will view these same charts, looking for technical excuse to rationalize their cold feet.
Such will be the mirror image of today's fundamental bias, which presently affords gold bulls their sanguine attitude.
NB: To clarify the wave counts in this report: Minor wave-c above completes a larger wave-C, which also marks the end of wave-2.
Chart #7 examines the 4-year overlay chart of the XAU versus the GDX:
Since the inception of the GDX, there has been a near perfect correlation between these indices. Obviously, this is critical to note for investing purposes.
As for wave counts and technical interpretations, therefore, there is no difference between the findings for the XAU throughout this report, and those concerning the GDX.
Nor is there a difference between the XAU and the GDX concerning their relationships to the respective precious metals.
My analysis commenced with the XAU, simply because the GDX only has 4 years of data (charts).
Similarly, there is only 5 months of data for the GDXJ. Hence, it was necessary to start with the XAU, and thereafter make reasonable extrapolations.
Chart #8 examines the 5-month overlay chart of the GDX versus the GDXJ:
Since its inception, the GDXJ has tracked the GDX very closely, except that it has gone farther at both the tops and bottoms.
Looking at all of the indicators, I am very comfortable with the conclusion that this index would have tracked gold in a similar fashion as the GDX, throughout the years, except that its outperformance of the precious metals at the peaks would have been even greater.
For timers, as an aside, here too directionality seems to change after relative performances come into line.
It is wise to wait to be 100% long the XAU, in deference to the probabilities of a wave-C decline to the 120 - 140 area.
The GDX and GDXJ would be trading at corresponding levels.
The decline's background should be mostly a sideways correction in gold, to $980 - $1,080. The main factor for the precious metal equities is now the stock market.
The Dow's peak could come around April 6. The action in the XAU and broad stock market have been pretty well correlated, on nearer term bases.
My analyses of the factors herein suggest that buying the precious metal stocks is presently an "unfavourable bet", in the context of my risk/reward assessment.
The precious metal equity indices' targets, however, are dramatically higher than here, regardless where these indices initially correct to. Timing, is another story.
As far as targeting the short term exit is concerned, liquidation is wise as wave-c of C of 2 waits below. Even if the wave count is slightly off, nothing changes.
If wave-b to the upside must yet complete, the target area would only be 175 - 180. Since the recent peak was just under 173, there is really little reason to assume the risk of staying long beyond next Wednesday.
By April 7, the XAU will have rallied the same number of days as previous run-ups, give or take a day.
Given the unrelenting bear-psychology-breaking rally in the broad market (which is typical of a peak), the April report will focus on the timing for this major Dow peak.
Meanwhile, "1931" will initially drag the precious metal stocks lower, and until the bulls relent. As at most bottoms, they will wait for a "sign" before going long.
Therefore, due to the interpretations above (charts #3 and #6, regarding the shorter term), the conservative approach is to be out of the precious metal stocks, notwithstanding the 100% investment stance in gold.
When looking at the precious metal stock indices, remember, the metal chart that most resembles them is silver's.
Above all, the longer term for everything gold and silver-related is extremely bullish.
Those who understand the argument for being invested in the precious metal stocks will not be immediately rewarded.
In fact, the market works to remove excessive ebullience (and gold investors are a cocky lot these days).
It's also called a tree-shaking, one that leads to an enormous buying opportunity.
However, the mood will be anything but ready to invest at the XAU's, GDX's or GDXJ's lows, as the stock market will be falling, damaging psychology and the "wealth effect."
When the stock market makes its initial low, the stocks first in line for purchase will be the gold and silver equities.
Therefore, those returning to the long side will do so with precious metal stock components. As the XAU later bottoms first, the first two months following the reversal from its lows, could prove to be a significant contributor to one's 3-year returns.
I am as confident that the resumed buying of stocks will commence with gold and silver equities, as I am that the bulls will be unprepared for it.
Note that the reversal from the lows is so dramatic in per cent terms, that being early is not that big a deal.
Falling markets usually obscures the clarity needed to go long. That is why it is good to analyze and plan.
This report has attempted to do so in an integrative fashion.
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