Gold and silver prices are at a significant cross-roads. At this point, the long-term outlook remains bullish, but continued short-term selling provides clues that the rally that happened in 2016 was a “false start” and gold and silver could be heading into a long-term range or a continued downtrend.
First, a little background. I own several gold and silver (and other precious metal) stocks that I started accumulating in late 2016 once gold and silver had pulled back significantly from their earlier rally. The rally in gold and silver was interesting, but on its own was not enough to spark my interest in buying either of these commodities. What was interesting was how much gold and silver stocks had sold off from the 2011 peak. While gold declined about 45% from its 2011 peak, and silver declined 72%, gold miner stocks had dropped on average 80%, silver miners 84%, and junior gold miners lost 90% of their value since 2011. Therefore, it was the combination of very depressed gold/silver stocks, plus the 2016 rally in gold and silver that led me to accumulate some position in the stocks (around November/December, on the major pullback). Therefore my analysis is based on being a gold/silver stock holder, and not necessarily trading the commodity itself (which I do swing trade when the right opportunity comes along).
Long-Term Outlook on Gold and Silver (and associated stocks)
I see two probable scenarios in gold/silver right now: an uptrend or a range.
Gold and silver both rallied aggressively in 2016, breaking out of the multi-year downtrend. That indicated that buying on a pullback was a good idea because if this is an uptrend the price structure unfolds in an upwave, pullback (where we are now), upwave, pullback, etc.. So the expectation is for another rally to the upside, taking the price above the 2016 highs.
Figure 1. Gold Continuous Futures, Weekly Chart
There are a couple issues though. The decline (following the rally) between July and December retraced more than 75% of the 2016 up-move. Typically we don’t see that deep of a retracement in gold following the first leg up in an uptrend. That opens up the possibility of a 1980s and 1990s scenario where the price rallies and then falls back toward recent lows, forming more of a big range than an uptrend (although, we can still have small uptrends–like the 2016-rally–within the range). Silver had a similar structure at that time. These ranges can last well over 10 years.
Gold falling back to $1050, near where the 2016 rally started, isn’t out of the question. BUT, over the last 100-years, any decline in gold of about 50% from a peak has been followed by aggressive bounces. Even in the 1980s and 90s when gold moved into a more ranging environment, it continued to have these very aggressive bounces. This provides a margin of safety in the gold and silver stocks, because even if gold and silver keep dropping there should be some good opportunities to get out of the gold/silver stocks on the bounces over the next few years.
Figure 2. Gold Since 1970 (Log Scale)
Right now I remain long-term bullish, with a price target of $1525 on gold over the next several years (grey box on figure 1). My target for silver is near $28 over the next several years. Therefore, I am not betting on a huge rally (relative to historic moves), but a rally like that would still provide 250% to 450%+ returns on my my gold/silver stock holdings based on my entry points (see Canadian Investor Stock Signals Newsletter). The upside on the stocks (depending on entry point) is built into a relatively conservative upside target on gold and silver, as gold and silver only need to retrace about half of their declines over the last several years to produce those stock returns (slightly more than half in gold, and slightly less than half in silver).
Even if the gold/silver targets are reached we still could be in a 1980/90s scenario and be moving within a big range. Historically gold and silver have spent a lot of time in big ranges (usually following major declines), followed by bull markets that last up to 10 years.
A decline below the December swing low in gold (about $1120, or $107 on GLD) would indicate we are in a 1980s and 90s type situation (or worse). If that happens we could very well be heading to $1050 or even $950. In the 1980s and 90s, after a big rally the price would fall and then stabilize about 10% below the prior low, so history indicates support should kick in around $950 or above. That is of course ONLY IF the gold price keeps declining in the short-term.
My bottom line view is that 50% (approx.) declines in gold have been rare, and have historically provided good buying opportunities. Right now we are still in a potential uptrend based on a major wave higher and now a significant pullback. Except for the 80s and 90s, a one-wave rally to the upside is very rare; typically we see at least two to three strong pushes to the upside once we get the first (with pullbacks in between).
Whether gold and silver continue to trend higher or form a 1980s-type range, both scenarios work out okay for me. If the range develops and the price continues dropping in the short-term, while I would expect a number of my stock holdings would be in the red (but not necessarily all because some of these stocks were so depressed in 2016 that they may not return to those levels even if gold/silver keep dropping a bit further) I have not maxed out my stock positions, so I could accumulate a bit more at decent prices to attain my full position size. Based on the most likely historical scenarios, over the next couple years the returns are likely to still be quite good…albeit a bit more drawn out than originally expected.
There is of course the scenario that gold and silver just keep tanking. It could happen. It is for this reason that measures are in place to control the risk within the portfolio, such as limiting position size on each trade and only making several trades within the sector (and they are spread out between gold, silver and other precious metal stocks). If the prices keep falling, I will look for a decent exit point on any rallies that may occur, and re-assess the situation.
Final Word on Gold and Silver (and associated stocks)
Gold and silver are still in potential uptrends over the longer-term, based the fact that they broke out of downtrends in 2016. Gold/silver stocks were also so depressed that even if gold and silver don’t rally like crazy, there is still a margin of safety because the stock prices were so low (but be prepared for some positions being in the red). If the uptrend doesn’t unfold, I believe a more ranging environment could develop over the next several years….this is even possible if the price reaches the targets on gold and silver. While this latter case extends the duration of trades, and potentially reduces the profit target on some of my trades, a good-sized profit is still likely attainable on gold/silver stocks holdings (depending on entry point…the closer to December 2016 levels, or lower, the better).
Plan ahead for all possible scenarios (up, down or sideways), not just the scenario you hope happens. The above scenarios are great and okay, respectively. Of course, gold/silver and the associated stocks could tank, and keep tanking. That is the risk of trading, and it is risk I am willing to take because the upside (with a conservative target) is many times greater than the risk (in an absolute worst case scenario).
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain
I don’t pretend to know what is going to happen. History is not a perfect indicator of what will happen in the future, but it at least provides some perspective on what to expect (and whether you can handle it). I just try to plan for all possible scenarios and only take trades if I believe my upside is great and my downside is small (relative to the profit) if favorable or unfavorable scenarios develop, respectively.
By Cory Mitchell, CMT – Trader, investor and author of the Canadian Investor Stock Signals Newsletter.