Opportunities and Caveats in the Precious Metals Sector

March 15, 2009 | By: Sol Palha

By nature man hates change; seldom will he quit his old home till it has actually fallen around his ears. - Thomas Carlyle (1795-1881, Scottish philosopher, author)

Gold has lately managed to surge past 960 and actually traded all the way to 1004 before rapidly pulling back. Even though the Dow has gone on to put in a series of new 52-week lows and has now traded well below 7000, gold has not surged to new highs, this suggests that the gold sector could be in for a sharp and short correction which could roughly last three months. If gold trades below 900 for more than seven days, the correction will probably gather steam, and at the very least gold should trade down to the 840-870 ranges. A weekly close below 840 could trigger a test of the 780 ranges.

The oil to gold ratio hit an extreme point in the last week of February; prior to that, one ounce could purchase between 22-24 barrels. Now one ounce can purchase 26 barrels of oil. It appears that some sort of correction is imminent in the gold markets, or that oil is going to experience a very strong move upwards, or it could be a combo of the two scenarios. Several strong negative divergence signals have been flashed, and this usually is a sign of an upcoming correction. Thus either gold mounts a strong correction with oil mounting a mediocre rally, or oil mounts a strong rally and gold mounts a mediocre correction.

Gold came within trading distance of testing its old highs at 1014, but ran out of steam as it hit 1004. It is now entering into a short term corrective phase (2-3 weeks) and a break below 880-900 for more than 3 days in a row would suggest that the correction is picking up steam as well as the duration. If gold breaks below the 880-900 ranges for more than three days, it will most likely lead to a longer term correction that could last as long as six months.

Taking a look at gold from the intermediate perspective, a break below 810 for more than 3-5 days in a row will be a pretty clear indication that Gold could trade down to the 750 ranges and possibly to the 720 ranges.

Silver

Silver mounted a very strong rally from its lows and as a result the pattern has changed and become more bullish. This now means that silver could have potentially put in a long-term low last November when it traded down to the $8 ranges. We still expect silver to pull back, but the pullback could be limited to the $9 ranges. If, however, Silver trades below $9.00 for more than 7 days in a row, it could potentially trade all the way to the $7.20-7.50 ranges before stabilizing, but as of now the likelihood of silver trading below $8 is rather slim. We will be looking forward to opening up several new positions in silver as soon as the appropriate buy signals are generated. A pullback to $9 or below should be viewed as a screaming buy.

Palladium

Palladium has traded down to the $180 ranges several times, and on the last three occasions it has flashed a series of back to back positive divergence signals; from a long term perspective, this is a very positive development and virtually guarantees that palladium will one day be trading well past $1000.

In the short to intermediate time frames, palladium's strength will be determined by how it responds to the corrections in the gold and silver markets. If during this corrective phase palladium can hold above $180 even if gold were to trade to, say, the $720-$750 ranges, then it would be very strong sign that this market is just waiting for a reason to explode. Expect this market one day to move in bursts of $30-$50 a day. If you have no position in bullion, now would be a great time to add to your positions and continue to add to them on all pullbacks.

Conclusion

Individuals should understand that while we expect gold and silver to pull back, we do not expect them to crash; this bull market still has a long way to go and to completely bail out now would be a very foolish mistake. It does, however, make sense to take some money off the table with the intent of re deploying it down the line. Any strong pullback should be viewed as lovely long-term buying opportunities; the long term trend for the dollar is negative and believe it or not, inflation will strike very suddenly and with force, as was the case with deflation.

For those who would like to short the Gold sector, a very easy way to do it is via the ETF, GLL. If you decide to short gold via GLL, it should not be a long term position as gold is expected to trade significantly higher towards the end of this year. This is a short-term correction and should probably end in 3-4 months.

In terms of playing the long side, one can purchase the following ETFs;

If you are bullish on gold, purchase GLD, and if you are bullish on silver, you can purchase SLV. Unfortunately, the Palladium sector has no ETFs, at least not those that are traded in the U.S., and so the best way to play this sector would be to open up long positions in Stillwater Mining (SWC).

Disclosure: We have positions in SLV, GLL, and SWC.

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