 Expected Metals Corrections
Adam Hamilton
Archives
Jun 17, 2006
This past Tuesday the entire precious metals realm watched in
stunned silence as gold plunged 7.3% and silver plummeted 10.8%
in a single trading day. Not surprisingly with gold bleeding
off $44.10 and silver $1.19 on that dark day, there was much
wailing and gnashing of teeth amongst precious metals investors.
But what did surprise me about
this whole fascinating, albeit brutal, episode was that it seemed
to surprise many traders! This is strange because the corrections
in gold and silver had been expected, not to mention discussed
extensively, before they made their fearsome appearances. Students
of the markets were ready and waiting for sharp precious metals
declines. Our Zeal clients had been well prepared for this event.
Why did I think these corrections
were coming? Speculation in the financial markets is the world's
greatest game. Like most other games, it is governed by probabilities
and heavily influenced by game theory. Precious metals are a
small side game within this giant markets game, and they have
to be approached as such if one wants to trade them successfully.
As in any other probabilities-based
endeavor, astute and prudent speculators become students of the
markets in order to increase their odds of winning. As they grow
to understand how markets work, they are far more likely to trade
near the right times than someone who does not study the markets.
A good speculator only trades when he perceives his odds of success
as being very high.
These odds are partially dependent
on game theory. Game theory is a branch of psychological research
that considers what other players are likely to do in a given
situation. A speculator's (or investor's) decisions of when to
buy and sell must be considered within the context of what other
traders are likely to do. Game theory is one of the key foundations
of contrarianism, ultimately the most successful trading strategy.
Buy when others are selling and sell when others are buying.
Combining these basic areas
of market studies led to a very ominous picture for gold and
silver in April and early May. Students of the markets intimately
know that all markets rise and fall, their prices flow and ebb
even within powerful fundamentally driven secular trends. Gold
and silver had both been powering higher for the better part
of a year and one of their periodic corrections was certainly
overdue.
Both gold and silver were also
stretched to their most extreme technical levels in a quarter
century, a warning sign that the probabilities favored a sharp
temporary reversal to relieve these extremes. The odds were way
out of favor for being long by early May. And from a game-theory
standpoint, euphoria ran rampant. Most traders were wildly bullish
right near the latest interim tops, as the majority always is,
so there were few short-term buyers left.
Thus trading probabilities
based on historical gold and silver precedent and game-theory
psychological considerations were screaming six weeks ago that
a major precious metals correction was almost certainly imminent.
To paraphrase a Bible verse out of Proverbs, the prudent saw
the coming short-term metals danger and took refuge, but the
simple kept right on buying and suffered for it. Markets take
no prisoners.
Now you are probably wondering
what good it does to meditate on this ex post facto. To become
a more successful speculator and investor, it is crucial to learn
lessons from market pain. If you didn't see this coming and prepare
your portfolio accordingly, this event is a great impetus to
deepen your own studies of the markets so you aren't caught off
guard next time.
And if you are paying someone
to help you navigate through this powerful commodities bull,
and your advisor didn't warn you beforehand in April and May
about the ballooning odds and looming danger for a major interim
correction in gold, silver, and the HUI, then you ought to fire
him. There is no excuse, absolutely zero, for a professional
to miss the ubiquitous warning signs before this recent selloff.
At Zeal we and our clients
were long these latest awesome gold, silver, and HUI uplegs early
and were blessed with fantastic realized profits even before
the euphoria set in by April. Yet as we were stopped out or sold
our PM trades, we remained in cash since the odds of a serious
correction were getting so large. Since then we have been building
up cash war chests to buy the feast to come of amazing PM bargains
at the next major interim bottom.
If you were hurt this week
in gold, silver, or the PM stocks, I feel bad for you because
you didn't have to be. These corrections were anticipatable and
expected. The best way I could figure out to illustrate this
was to create some charts of the latest mighty gold, silver,
and HUI uplegs and their young corrections. Superimposed on top
of these charts are numbers that correspond to comments I wrote
to our clients at specific points in time. There was no need
for anyone to lose much money in precious metals in the last
month or so.
All these quotations are easily
verifiable. Actual links for web essays are provided. Zeal Intelligence
subscribers can log into the Subscriber Charts section of our
website and look in the ZI archives to verify any ZI citation.
And Zeal Speculator subscribers can e-mail us to get any back
copy of ZS they'd like in order to find the original quotation
listed below.
Friends, believe me these metals
corrections were expected! Anyone who tries to convince you otherwise
is either naïve or hiding the truth.
Early on in this metals upleg
last summer, we were very bullish when sentiment was rotten.
In addition to being bullish on gold and silver, we were putting
our capital where our mouths were and aggressively adding long
positions in precious metals stocks and stock options.
1. Gold $427 "Contrary to popular belief driven
by phenomenal pessimism in gold stocks, gold itself is looking
fantastic technically. ... This leaves a strong base for a new
gold upleg to ignite as soon as the dollar's bear rally fails.
Such an event could happen today" - Zeal Speculator 5.11.2005
2. Gold $435 "Gold may very well be forging
into Stage Two now, where it rises in all currencies at once.
... Stage Two also represents a much steeper upslope and bigger
gains." - Zeal Intelligence 7/05
3. Gold $495 "Yet despite this gold bull,
the metal remains really cheap relative to history. ... Investor
demand will keep driving prices higher and these very higher
prices will attract in increasing legions of global investors."
- ZI 12/05
4. Gold $517 "Although its upleg does not
appear to be over, it had become overbought on a short-term basis
and needed a breather. While I know this pullback spooked a lot
of investors, technically it turned out perfectly. Gold retreated
to its upleg resistance which is fast becoming new support by
the looks of things. Textbook-perfect bull-market behavior is
manifesting itself in gold!" - ZI 1/06
By early February, gold's technicals
had become quite overbought and the odds were no longer favorable
to add new longs. So we ratcheted up our trailing stop losses
just in case gold fell, which it ended up doing. But this strategy
also enabled us to remain long until the last possible moment
in case gold decided to shoot higher right there and surprise
to the upside.
5. Gold $571 "traders must not forget that
all bulls flow and ebb. In tactical terms it is quite apparent
that gold, silver, and the HUI are stretched far above their
respective 200dmas. Gold has surged so far so fast that it hit
a bull-to-date record multiple of its 200dma. While I have been
arguing for months now that the uplegs in Stage Two where gold
moves independently of the dollar are bound to be larger than
what we are used to, gold is looking increasingly overbought
technically. I am going neutral on it for now. All neutral means
is probabilities are favoring a normal healthy bull-market correction
so it is not prudent to deploy new longs at the moment. But neither
is it prudent to go short now since bull market surprises tend
to the upside." - ZI 2/06
6. Gold $652 "While gold's fundamentals remain
as sound as ever, global mined supplies are decreasing as the
mines process low-grade ore and global investment demand is growing,
remember that all bulls flow and ebb. Sooner or later a correction
in gold is inevitable. With its 200dma now near $505, quite a
selloff is certainly possible." - ZI 5/06
By early May when other folks
had totally sold out to the euphoria and were labeling people
who even discussed the possibility of a major correction as "morons"
and "idiots", I was warning our clients that euphoria
was extreme and the correction would come. This is the way all
markets work in history so this was the position students of
the markets should have been taking since the odds were out of
our favor for PM longs. This warning to our ZS clients was published
less than 48 hours before gold's latest interim closing high
of $720.
7. Gold $700 "While my gold and silver-related
investments are thriving, the speculator in me continues to believe
that gold and silver have risen too rapidly lately and need to
correct to rebalance sentiment. This viewpoint is extremely unpopular
and it gets even more so every day that gold and silver continue
to rise. ... Like all other bulls that came before them, they
will rise and fall, periodically surging in mighty uplegs and
then correcting down in order to rebalance sentiment when folks
get too euphoric. One of the great paradoxes of the markets is
euphoria is always the hardest to see when it surrounds us."
- ZS 5.9.2006
After gold's initial break,
one would think the overly euphoric would have quickly learned
their lessons. But as usual they didn't. While others were proclaiming
that gold's correction had to be over since it bounced, I was
warning our clients at Zeal that it almost certainly was not
over. I even warned that the odds looked highest for a rapid
fall. This was published 9 trading days before gold's plunge
this week, plenty of time to prepare.
8. Gold $651 "Since every bull I have ever
studied in history has a strong tendency to revisit its 200dma
when it corrects, and every single 1970s Stage Two gold upleg
retreated back to its 200dma before bottoming, I think gold's
200dma remains the highest probability target for this correction.
It remains a long way down from here though, near $534 today.
There are two ways gold can return to its 200dma, either it rapidly
falls or it slowly grinds sideways and waits for its 200dma to
catch up. I'm betting on the former this time around. Once a
sharp correction begins, it starts scaring people and gathers
downside inertia. In a lot of cases this momentum actually carries
it below its 200dma for a month or two. So I suspect gold has
the highest probability of falling under its 200dma before this
correction runs its course." - ZI 6/06
1. Silver $7.01 "When speculators get interested
in silver it can rocket higher in a heartbeat, so there is no
reason to be concerned about silver's lackadaisicalness."
- ZI 7/05
At Zeal we were very bullish
on silver late last summer when despair abounded. The lead article
in the 9/05 ZI was called "A Silver Lining" and its
core thesis was that silver looked fantastic fundamentally and
technically and silver ought to surge once speculators returned
from their summer vacations. The time to be bullish on anything
is not when everyone else is like in early May 2006, but when
barely anyone else is like in August 2005.
2. Silver $6.78 "No other major commodity has
more potential for legendary gains in this ongoing primary commodities
bull than silver. ... Sooner or later silver will resume trading
in line with this commodities bull and its own fundamentals,
and silver investors should earn great fortunes." - ZI 9/05
3. Silver $8.27 "Despite the strong runs in gold
and silver last month, they're not yet looking toppy in a technical
sense. ... The dawn of Stage Two could be catapulting us into
a whole new ball game." - ZI 12/05
4. Silver $9.08 "The bottom line is silver is
really looking fantastic technically. Its new bull-to-date highs
this week confirm that its young secular bull is alive and well
despite last year's naysayers. While silver's gains haven't leveraged
gold's yet, they almost certainly will in the years to come yielding
vast riches for prudent silver investors. ... And while silver
is above its resistance now, today's upleg certainly has the
potential to surge higher still especially if gold's own upleg
persists." - Tactical
Silver Trends 4 essay 1.6.2006
By early February silver, like
gold, was starting to look overbought technically so I went neutral.
I did not sell or recommend selling silver-related trades, I
just ratcheted up our stop losses to realize more of our gains
if the market indeed retreated. The odds were no longer favorable
for adding new longs in silver-related trades. Existing investments
and speculations were fine to hold for the ride, but it looked
too risky to add new ones.
5. Silver $9.83 "traders must not forget that
all bulls flow and ebb. In tactical terms it is quite apparent
that gold, silver, and the HUI are stretched far above their
respective 200dmas. I am going neutral on it for now. And since
silver is indirectly driven by the fortunes of gold and the HUI
is directly dependent on it, they demand neutrality too. All
neutral means is probabilities are favoring a normal healthy
bull-market correction so it is not prudent to deploy new longs
at the moment. But neither is it prudent to go short now since
bull market surprises tend to the upside." - ZI 2/06
Silver's ensuing parabola,
while exciting, was very dangerous. I continually warned our
Zeal clients about the immense risks inherent in buying into
a parabola. Market history clearly teaches that the only way
a parabolic ascent can end is badly. Fighting this silver euphoria
made me very unpopular, but that was fine with me as I am playing
the markets game to win, not to be loved.
6. Silver $11.49 "Then silver exploded up in a
way that only speculators can drive. While exciting, such a surge
demands extreme caution. Silver has stretched nearly as far over
its key 200dma support now as it did back in April 2004 before
a wickedly vicious crash. If you have leveraged silver longs
do not forget that silver tends to fall faster than it rises
and such corrections happen blisteringly fast with virtually
zero warning. While I remain incredibly long-term bullish on
silver, the short-term probabilities overwhelmingly favor a correction
now. It makes no sense to add long positions at a time when the
odds are stacked against us. Sooner or later, silver will inevitably
converge with its 200dma again as it has without fail in the
past and we will have far superior prices for entering trades.
Contrarians avoid buying wild euphoria." - ZI 4/06
7. Silver $13.51 "Silver, which I warned about
last month, blasted higher in a classic tactical parabolic ascent
before crashing. Once parabolas fail, they have a really high
probability of crashing into full-blown corrections that end
near their 200dmas. Silver's is way down around $8.75, so please
be careful here. Silver too needs a healthy correction to rebalance
sentiment and lay the foundation for its next mighty upleg. Before
it crashed it was up an astounding 118% in this upleg and stretched
70% above its 200dma. Such extremes are simply not sustainable."
- ZI 5/06
Despite the odds, silver kept
rising. But history shows that buying parabolic tops is the height
of folly, so I kept warning our clients of the looming probability
for a major correction. These were my final silver thoughts less
than 48 hours before silver's latest interim top. The worst time
to buy anything is when it is the most tempting, and silver was
playing quite the temptress near $15. Like the mythical Sirens
though, it was seducing newly-long silver traders to their deaths.
8. Silver $14.49 "With gold and silver both way
overbought technically today, the odds are way out of our favor
that they will continue surging. This is really the bottom line
in my mind on gold and silver today. I love both metals and am
very bullish on them in the long term. But as a rational speculator
governed by the probabilities, I cannot violate my trading principles
and buy now when gold and silver look so stretched. And if I
cannot buy myself and place my own capital at risk right now
in gold and silver, then I cannot recommend you take a big risk
that I am not willing to take." - ZS 5.9.06
On an interesting sidenote,
when silver closed at $12.42 on May 19th a popular silver commentator
publicly wrote and published an essay that included the following
quotations. "loads of so-called analysts are calling for
a correction, or trying to describe this week's price action
as a correction. Sigh." "The word 'correction' is the
wrong word to use to describe a dip, or pause, in the gold price."
"You should not try to predict short-term price movements.
Upon what reliable indicator can you rely for short term price
movements? There are none."
This gentleman continued, "Just
think of the absurdity of trying to call a top in the middle
of a bull market." "And I've never, ever, seen anyone
successfully call the tops and dips in this bull market from
1999 onward. Many try, but none are successful. Furthermore,
I've never seen anyone successfully call both a top and a bottom,
to successfully trade a dip in the gold price."
Are any of these statements
true? Nope. At Zeal we have been actively trading major gold
and silver uplegs and corrections since these bulls began. I
realize it is impossible to predict exact tops and bottoms, but
we have tried and have been blessed with success in correctly
riding the middle 80% or so of each major upleg and correction
since 2000. I published an
essay the same day as this quoted one above to refute the
spurious arguments that markets can't be traded and gaming corrections
is impossible. Nothing could be farther from the truth. Doing
these very things is what speculation is all about!
As a speculator who loves this
game, my favorite way to ride the gold and silver bulls is via
elite leveraged gold and silver stocks as well as stock options
on world-class producers. Hence this is where the rubber meets
the road at Zeal, buying gold and silver stocks early in their
uplegs and then letting them slide into their ratcheted-up stops
when the uplegs grow mature. In this latest round, the upleg
above, our realized gains on recommended stock trades ran as
high as 116% while our realized PM-stock-options gains ran as
high as 729%. We started buying low early last summer when folks
were still pretty scared in general.
1. HUI 186 "With the HUI's correction just
average so far, the currency countertrend reversals mature, and
gold advancing modestly despite the dollar, I believe the probabilities
are as high as we've seen them in a year that a major new PM-stock
upleg is brewing." - ZI 6/05
2. HUI 196 "Gold stocks have been trending
higher since May now and I still expect a major HUI upleg in
the coming six months for all the technical reasons often discussed
here." - ZS 7.20.2005
3. HUI 240 "The bottom line is the HUI technicals,
despite its strong run since May, still remain very bullish.
The index is definitely not overbought yet in light of past bull-to-date
precedent and indeed it remains nearly oversold still by some
measures. Major bull-market uplegs take some time to unfold and
our current specimen continues to look technically young."
- Bullish HUI
Technicals essay 9.16.2005
4. HUI 245 "The bottom line is the technical
indicators we have used to successfully trade the HUI for years
are not yet showing a high probability of topping. The big selling
season is not here. But until the selling signals start flashing,
there is no sense worrying about a major HUI top. Odds are you
can sell later at much higher profits." - ZI 10/05
5. HUI 243 "While this upleg is up 53% so
far, it remains modest compared to the HUI's average upleg gain
of 98% bull to date. If this upleg matures in line with the averages,
330 is the next target. I suspect this will prove conservative
though. The combination of the HUI breaking decisively above
its December 2003 bull highs near 257 and gold entering Stage
Two could drive this upleg much higher." - ZI 12/05
6. HUI 261 "The bottom line is the HUI's
leverage to gold looks just fine despite popular perceptions.
... In leverage terms the current HUI upleg looks modest so far,
but this is par for the course. The HUI leverage to gold always
looks anemic until the final euphoric surge to new interim tops
that marks the end of major uplegs." - HUI
Leverage to Gold 2 essay 12.9.2005
7. HUI 277 "One of the reasons gold-stock
sentiment has been so rotten was because the HUI had been failing
its long struggle to break above its two-year-old highs at 257.
It is wonderful to see this index finally shoot above these levels
to prove that its bull is still alive and kicking. I suspect
these new highs combined with new gold and silver highs will
lead to a surge in new PM-stock interest. This should drive a
fast spike up to 330ish or so that may mark the end of this upleg."
- ZI 1/06
Finally in early February when
the HUI reached its initial interim top, I went neutral on it
since our technical indicators suggested it was getting overbought.
Indeed PM stocks did correct for the next couple months before
gold's latest dollar-slide-driven surge dragged the HUI up higher
to its latest May interim highs. While our short-term PM-stock
speculations were largely stopped out with excellent realized
profits after the February interim top, our long-term PM-stock
investments that we do not trade enjoyed the awesome climb higher
to the HUI's latest peak in May.
8. HUI 342 "traders must not forget that
all bulls flow and ebb. In tactical terms it is quite apparent
that gold, silver, and the HUI are stretched far above their
respective 200dmas. I am going neutral on it for now. And since
silver is indirectly driven by the fortunes of gold and the HUI
is directly dependent on it, they demand neutrality too. All
neutral means is probabilities are favoring a normal healthy
bull-market correction so it is not prudent to deploy new longs
at the moment. But neither is it prudent to go short now since
bull market surprises tend to the upside." - ZI 2/06
As the HUI neared May's secondary
top, I warned our clients at Zeal that corrections in commodities,
dragging them all the way back down to their 200dmas, were growing
more probable all the time. As I said at the time, this was not
a fundamental argument, the fundamentals looked awesome. It was
a pure technical argument since commodities looked so temporarily
overbought. There is no inherent contradiction in being briefly
short-term bearish while remaining rabidly bullish for the long
term.
9. HUI 379 "We may be in for sharp corrections
in major commodities in the months ahead. But regardless of how
weak technicals become, commodities fundamentals remain rock
solid. It takes many years to find deposits, build mines, and
bring them into production. In light of a strong fundamental
foundation, any 200dma approaches will be awesome buying opportunities."
- ZI 5/06
And finally, in early June
after the HUI had been climbing higher for over a week after
its initial slide and many folks were claiming the PM-stock correction
was over, I warned of just the opposite. Corrections tend to
last quite some time because their job is to utterly destroy
the wildly bullish sentiment that spawned the latest interim
top from which the correction began. It takes longer than a mere
couple weeks to crush the spirits of the overly enthusiastic
bulls.
10. HUI 334 "And by bull-to-date standards,
this correction has barely started. We are 14 days into it so
far and down 21% at its worst point on a closing basis. The five
previous major HUI corrections in this bull averaged 30% losses
over 88 trading days. And the biggest uplegs tended to have deeper
losses compared to the average. This recent upleg that just broke
was up 137%. So odds are we are in for considerably lower HUI
levels and months of grinding. If the HUI corrects at its 30%
bull average, 275ish is where it will bottom. If it drops 35%
like the comparable big uplegs that went before it, then we are
looking at 255ish. Both are below the HUI's 200dma. Unfortunately,
unlike gold, we're not able to rely on the HUI's 200dma holding
as support. In both 2004 and 2005, the HUI spent four to five
months or so in each year well below its 200dma. Its corrections
in both of those cases each bottomed just under 0.80x its 200dma."
- ZI 6/06
So why did I put this essay
together? I want to combat the totally false notions so prominent
in April and May that corrections aren't necessary and that even
if they are they can't be anticipated or gamed. That is utter
nonsense. The art of speculation is all about buying low and
selling high, which requires diligent students of the markets
to intensely study them and ferret out their rhythms in order
to better understand their probabilities.
If any person or company you
paid to help you navigate the markets did not at least warn you
in April and early May that sharp gold, silver, and HUI corrections
were at least possible, then perhaps your loyalties are misplaced.
Serious students of the markets saw all kinds of warning signs
leading up to these events, but careless cheerleaders blundered
on through and got slaughtered since they have not respected
market history.
At Zeal we are speculators.
I love speculation. My business card says "Speculator"
for my title. I study the markets because I want to make profitable
trades in my own accounts and grow as a speculator. Since I play
this game for trading profits, I couldn't care less how unpopular
my contrary opinions are near major interim tops and bottoms.
The markets are not where one should come if they seek acceptance.
My business partners act and
feel the same way. While our research is designed to fuel our
own personal trading, we sell our research because it helps us
stay on task and maintain discipline. When our clients are relying
on us to research and trade, we have to keep relentlessly studying
the markets all the time which ultimately helps us grow into
better speculators.
Our mission is to actively
game the markets with the goal of launching profitable trades,
both short-term speculations and long-term investments. Since
we are playing this great game with our own precious capital,
we strive darned hard to understand the probabilities and communicate
them to our clients. If you weren't already in cash through the
vast majority of these recent gold, silver, and HUI corrections
and you got hurt, you certainly didn't need to absorb those losses.
Since we expected these corrections,
we raised our trailing stop losses in anticipation and have built
up big cash balances for the coming feast of bargains. The best
times in a secular bull to buy elite gold and silver stocks,
and stock options, are when the metals and stocks fall under
their 200dmas for a period of time and destroy over-exuberant
sentiment. If you are as excited about the next awesome gold
and silver upleg as we are, you ought to join us for the coming
ride.
Our primary research service
is our monthly Zeal
Intelligence newsletter, where most of the quotes in this
essay came from. Subscribe
today to see our coming specific PM-stock and options trades
once the probabilities for success seem wildly in our favor again.
We also recently published a Zeal Report detailing our favorite
20 gold stocks these days in fundamental terms. Read it before
the coming awesome buying opportunities arise so you are comfortable
with some of the most promising gold stocks prior to the actual
technical buying signals arriving.
The bottom line is the recent
sharp corrections in gold, silver, and the HUI were totally expected
and anticipated. No mere mortal can see the future and know exactly
when they were coming, but the ballooning probabilities in favor
of major corrections leading up to these events were unmistakable.
No student of the markets or serious speculator should have been
at all surprised by these retreats.
Such corrections are totally
necessary within a secular bull from time to time in order to
keep sentiment balanced and prevent the bulls from going parabolic
too early and ending prematurely. But just as in the previous
five major PM corrections in this bull, the underlying PM fundamentals
today remain awesome with the best of these bulls yet to come.
Adam Hamilton, CPA
June 16, 2006
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!
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