Three weeks ago we wrote that
the short-term
outlook in precious metals was bullish. Quoting our conclusion: "The
bottom line is this sector is very close to a breakout which would likely
confirm the May bottom. The price action has started to improve and the
sector has not been deterred by the aforementioned bad news which, in normal
conditions would have caused a selloff. In the meantime, the public has been
bearish the entire year and the dumb money has started to exit the market. It
is this combination of factors that lead us to a firm bullish posture over
the rest of the summer." In terms of weekly closing prices, GDX and
SIL closed last week at a four month high, while GDXJ closed last week at a
three month high. Silver closed at a four month high while Gold closed at a
five month high. From that it would seem that these markets are overbought.
However, a quick study of the long-term charts, sentiment and valuations
confirms that we are in an absolute sweet spot. Markets have bottomed, a new
cyclical bull has begun and there is substantial room to move over the coming
months and year.
We begin with a chart of the
bull market in the HUI and we highlight the cyclical bear markets. The
2011-2012 bear lasted about as long as the 2004-2005 bear but was a bit
deeper (42% versus 36%). The fact that this bear corrected the recovery from
the 2008 crash could be why various valuation and sentiment indicators are at
such compelling levels (as annotated in the chart).
Next we chart our proprietary
Silver index, which is comprised of 10 "growth oriented producers."
(The ETF SIL only has a few years of history). This index corrected 60% in
2004, 90% in 2007-2008 and 50% from 2011-2012. The current bear market was
the almost the longest (short of the 2007-2008 bear) but the smallest with
only a 50% correction. Yes, to say only 50% is ironic but in looking at the
chart one can see that the correction appears to be quite routine. This chart
has potential to be a cup and handle pattern which could have massive bullish
implications for the next few years.
How does this bull market
compare to the past? The Barrons Gold Mining Index (BGMI) had two tiny
cyclical bears and two large cyclical bears. The circles show consolidations
within cyclical bulls which lasted more than three years.
Visually we can understand why
the sector is beginning a new cyclical bull market. Yet let's take a look at
some simple sentiment and valuation data. Below we show info from SentimenTrader which shows the Rydex
Precious Metals Fund. At the recent bottom, the assets were the lowest
they've been since 2008. In fact, going back 10 years, it was the second
lowest point (with 2008 being first). Also note that the precious metals
assets (as a percentage of all Rydex funds) were at a minimum of a six year
low.
Next, we've shown this before
but it's worth showing again. We calculated that the PE ratio of the HUI Gold
Bugs Index at the May low was 12x earnings. This chart from the Erste Group displays the year by
year PE of the HUI. If Gold moves higher then earnings should increase.
Combine that with rising valuations and that explains the potential for
substantial gains.
The confirmation of the bottom
is obvious. Now what? Well, the question is if the sector will continue to
zoom higher similar to 2005 and 2009 or if it will consolidate for months
(similar to 1972 and 1977) before making a parabolic advance in less than two
years. In any event, that is just semantics and for the hyper traders out
there. In either scenario we are early in a new cyclical bull and there is
tremendous opportunity to be had.
Good Luck!
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