A Bottom, Finally?

From The April 2013 HRA Dispatch

Just when it looked like things couldn't get worse they got a lot worse. The gold market endured its worst two day drop in 30 years when massive selling took the price to $1325. There were a lot of reasons given for the panic - and it was a panic - but the chief culprits seemed to be a short recommendation by Goldman Sachs, rumors of potential selling by several European central banks and fears that the US Fed was about to take the punch bowl away.

An added reason I think was unwinding of long Yen carry trades, some of which had long gold holdings on the other side. Selling gold and yen to close out the yen longs and go short added pressure to the situation. Large short holders in the gold market saw a profit opportunity and sold hard on the first day of the large drop, triggering stop loss orders as successive "resistance" levels were passed through. Once the drop hit the news wires retail holders of GLD and hedge funds that were just riding the trade continued the stampede. By the time gold bottomed on the Monday "everyone" knew it was a bear market and that the price had nowhere to go but down.

Is there any good news to be had in this scenario? There may be though it's too early to be sure. One of the biggest problems with both gold and the market for companies that explore for and produce it has been the lack of a bottom. The market has been awful but there were few signs you could point to that indicated a bottom might be in, or even on the way. It was a slow motion train wreck that never looked like it would end.

That may have changed two weeks ago when the gold market was crushed. Not only was the price action violent but the trading volumes on the gold market were huge. As some of you know, I sent out a Special Delivery on April 14th in which I said I thought there was a capitulation bottom coming on gold and the faster the drop the sooner the bottom would arrive.

"Fast" barely did justice to the drop that occurred on the 15th, but it certainly fulfilled the description of capitulation. There was undisguised glee from numerous mainstream finance sites and columnists. Gold had entered a "bear market" officially, having declined 20% from its peak in 2011. Everywhere you looked there were articles about gold being just another market bubble and how it had fallen from its parabolic top.

While gold was getting slaughtered gold stocks were seeing equal declines. Just another day at the office for a sector that's been despised for two years. The HUI gold index lost 15% in four trading sessions and the TSX Venture, home of the Juniors, fell 10% during the same period.

Are we done yet? Or are we just done? A lot of comparisons have been made to the 1980 top in the gold price. I'm not a chart guy but I don't find those comparisons convincing. 1980 was a parabolic top which means the price fell as fast as it rose. A lot of writers talking about parabolic tops don't seem to be aware of the mathematical definition of the shape.

The current chart looks a lot different than 1980. The gold price saw declines - and gains - for two years before the recent massacre occurred. It's a big stretch to call that parabolic.

More to the point, the behavior of market participants seems a lot different this time around. When gold peaked and quickly fell back in 1980 retail gold owners couldn't get rid of the stuff fast enough. There were lineups around the block at bullion and coin dealers as people sold their recent gold purchases back to the stores - if the stores would take them.

The behavior of retail physical gold buyers is very different this time around. There have been lineups to buy, not sell, and sales volumes at coin and bullion dealers from Albuquerque to Mumbai to Beijing have been two or three times normal. A couple of central banks have also reported making purchases since the drop.

Central bank activity will be important to the short term direction of gold. They have been buyers, to the tune of 3-500 tonnes a year for the past few years after being net sellers for decades. Several central banks that have been accumulators recently have shown considerable smarts when it comes to market timing. Russia and South Korea have shown a pattern of buying dips and there may be others doing it as well. I noted in a recent SD that I think the odds of peripheral EU countries selling their gold holdings seemed slight. My view on that hasn't changed. It's one thing to push around Cyprus but I think the EU would not want to repeat that with countries that it thinks are being "good" like Spain and Portugal, even if they are struggling. Italy isn't and probably won't ever be considered "virtuous" by northerners but it's equally unlikely Italians will care. Italy has by far the largest gold reserves of the peripherals but I cannot imagine them selling gold, or doing anything else, just because northern Europeans demanded it. They're more likely to add to their holdings just to infuriate them.

As the chart above indicates, gold has trended up ever since the mid-April dive. It managed to get through $1400 and $1430, both of which acted like substantial resistance areas. There are quite a few more resistance areas to get through before bullion is priced at levels that calm traders. More recent reports indicate heavy buying in the big consumer countries (China and India) continues unabated.

It may be significant that most of the early attempts to break through resistance levels occurred in Asian markets and that the trading volume on those markets has been quite high. I am particularly interested to see if Japan becomes a major buyer. It never has been in the past but the inverse relationship between the gold price and the Yen certainly isn't lost on Japanese consumers. The Japanese government has done an impressive job of pushing the Yen down. That looks like a crowded trade to me but if the average Japanese believes their government can keep moving it down gold would be a good insurance policy. We'll see what happens but retail Japan has enormous buying power should they choose to use it.

So where do we go from here? There is still a large speculative short position, surprisingly large given recent price moves. It looked like there was some covering at 1400 and 1430. I suspect there would be a lot more if the price can get back through 1500 in the short term. Getting a 15 handle on the gold price in the next week or two will depend on the outcome of and reaction to a couple of central bank meetings as much as anything.

Fear that the US Fed would stop or even reverse QE has had a large impact on the gold market. There has always been contention among Fed committee members about it. That won't change but there was notable softening by some of the more hawkish members of the committee recently. The last monthly employment number and weak manufacturing and inflation numbers makes worries about an overheating economy look silly. The US economy is still a very long way from full capacity. If moderate Fed committee members continue to talk about extending the bond buying into 2014 that would only help. Next Friday brings the next employment report, with a consensus estimate for a 160k gain in jobs. I suspect last month's number was partially bad data but if employment misses again expect the US Dollar to get hit and gold to jump.

The ECB also meets next week and there is growing consensus they will cut some of their target rates by 25 basis points to 50. That move might hurt the Euro and Gold price but it really depends on how priced in the move is already. If the ECB was to do something more dramatic like a new refi program it could generate enough optimism to actually move both gold and the Euro up. That isn't a likely scenario but it's not out of the question. The EU money supply has been contracting lately and it looks certain the EU will go deeper into recession unless someone does something fast. The EU may loosen things a bit even though Germany is dead set against it.

We are a long way from being out of the woods. Gold's bottom does look like capitulation and that is the most likely scenario to bring in new buyers. The same would hold true for the junior market. While we did not get capitulation style volume there was definitely a high level of disgust and forced selling on margin calls. There certainly hasn't been a big bounce but I didn't expect one. IF gold can get through $1500 and hold it there should be more of a bounce in store for producers and companies with viable looking resources.

As I have noted many times recently most pure early stage explorers are broke. They are not in a position to generate news until they dilute to raise money. The financing window is still closed so that will not happen overnight even if gold keeps rallying. It will be a long slow climb.

The one exception to that are discovery companies as I have also harped on lately. One such company appears in the update section. It's up over 300% in three trading sessions after reporting a discovery drill hole on one of its projects. That is the sort of move that reminds traders of why they play exploration stocks. Such reminders have been very few and far between these last two years. Let's hope that discovery name has some company soon.


Hard Rock Analyst (HRA) has been publishing newsletters about resources and resource companies since 1995. HRA delivers opinion on economies and economics, industry trends and macroeconomic drivers that move the prices of commodities and the companies that explore for and produce them. More importantly, HRA introduces readers to companies that have the combination of projects, management and financing ability to succeed. HRA looks for explorers that have the potential to at least double in price over the next 12 months with good exploration results. In addition, companies that are growing resources and/or on track to move through feasibility and either become takeover targets or go into production independently are also reviewed.

The numbers tell the story in terms of the success of HRA's methods. The average gain for 87 closed positions over the 2003-2012 period is 220% and no less than 21 of those 87 companies were taken over by producers!

The HRA - Journal, HRA-Dispatch and HRA- Special Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing timely and factual analysis of junior mining, resource, and other venture capital companies. Companies are chosen on the basis of a speculative potential for significant upside gains resulting from asset-based expansion. These are generally high-risk securities, and opinions contained herein are time and market sensitive. No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer, solicitation or recommendation to buy or sell any securities mentioned. While we believe all sources of information to be factual and reliable we in no way represent or guarantee the accuracy thereof, nor of the statements made herein. We do not receive or request compensation in any form in order to feature companies in these publications. We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form for other than for personal use without the prior written consent of the publisher. This document may be quoted, in context, provided proper credit is given.

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