Breathers vs. Game-Changers – How to Tell Them Apart?

Every market corrects from time to time, but sometimes those corrections are really the start of new, big moves. How to tell the difference?

As always, there are no certainties in any market, so the only thing that we can get is a greater chance of being right. And the odds for that increase as we get more context about a specific situation. The odds increase even more if the context that we get already caused similar reactions many times in the past.

Fortunately, we have this kind of reliable context in the case of the precious metals market and the current situation in it.

Here’s what the gold price did yesterday.

Breathers vs. Game-Changers – How to Tell Them Apart? - Image 1

It was up by $6.40. That wasn’t significant on its own and it didn’t even invalidate the sell signal from the Stochastic indicator.

And it’s not the move in gold by itself that’s important. What’s important is how gold stocks reacted to it.

They should have moved higher as well.

Breathers vs. Game-Changers – How to Tell Them Apart? - Image 2

But they didn’t. Instead, they moved lower yesterday. That was a daily decline by just 7 cents, but still, given gold’s upswing, miners should have rallied, so even a tiny rally here could be viewed as something bearish. The decline, however small, in this case, is a clear bearish indication.

This is something that we saw working many times in the past as a good indication that “down”, not “up”, was the true direction in which the precious metals market was heading.

And we’re seeing it all over again.

Breathers vs. Game-Changers – How to Tell Them Apart? - Image 3

The USD Index moved a bit lower yesterday, but it’s not really important given that it had already invalidated its move to new 2023 lows, thus flashing a powerful buy signal.

This means that neither yesterday’s move lower nor today’s pre-market move lower in the USD Index is likely to change the direction of the U.S. dollar’s big move – which remains up.

This, in turn, means that the main trend for the precious metals market remains down, not up. That’s what the relative gold-stock-gold performance is telling us, too.

Meanwhile, the S&P 500 was pretty much flat yesterday, so what I wrote about it remains up-to-date also today:

Breathers vs. Game-Changers – How to Tell Them Apart? - Image 4

The current weekly candlestick might appear more bullish than the early-2022 one, because its white and points to a rally. BUT let’s not forget that the week is not over. In fact, the above chart is based on only two sessions out of five. Consequently, quite a lot can change and at the moment, the similarity appears to be intact.

Before wrapping it up, let’s zoom out and take a look at what’s happening in the precious metals market from a very long-term point of view.

The below chart features the XAU Index to gold ratio. The XAU Index is a proxy for gold stocks and silver stocks (senior producers). Since many choose to invest in miners instead of owning physical metals, this ratio can be used as one of the proxies for the overall health of the precious metals market.

Breathers vs. Game-Changers – How to Tell Them Apart? - Image 5

Before 2008, the ratio was quite stable, and it was on the rise between the 2000 bottom and the early-2006 top.

It’s been declining since the time, despite medium-term rallies.

The declining black resistance line remains unbroken, and the trend remains down. And there were two major breakdowns below the previous medium-term lows.

The first breakdown happened in 2008. Then we saw corrective upswings in the following few years, and the decline resumed after 2011. So, while gold soared between 2008 and 2011, miners’ performance was relatively disappointing at the peak. Miners moved higher in a substantial manner, but they didn’t soar “todamoon” as many had expected them to. That spelt trouble ahead, even though very few were paying attention to this sign.

What happened next? Gold declined, and the pace of the slide picked up in 2013. The ratio, however, heralded that in a substantial advance.

It did so in a specific manner. At first, the ratio corrected from the 2008 bottom, and then it moved back and forth around the level of the previous (2000) low. And then it started a major decline. During this decline, there were consolidations, and I marked the first visible one with an orange ellipse.

Fast forward to the more recent past. After the early-2016 bottom, the ratio corrected quickly, and then it moved back and forth around the previous (2008) bottom. We saw the last of the tops that formed slightly above that level in early 2022.

What we see now appears to be a consolidation very similar to the one that we saw in late-2021 and early-2022. After it formed, the decline simply continued. And that’s exactly what we’re likely to see now.

The history rhymes, and the XAU to gold ratio currently shows us two major things:

  1. The “strength” of the precious metals sector that we saw in recent years is not necessarily true. It was visible almost only in gold, and that – based on how things developed historically – is not a predictor of sustained rallies but rather an indication of bigger declines.
  2. The correction / pause that we’ve been experiencing in recent weeks is probably close to being over, and the next big move is likely to be to the downside.

What does it all mean? In short, the counter-trend corrective upswing is likely over, and huge declines are likely just beginning. The huge profits that we recently reaped in the FCX recently are likely to be joined by massive profits from the current short positions.

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Przemyslaw K. Radomski, CFA
Founder, Editor-in-chief