PRECIOUS METALS SECTOR KEY UPDATE - it's always darkest before the dawn...

originally published May 22nd, 2014

Beneath the surface, the outlook for gold and silver is brightening considerably, which is actually reasonable when you stop to think about it, given the big inflationary pressures working through the system as a result of all the stimulus of recent years. The most surprising thing is that gold and silver have dropped as far as they have since 2011, given all this. Sentiment towards the Precious Metals sector remains awful at this point – the sector has been abandoned – and this is exactly the situation you want to see before a major rally.

This is a good time to review the charts for the sector, as we appear to be on the cusp of a sizeable move, after the quiet of recent weeks. Let’s start by looking at the 2-year chart for gold, a timeframe selected because it enables us to view all of the action from the plunge in April of last year to advantage. The failure of key support in April of last year lead to a plunge into late June, then we had a sizeable relief rally, and after that gold dropped back again to test the support at the late June lows in December – it held and so a Double Bottom is in place. Notice how the drop from late August through December last year was a lot less panicky and much more gradual than the April – June plunge, which is characteristic of a Fan correction, and the fact that it didn’t make a new low is highly significant. The strong rally in February and March this year is a sign that gold is turning, but it has had to correct this move and do more work basing before it is ready to begin a major advance. This is why it has reacted back beneath a third fanline, and you will notice that the angle between this fanline and the 2nd is about the same as the angle between the 2nd fanline and the 1st. Once the price breaks above the third fanline, gold will be on its way, even if it has resistance to contend with on the way up. The nearby support in the $1270 area looks like it is going to hold, for reasons that will become clear when we look at the long-term chart, if it does fail it is considered likely that it will be a “false move” and followed by a rapid reversal to the upside.

You can see just why the outlook for gold is so good on its 14-year chart below. Here we see that the decline from 2011 looks like nothing more than a big correction within an ongoing long-term bullmarket, defined by the expanding channel that contains all of the action from the bullmarket’s inception in 2001. This correction is sizeable in percentage terms as gold has dropped over 36% from its highs, and considering the inflationary pressures bubbling under in the system as a result of all the money creation, it is remarkable that gold has dropped back this much, but perhaps the right way to look at it is that it has served to flush out the speculative excesses that were present in 2011, and it has certainly done that with silver which has dropped back 60% from its highs. Another way to look at it is that gold has a lot of catching up to do, to reflect the ongoing debasement of money over the past 3 years while it has been dropping in price. Looked at like this you can certainly appreciate why there is scope for a big rally, and once it gets going it will feed on itself as investors reevaluate gold and discard their recent negative mindset towards it.

Gold stocks meanwhile appear to be marking out a Head-and-Shoulders bottom. We focused on the Market Vectors Junior Gold Miners in the recent past because of its extraordinary volume pattern. This was very bullish early in the year as GDXJ powered ahead on huge volume in a parallel channel, but it was somewhat perplexing when it then reacted for a while on even heavier volume, when we would have expected volume to ease. Otherwise the pattern looks strongly bullish, and it now looks like GDXJ has dropped down to form the Right Shoulder low of a large Head-and-Shoulders bottom – and volume is easing at last, which is a positive sign. If nearby support fails and it drops back to its December lows, which looks unlikely at this point, we will have to have a rethink. In that event it would probably morph into some other base pattern. If this interpretation is correct and the nearby support holds, it is clear that we are at a great entry point here.

The 6-month chart for GDXJ shows recent action in more detail. On it we can see the orderly parallel uptrend from December through March, and how it deceptively broke higher again in mid-March before the uptrend abruptly ended. After an initial steep drop, downside momentum has largely dropped out, and the reaction appears to have taken the form of a 3-arc Fan Correction. The bull hammer in mid-April may mark the low of the correction and it is interesting to observe that the gentle decline this month has brought the price near to the support at this hammer. This is a good point for it to turn higher and as we can see it won’t take much to break the price above the 3rd fanline, which should trigger a strong rally.

Turning now to silver we see that it looks considerably weaker than gold at this point, which is normal at this stage in the cycle, as gold takes the lead in the early stages of an uptrend. However, on its 2-year chart we see that it is at a good point to turn up, as it is again at a zone of strong support just above earlier lows. Here we should note that silver could drop to the $17.50 area short-term without spoiling its long-term pattern. We’ll see why that is below on its long-term chart.

On its 14-year chart we can see that silver is at an excellent point to turn up again and start a major uptrend. Despite its brutal decline of the past 3 years that has shaved 60% off its value at its highs, silver HAS NOT broken down from its expanding long-term uptrend. Currently it is close to the lower boundary of this long-term uptrend and it has room to drop to the $17.50 area short-term without breaking down. There are 2 big reasons for silver to turn up here. One is the support of the long-term channel line, the other is that fact that it is at a zone of strong long-term support – a support level of similar caliber to the one that generated a major reversal after the 2008 crash. If silver does embark on a major uptrend soon as expected, then it is clear that should it attain the top line of the channel once again, we are looking at fantastic gains from here. The market has written silver off here, which is exactly what you expect and want to see at an important market bottom.

A key determinant of the trend in gold and silver as ever is the US dollar, which we have looked at repeatedly in recent weeks as it is at such an important juncture. The US dollar index is being pressed down onto key support in the 78 – 79 area by the large Dome pattern shown on its 4-year chart below. If this support fails then the dollar index can be expected to drop sharply to the low 70’s. Such a drop will trigger an inflationary tidal wave across the US and can be expected to drive a major rally in gold and silver. While the Fed can be expected to use every trick in the book to stop this breakdown occurring they may be powerless to stop it, on account of the dollar inching ever closer to losing its status as the one global reserve currency. With respect to this there was a major development at the weekend when Russia and China signed a major gas contract that was 10 years in the making. This symbolizes the growing cooperation of these 2 powers as they move towards ditching the dollar as a medium of exchange.

Posted at 9.00 am EDT on 22nd May 14.