Monday, 28 May 2012

Climbing the wall of worry

Gold and Silver Miner weakness has been with us for too long. On the "gold miner pulse" blog page, you find continuous (at least weekly) updates on how major precious metal miners are priced relative to gold. For that purpose the HUI/Gold ratio is used. By mid May, it bottomed below 0.25, a value not seen since the very October 2008 market bottom. In the previous posting, The Slump in Precious Metal Miners you read it in detail.

Soon afterwards, precious metals recovered as too audacious short selling was reverted and predictably miners rallied back. Last week has however been atypical. We have seen miners climbing the wall of worry, despite precious metals hesitating and dropping back near their mid-May lows intra-day. Miners upheld, once supported by a more favourable stock market sentiment, then again by precious metals holding steady as stock markets turned south again. For over a year, we had been used to see miners always choose the worst outcome possible:
  1. weakening as stock markets sold off, despite precious metals strength,
  2. leveraging precious metals weakness to the downside
  3. failing to catch up with precious metals during the 2011 rallies
It has worn out investor sentiment. Yet the nightmare seems to end...

Hedge fund strategies

Since quite some time - it used to be emphasized over a year ago - hedge funds had adopted a strategy of shorting the miners, while maintaining a long position in precious metals. Even though precious metals haven't exactly performed well lately, this strategy pays off while miners slid precipitously. With HUI/Gold at rock bottom level, this strategy becomes increasingly dangerous. Hedge funds need counting on stock markets deteriorating to generate the adverse sentiment strong enough to drive down PM miners even further.
It's a narrow base to build or maintain a strategy on. Last week, we first started noticing some covering of the immense short positions in precious metal miners. On days when precious metals weakened, the offer to sell miners increased likewise. But rather than selling off, demand volume soaked up mining stocks offered. Most majors upheld rather well. With a lot of hedge funds needing to revert their precious metal mining shorts, those served first will exit at a profit. The Johnny-comes-lately will bleed. Reverting this type of position also implies selling (most) of the precious metal long positions, which may explain to a certain extent why precious metals didn't really flourish last week.

It looks as if the miner recovery will have legs. We will see this baby grow, especially as further QE or LTRO (or whatever it will be called like) will prove necessary to keep the financial system afloat and to prevent us heading for an Autumn 2008 revisited, with stock markets imploding.


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