Precious Metals Parabola Likely to Begin Later This Year

By John Cassimatis  JAN 06, 2012 1:45 PM

There is a great deal of chatter about a precious metals bottom, and much of it is valid. However, downtrend lines still dominate the near-term landscape.

 


Yes, it is quite amazing just how long it takes for one’s theses to play out; in this case, just how long an overleveraged and over-managed financial system can stay glued together.  Believe me, I am not a pessimist, nor do I wish our world to be plunged into chaos and even more uncertainty than we already experience.  I am a realist, and the picture has looked bleak for the better part of a decade now.  Gold and silver have risen from the dead over that period and now find their place among the general population’s lips. 

The End of Phase 2

Phase 2 in the metals was supposed to see more vigorous drives than its predecessor, Phase 1, which was more of a simple inverse relationship to the dollar.  It did indeed.  More institutional participation was expected and showed up.  The moves in the metals were supposed to be less correlated to the dollar, and we witnessed periods of that relationship being both direct and indirect.  Phase 2 went down like the paper read, and it ended midway through 2011.  The resulting consolidation has been tricky and often violent.  While I am not quite inclined to call it officially over yet, there is some gumption to the possibility that they confirmed their bottom on the Thursday before New Year's at 1525 gold and 26 silver.  If we look back to the consolidation between Phase 1 and 2, during the credit crisis meltdown, we find that gold dropped close to 40% and silver around 60%.  From Phase 2 highs, this would indicate further declines to 1200 gold and 17-19 silver.  Again, while those prices are certainly possible, especially in an environment where the dollar shows relative strength against the euro, it will take a good bit of work to get the metals down there.  Current prices are attractive to many investors including myself, especially if one takes a longer term approach.  My strategy is to take some smart stabs here and there just in case the metals decide to test and breach their rather intact downtrend lines sooner than expected. 

Phase 3 Fireworks

Most long-standing bull markets end with some sort of mania phase.  I am quite certain that this has not yet occurred for the metals.   While the action in early 2011 was impressive to be sure, it was not the end-all ramp that naysayers are claiming.  The retail sector was still predominantly on the sidelines for most of the move.  That group’s ultimate participation will be the main driver of the explosion that is, on paper, called Phase 3.  This phase is supposed to see close to 90% of the gains in just 10% of the time.  My timeline is beginning to take shape.  I think the consolidation resolutely ends by September this year and then you mark off 10% of the time.  The bull market is now 11 years old so we could be talking about a Phase 3 top in late 2013/early 2014.  Of course, such a move will need a catalyst.  At this point, the most likely emerging catalyst seems to be on this subject of European debt and the interbank contagion that could result from widespread writedowns.  Of course, US debt continues to break post World War II records in both nominal terms as well as versus GDP.  Only Ron Paul represents any substantive change politically, and of course that will come with its medicine.  There are clear reasons to fear that the stitches and crutches provided by central banks will ultimately be overwhelmed, despite how their actions have prevented a complete system breakdown thus far.

MF Global a Harbinger

For those wondering just how painful a bank crisis could be, look no further than MF Global (MFGLQ.PK).  This experience has taught us first hand to pay no attention to laws and protections provided.  Segregated accounts simply do not exist.  Further, we see just how much fine printed law allows banks and brokerages incredible latitude in the types of transactions they can perform.  We have also seen that money ‘in the system’ is not nearly as traceable as one would think or hope, and clawback rules are often subject to other fine print laws preventing it.  Make no mistake, MF Global has now institutionalized the concept of stealing customer money in a bind.  In a great and widespread pressure, tracking money will be like the proverbial needle in a haystack.  Public claims have been made on identifiable private property.  No backstop has emerged.  It is truly scary stuff, and whether or not you had exposure to MF, lessons for the future must be learned.  In such an environment, one could easily see another catalyst for parabolic precious metal gains to emerge.  Certificates and rights will matter little in that scenario.  Keep this in mind as you decide just how to play the sector.

Current Strategy

There is a great deal of chatter about a precious metals bottom here and much of it I think is valid.  They have certainly held at a predictable and important retest point.  My only hesitation in jumping in full throttle is that downtrend lines still dominate the near term landscape and the consolidation has not been as long as prior ones.  Most consolidations thus far have been about 18 months long.  Obviously, as your broker will tell you, past results are no indication of future performance.  The best strategy seems like smart bids on weakness to begin building a position.  Then, if technical accomplishments emerge in the future, like the breaking of a downtrend line, one can average up.  It’s far easier to average up than to ignite a position from scratch on such a feat.  I will be picking here and there, cognizant still that the likely upside that is to come could be capped at technical resistance.  With that said, the COT report, sentiment levels, daily and weekly RSIs, have all returned to far more bullish readings.  In the end, I cannot rule out a summer drive to new lows in both silver and gold.   What I can say quite emphatically is that a move to fresh lows will present an even better entry point than the enticing one available now—a precious parabola has not come yet.  No, quite certainly, it is in the making.  The only question is how precise, how cute, how risk-tolerant, one is in these moments in front of it.

No positions in stocks mentioned.

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