Well Planned Portfolio Configurations Critical At This Point
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Friday, July 18th, 2008.
Just a few quick words this morning accompanied by a smattering of charts to keep you updated at where we are with the present correction in precious metals. In a nutshell, any further weakness in precious metals shares will increase the likelihood of one more Minor Degree wave lower being necessary before the larger correction is compete. As mentioned a week ago, the small speculators (see yellow bars) have been squeezed out of the crude oil market, which is bearish. And although the Gold / Crude Oil Ratio's turn higher should prove to be a big plus for gold at some point, the initial reaction by orthodox traders will be to think deflation, and sell gold in response.
Further to this, it should be understood a sustained turn higher in the Gold / Crude Oil Ratio will be a big plus for precious metals eventually irrespective of crude's absolute performance, where as demonstrated a few weeks back, historical peak values (see Figure 1) are in the 30 area, meaning even if oil corrects all the way back to $100, the metal of kings would still not top out until the $3,000 mark was attained. This is of course because gold (and silver) is not a commodity, but the ultimate currency / safe haven, where a deepening financial / confidence crisis will kick in as the main market driver at some point, removing pricing control from simple-headed traders / price managers who continue to minimize it's intrinsic value as a store of wealth.
Once more people's savings are wiped out in the stock market however, the lights for increasing numbers will come on, which will overpower those who chose to ignore gold's traditional role as a necessary part of everybody's portfolio for those rainy days. As mentioned above though, it appears first we must endure another Minor Degree correction lower, which means the Amex Gold Bugs Index (HUI) might be pushed under the 400 mark one more time. (See Figure 1)
In terms of things that must happen before precious metals shares can continue higher, Dave's observation regarding the weekly Bollinger Band analysis included below is quite enlightening, suggesting prices must either consolidate at current levels for several more months before they will be in a position to rise; or, a sharp correction lower must occur. Here it is reproduced for you, as follows:
"One thing that bothers me, as I have mentioned the past 4 months is the lower depth of the 55 week MA Bollinger band. It is at 295.8, up from last week's value of 291.6...I would expect that the lower 55 MA BB to be near 350-380 before triggering the next leg up."
So, irrespective of the fundamental backdrop, it appears one more wave lower that will constitute the final leg of the consolidation process that will satisfy this technical condition is in the cards, with a decisive break below the swing line in Figure 1 a likely signal this process is underway. Of course with the positive market internals related to the Philadelphia Gold And Silver Index (XAU) discussed the other day, any weakness here should be muted, and possibly reversed more quickly than appears likely at present.
Some of you will be asking, if we are facin g more weakness here, what effect will this have on my juniors? Answer: It appears that as long as the credit cycle and stock market are contracting, so will your juniors, where commodity pricing does not matter if project financing is not available. This is why it's imperative that you do not have too much in companies with no production right now, because until the prices of gold and silver are high enough for capital pools to feel comfortable about lending money for start-ups, non-producing juniors are being considered 'dead money'. Here is a picture of the SPX/TSX Venture (CDNX) Composite index that shows prices are right on support of a massive descending and contracting triangle that appears headed for a breakdown. And if that's not scary enough for you, please notice the measured move on a break is down to the 1300, which would involve a halving of prices from current levels. (See Figure 2)
Now I don't believe the prices of juniors will be halved from current levels, but perhaps that's the problem, perhaps I am naïve in this respect. Because realistically, until the credit becomes available for project financing again, which may not be for quite some time, as pointed out above, the market will continue to view non-producing venture / start-ups as dead money, where a weeding out process of the hundreds of new companies that came along over the past few years will be necessary before a more healthy sector can be expected to emerge. (See Figure 3)
Thus, as stated previously, it's imperative you weed out the non-producers from your portfolios such that they only make up a small percentage of your overall equity because the next six-months could be very nasty in this regard irrespective of what liquid shares are doing. That is to say, while liquid shares might bottom sooner than later once gold hurdles the $1,000 mark, if negative credit cycle conditions persist, along with commodity pricing being insufficient for producers to self-finance, venture companies can remain under pressure for longer than many will remain solvent.
As mentioned above however, at some point the positive fundamental backdrop for the metals themselves will shine through sufficiently to attract financing back to the sector because the profits will be there to justify the risk, and this is when the shares of those companies that remain will shine as well. And perhaps this balance will be reached when (if) we arrive at a double bottom in Figure 3, where again, once gold and silver commence their next advances, perspectives of financiers should change, as producers will quickly become cash rich. In terms of what to expect in commodity pricing as seen through the silver chart, it appears one more stab at the $16 area might be in the cards before it doubles. (See Figure 4)
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Good investing all.