Gold Forecast By Reading Between The Candlesticks

Very little changed in the precious metals market yesterday and the vast majority of investors and traders will think that this means that nothing changed. And that will be very wrong. “What changed” is not the only important question that one should be asking. “How did it happen” and “in light of what” questions and replies to them provide very important details to those, who can read between the lines in reports and candlesticks on charts.

Even though we don’t have much to say about gold’s short-term price action, what happened in the markets related to it makes the outlook for the yellow metal quite clear.

Let’s start with the “in light of what” part of the analysis. Gold, silver and mining stocks haven’t done much in light of…

The USD’s Daily Decline

USD Index moved lower yesterday, moving to our likely downside target. We wrote about the possibility of the USDX reaching the 96 level and yesterday’s intraday low was 95.99. The zigzag reflecting the early-August 2017 zigzag may have just completed. May, because even if the USDX moves a bit lower, this similarity will remain present.

The USD Index bottomed at the intersection of the two rising red support lines – one is the neckline of the inverse head-and-shoulders pattern and the other is the rising support line that’s based on the previous intraday lows. If the rising blue line was based on the closing prices it would be crossing the declining green line that’s based on the closing prices, thus creating another triangle-vertex-based reversal. We didn’t annotate the latter on the chart as it would make it too unclear. However, both vertexes confirm each other and suggest that the turnaround in the USDX is here or at hand.

Yesterday’s decline should have caused the precious metals sector to move higher. Gold was up by just $2 and silver was up by just 2 cents. This is a weak reaction, that is – by itself – a bearish indication, confirming that the days of this corrective upswing are numbered, or that it is already over. This is in tune with the reversals on the USD Index chart, cyclical turning point for the mining stocks, and triangle-vertex-based reversal for silver.

That’s also in perfect tune with what we wrote about the mining stocks performance relative to gold yesterday. The outperformance was too significant, and the bullish flame was too bright to last long.

Mining Stocks’ Lack of Strength

In yesterday’s analysis, we described the situation in the mining stocks in the following way:

The situation in the mining stocks is not developing in perfect tune with their major downtrend, but within the borders of what one might call reasonable for a downtrend. A local head-and-shoulders formation was invalidated, which was a bullish development for the short term (and only for the short term) and it was followed by higher mining stock prices. What does it imply for the future? It suggests that the rally that was likely to happen based on the invalidation, may have already happened. Moreover, since the miners are approaching their resistance levels, it seems that the upside potential is quite limited.

The gold miners are already in the lower part of their target area. This means that they might have already topped, or that the top will be formed at slightly higher levels. The HUI Index is already at the height of the left shoulder of the previous head-and-shoulders pattern. It might reverse right away, but it might move also to the right shoulder (at about 152.5) or to the rising dashed line that’s based on both above-mentioned shoulders (at about 154).

Gold miners are naturally connected with the price of gold and if gold declined significantly from here, it would be normal to expect the mining stocks to decline. And indeed, we expect both to decline. But does it mean that the bearish outlook for the mining stocks is based only on the outlook for gold? Of course not. One of the things that should be considered is mining stocks’ relative performance to gold.

They just jumped relative to gold, so that’s definitely bullish? No.

In all areas of life, things in excess can easily turn into their opposite. And that seems to be the case here.

Mining Stocks’ Outperformance: The Brightest Flame Burns Quickest

The above chart features the gold stock to gold ratio. It rallied recently and the rally was sharp. Too sharp. The ROC (Rate of Change) indicator in the bottom part of the above chart shows the rapidness of the recent growth in the ratio. In other words, it gives a numerical and comparable value of how fast miners outperformed.

This value moved to its previous extreme and this was the case only two times in the recent past. Once about a month ago, and once in February. What happened next? The orange line in the background of the above chart shows what happened in gold. It moved back and forth for several days and then it declined. The most important thing is that the rally didn’t continue in any significant way. Whether it was the top or not wasn’t that critical. It was critical to close any remaining long positions at that time and at least consider opening short positions. In the absence of other bearish factors, one might have preferred to wait for more bearish confirmations, but at this time we have multiple sell signals in place, many of which are very strong.

In Metallica’s Mama Said song, one of the verses starts with the statement that “the brightest flame burns quickest” and it’s likely that we just saw an example thereof in case of the gold stocks to gold ratio. The rally was too sharp to be sustainable and thus it’s quite likely to end rather sooner than later.

This brings us to the “how did it happen” part of yesterday’s price action.

Both proxies for the mining stocks: the HUI Index and the GDX ETF moved higher yesterday, but reversed and erased their previous gains before the end of the session. Precisely: the GDX ETF erased a little less than it had gained, and the HUI Index erased a little more than it had gained.

The momentum had been strong, so it’s quite normal that they initially moved higher. But, what is not normal and what should get one’s attention, is the weakness that followed. That’s one of the most interesting gold trading suggestions – measuring the strength of mining stocks reaction to what happens in the underlying metals. If this was a true rally, miners should have shown strength and they certainly didn’t. They got ahead of themselves like it was indicated by the ROC indicator in the HUI to gold ratio. In yesterday’s analysis, we emphasized that this spike in the ROC most likely suggested that the rally is not likely to continue in any significant way. And that’s exactly what happened.

The PMs had a good reason to rally further (a daily decline in the USDX) and they didn’t. Miners should have rallied and they didn’t – they showed that they had it in them (early rally) and that “it” wasn’t enough. “It” – the buying power seems to have dried up. If the buyers are giving up, then who’s going to keep pushing the price higher? The likely action for the price in such case is to simply decline. And that is the outcome that is confirmed by multiple strong medium-term sell signals.

Silver’s Upcoming Reversal

Silver’s triangle-vertex-based reversal is today… Or tomorrow, as it’s not 100% clear if the lines (upper rising red line and the black declining line) cross today or tomorrow. The reversal might take place today or we might have seen it yesterday.

Actually, if silver moves higher today, outperforming gold, it will not be a bullish sign. The white metal tends to outperform right before local tops and since we are expecting such top to form here, temporarily (perhaps just a few hours of exceptional strength relative to gold) rally in silver would be quite normal.

Then again, we wouldn’t bet the farm on this rally and the reason is the analogy to 2013, when silver corrected 50% of the previous decline before plunging. And silver is at this important retracement right now. Consequently, an additional upswing would make the current situation less similar to what happened in 2013 and since the link between both situations remains in place, bigger deviations from it are not likely.

Still, the analogy to 2013 is exactly that – an analogy – not a 100% copy. Consequently, even if silver moves above the current 50% retracement, it will not automatically invalidate the 2013-now link.

All in all, the very short-term outlook for silver (meaning today and tomorrow) is not clear, but it doesn’t matter much, because the outlook is clear for the next several weeks and the amount of bearish confirmations that we have is more than enough to foresee much lower gold and silver prices.

If you haven’t read yesterday’s analysis, we strongly encourage you to do so today – it explains silver’s 2013-now link in greater detail.

Summary

Summing up, the small corrective upswing that was likely to take place based on the few short-term bullish signals seems to have already taken place – either entirely, or mostly. It seems that we will not have to wait long before the big downswings resumes. And if the likely outcome takes place and the decline is indeed similar to the one from 2013, all this waiting will be extremely well worth it. We may see somewhat higher PM prices in the next few days, but this move is not likely to change anything. The key word here is “may” – the big plunge could take place any day, so we are not adjusting our positions based on the above possibility. The risk to reward ratio continues to favor short positions in gold, silver, and mining stocks because of all the long-term factors that remain in place and that we discussed recently. It seems very likely that gold, silver and mining stocks will soon do what bitcoin did recently – they will dive (by the way, we’ve been shorting bitcoin). The difference is that the precious metals sector is likely to form a major bottom within the next several months and then rally above its previous highs, whereas bitcoin’s future may not be so bright. Bitcoin seems to have had its own dot-com bubble, while gold’s trend remains strong in the long run.

Naturally, the above is up-to-date at the moment of publishing it and the situation may – and is likely to – change in the future. If you’d like to receive follow-ups to the above analysis (including the intraday ones, when things get hot), we invite you to sign up to our free gold newsletter today – it comes with a 7-day no-obligation trial of our daily premium Gold & Silver Trading Alerts.

Przemyslaw Radomski, CFA

Editor-in-chief, Gold & Silver Fund Manager

Sunshine Profits - Effective Investments through Diligence and Care

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All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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