Commodity Trade Mantra

Why The Gold Bear Attack Crash Really Happened

Why The Gold Bear Attack Crash Really Happened

Why The Gold Bear Attack Crash Really Happened

You have just witnessed a historic crash in Gold.

This is a quote from the Yahoo Message Board for gold mining stock GSS posted yesterday at 6:19 PM:

“Terrible, terrible, terrible and tomorrow will continue, unfortunately I am out. I will sell at opening.”

On Friday there was an article on with the title “Shares of GSS Oversold.”

On Monday GSS crashed 25% to close at 94 cents a share making a mockery of the article even if it was right. Consensus analyst estimates are for the company to make 24 cents a share in 2014. It closed with a forward 2014 P/E of 3.36.

NEM is paying a 5% dividend. NSU has a P/E of 4.71 and forward P/E of 3.57. GFI has a P/E of 7 and forward P/E of 5. The gold stock ETF GDXJ is paying a 6.13% dividend.

Gold stocks are cheap on a valuation basis. Dirt cheap. They are so cheap now that no one wants them anymore. People like to chase things as they go up in value and flee as they fall and if they fall fast enough and far enough they scream in panic and pain.

You see yesterday gold fell 119 points for an 8.06% drop while the HUI gold bugs index fell 9.4%. These drops of course came after similar outsized drops on Friday. There was enormous selling in the GLD and GDX exchange traded funds too. GLD saw over 93 million shares trade when it does an average of only 10 million shares of trading volume in a day. GDX did four times its normal trading volume too.

These have been the biggest back to back down days in Gold since 1983.

The moves have hurt my account a little. For disclosure purposes even though I’m just about 3% invested in GLD and 3% in GDX that’s enough to feel a little pain. I’m roughly 90% invested in my account in stocks and ETF’s all over the world, with a heavy emphasis on Ireland, Greece, and Europe and about 6% in gold related issues, so I have a little cash ready to go.

After gapping down in the morning gold stocks put on a weak effort to bounce, but then by the close gold tumbled. By the close yesterday the DOW ended down over 265 points too as every market came under pressure.

When you see a market go down big in the morning and then try to bounce only to collapse towards the end of the trading session what you are seeing on the close are margin calls. On a big gap down people on margin hope for a bounce and if it doesn’t happen and the market turns down they are forced to sell in panic. In big down markets that can cause a big volume expansion and sharp move lower in a short amount of time. This appears to have happened in the last hour of Monday’s trading.

I will repeat quickly what I told you Sunday – gold has been in a bear market since it peaked in the last quarter of 2011. That is why it is falling. People are trying to come up with explanations for the gold drop, but this is the real one – plus the fact that so many hedge funds flocked into gold.

The chart of gold tells a simple story and makes the real reason for the crash apparent:

After peaking above 1900 in 2011 gold has been in a sideways/downtrend ever since with support at the 1550 level. On Friday it opened below that level.

This meant that everyone who had bought gold since the summer of 2011 was now sitting on a loss. Every hedge fund in the gold trade was down and every investor who bought gold themselves since then was too. Losses lead to panic. That is why the 1550 level was so important – and why it has led to this current gold crash. Every computer program yelled sell once the 1550 level was breached and the selling built up into a crescendo – into a crash.

As I put it in the title of my article yesterday this is the “Final Liquidation of the Gold Bug.”

Gold has fallen over 15% in the past four weeks and is now down over 30% from its high of 2011. Gold stocks though have fallen 23.57% in just the past four weeks and are now down 58% from their highs of 2011.

The thing is the moves of just the past four weeks are the type of moves that could take months to happen and not just weeks. This is a crash.

People are saying this is the start of a new bear market in gold, but gold has been in a bear market now since 2011. This is how bear markets end, not how they start. The current action reminds me very much of what happened in Europe last year. European markets had been in a decline for well over a year and then fell huge in the space of a week, with many of them falling 10% in a single day more than one day in a row. All of the news was bad and that was the bottom.

I bought into European markets and made investments in countries such as Greece even though people were saying not to because the news was bad, thanks to this bottom. When a total crash comes it gives you an opportunity to buy stocks at such cheap valuations that it practically doesn’t matter what happens in the future.

Last year you could for example have bought one of the largest power companies in Europe based in Greece trading with a P/E around 4 and paying a beefy dividend thanks to the Europe crash. It was a good investment even though the news was bad, because people were not going to stop using electricity in Greece. But talking heads on CNBC said it was too scary to invest in Europe.

Gold stocks are now so cheap that they are at stupid valuations and are paying big dividends. On the close yesterday Newmont had a P/E of 8.99 and paid a 5.01% dividend. That doesn’t necessarily mean today has to be the bottom, but what it means is that when the bottom does come it really doesn’t matter what the “news” of the future is. People are not going to stop wanting gold just as they are not going to stop using electricity in Greece. But talking heads on CNBC are saying buying gold now is stupid and headlines all over the Internet now are saying the same thing.

But Gold will still be around well after I am dead and long gone and long after the Federal Reserve Board ceases to exist too.

I was just a chap in 1987 so I wasn’t in the market then, but this move in gold is probably something like what people experienced during the 1987 stock market crash.

Back in 1987 the stock market broke through some key technical support levels and provoked a crash. That crash though came in the context of a secular bull market that didn’t end until March of 2000 so it made for wonderful buying opportunity. The current secular bull market in gold started in 2001 so this is likely to become a similar great buying opportunity as that one proved to be for people who were able to take advantage of it.

The “flash crash” we saw happen for a few hours in 2011 occurred when the DOW fell through its 200-day moving average. That technical breach provoked computerized selling and some short-term panic. But it came and went so fast that it didn’t really disturb the psychology of most investors. It was over before the close of trading so those who just saw the news in evening felt no pain from it. In fact most people do not even remember it.

It takes overnight pain and suffering to create a real memorable crash. Friday’s big drop in gold brought weekend misery for gold bugs, but I want to buy more mining and commodity stocks. Yesterday I sent a list of ones I am watching to Premium Power Investors. I am waiting to buy though. I have to be careful, because I’m already 90% invested.

I have seen some gold sell-offs in the past and they seem to have a pattern to them. They start with the gold stocks falling for weeks sometimes for months at a faster rate than gold does. The stocks tend to lead the action in gold so they go down first.

The relative strength Gold stock index divided by gold (GDX/GLD) ratio drops as this happens. This is the longest stage of the drop.

Then in the second stage both gold and the gold stocks tend to fall at roughly the same rate over a week or a few days. In the final phase – which plays out over a few hours and doesn’t always happen, because sometimes the bottom is instant – gold falls at a faster rate than the stocks do. Sometimes gold stocks go up or are even in a morning in which gold is down big. If this had happened Monday morning I would have bought then.

Looking at a daily chart you can see that since the start of this year gold stocks have been falling at a much faster rate than gold on this correction. Then on Friday the drop in gold speeded up. Take a look at these two charts:

Now this is a short-term 60 minute chart of the GDX/GLD ratio. Below the main chart is a chart of GDX and below that GLD so you can see them separately too.

What happened Monday is that in the morning the gold stocks tried to bounce while gold sat there. Then they got sucked back down when gold and the broad market plunged on the close. In other words the gold stocks tried to display some strong relative strength against the metal and by the close both were down about the same.

I take this to mean that we are in the second phase of this gold correction. The first phase is the long one, the second one can just last a day or two, and the final phase if it happens normally just lasts a few hours. So if I see gold stocks display strong relative strength against the metal I will take that as a sign that a final bottom is being made.

Again I do not take this crash as a sign that some big thing is now happening in the world economy or we are at the verge of an epic new trend in it or anywhere else. Nothing else is crashing like gold is. If we were in “deflation” everything would be in a total meltdown, including the US stock market.

I take this as a technical event, much like the very short-lived “flash crash” of 2011 or the 1987 stock market crash, which happened in the middle of a secular bull market and proved to be a wonderful buying opportunity.

I made money from the crash in Europe and Greece last year. Crashes make stocks so cheap that they become true bargain plays – not simply because they are at low prices, but because they reach low valuations based on P/E’s and dividends and in the long run if you want to invest with a time horizon of a few years that is what matters the most in the end.

Once gold, silver, and the mining stocks bottom the miners will outperform the metals going forward. The reason why is because gold has held that 1550 support level up until Friday and has now completely crashed below it. Silver is in the same situation. Look at the charts.

The stocks though didn’t exactly do this. They have been falling for months and did not make huge gaps below support like the metals did. So once they bottom they will be in a position to rally strongly while gold will likely go sideways for at least six weeks and maybe a few months much like the S&P 500 did after the 1987 stock market crash and did after the “flash crash” of 2011.

In sum, once the bottom comes I think gold will base in a range for a few months while the gold stocks bottom and take off in more of a V bottom, probably after a few days of stabilization first. Gold stocks have been lagging the metal now for over two years. After this bottom they will lead the metal and take everyone by surprise.

Courtesy: Mike Swanson

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