There was some growth seen in gold and mining stocks that could make investors feel optimistic. Does this upward move change anything in the medium-term bearish perspective, though?
The precious metals sector moved higher yesterday, so you might be wondering if anything changed, and if so, what would that be.
In short, practically nothing changed. The only thing that really changed is that the probability of seeing a bigger rebound from ~$27 in the VanEck Junior Gold Miners ETF (NYSE:GDXJ) decreased because of yesterday’s rally and last few days’ correction in general.
Why would that be?
Because markets correct when they get ahead of themselves in a given move. They rally or (like in this case) decline too far too fast. When they do, the force that has been pushing them in a given direction is temporarily gone, while the other side of the market gets the upper hand.
Then the test comes. Were these “new” price levels accidental? Or is this a new reality? Depending on that, people will either wait it out or act – buy or sell. The test can take place in all sorts of ways. The most obvious one is simply “time”. After a price moves below some key levels and remains there for an extended period of time, becomes obvious that the move was not an accident and that prices are actually staying there – perhaps for good and perhaps simply for much longer than just a few days.
Another way for markets to check if something is temporary or if it’s here to stay is through the verification of moves above or below certain levels. If these corrective moves bounce from the previous support and it proves to now be a resistance, it becomes clear that “things have changed.”
Why are markets measuring this at all? Because ultimately, whether something is expensive or cheap depends on what one compares it to. Context is king, right?
This can be discussed on many levels, but to simplify, one way to answer this question is to check if it’s above or below certain thresholds – support / resistance levels like Fibonacci retracements, previous highs/lows, moving averages. Indicators are also useful here.
However, the key thing is that if one stops viewing gold as “being at the bottom of a trading channel” and starts viewing it as “being after a breakdown below the previous lows,” the perspective changes. In the first case, gold seems like a good buy as it’s cheap relative to the trading channel, while in the second one, gold seems expensive as who knows how low it could fall if the previous lows just failed to hold.
Why am I writing all this? To explain why the recent price action actually made it less likely for PMs to rebound after an additional short-term decline (with GDXJ at about $27).
Since gold, silver, and mining stocks are correcting right now, it means that the verification – the shift in perception of the current price levels – is already taking place. Thus, if the markets “accept” the current levels as the new base, a move to “just” $1,680 in gold or $27 in the GDXJ might not be extreme enough to trigger a visible rebound.
This means that the markets could move much lower without a more visible pause in the meantime. This would imply at least a $100 decline in gold and a possible slide to the 2020 lows in mining stocks in the absence of a more visible correction in the meantime.
For now, let’s take a look at the shape of the most recent upswing in the GDXJ.
In short, it’s a perfect flag pattern. That’s the most classic way for the markets to correct after a bigger move. The sizes of the two immediate-term rallies are practically identical, making the pattern so perfect.
While the above chart might give the impression that the GDXJ invalidated the breakdown below its July lows, it’s not really the case. You see, it’s the daily closing price that really matters here.
The daily closing price on Sept. 7 was $29.97, and the lowest daily close in July was $30.02.
There was no invalidation – just verification of the breakdown, which has so far been successful.
We saw the same thing in the senior mining stocks – the GDX ETF. No invalidation, just verification.
This means that the medium-term outlook remains very, very bearish.
Oh, and by the way, seeing a correction here is not that odd because of the seasonality present in the US Dollar Index.
The US Dollar Index tends to reverse (even if just for a short while) close to the turn of the month.
It recently moved to new highs, so it’s perfectly normal that we see a move back to the previously broken levels. Given the above, it’s perfectly normal that we see it now.
Since the precious metals’ prices are negatively correlated with the US Dollar Index, the correction in the former is likely linked to the correction in the latter.
All in all, it seems that the current correction in mining stocks is quite normal, and it doesn’t invalidate the extremely bearish outlook for the medium term at all.