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Gold Versus Paper

Turning paper into Gold June 4, 2011

1. BIG PICTURE OVERVIEW (Secular – years to decades)
We’re in a secular bear market for common stocks and real estate. This not only affects the U.S., but almost all developed/”first world” economies. Common equities as an overall asset class are for renting in this environment, not owning. When secular bear markets occur in a fiat world, money and credit are pumped into the system, using governments as more-than-willing borrowers when the private sector ain’t interested in more loans. The natural forces in the economy are deflationary, make no mistake about it. A global real estate crash after a bubble in most of the developed economies in the world creates global banking insolvency, and this is highly deflationary. However, we have governments that will step in and gladly spend other people’s money until the cows come home to arrest the deflation. Images of Helicopter Ben keep both deflationists and inflationists awake at night. Can those with a printing press overwhelm the remaining free market forces left in the world? We are unfortunately going to find out the hard way. Gold, as the monetary commodity par excellence, is in a secular bull market that is far from over. It likes chaos in the monetary world, whether inflationary or deflationary. Never forget that Gold dropped during the Great Fall Panic of 2008, but was already back to $1000/ounce by the time the S&P 500 fell to its infamous 666 abyss in March of 2009. In other words, Gold was basically net flat during the greatest deflationary crash of the last 40 years or so. This means the purchasing power of Gold increased dramatically during this time, as it will continue to do during this secular bear market in traditional asset classes. My best long-term recommendation is to buy Gold, although I don’t think the current price is a good buying opportunity. Subscribers will be notified when a good buying opportunity arrives in the Gold sector. Silver will tag along with Gold and may well outperform Gold over the entire cycle, but it will be a much more manic-depressive (i.e. volatile) ride. Gold stocks are like silver – wild and often unreliable, but with potential for big gains during certain periods. Other commodities should also do well relative to common stocks, but like silver will get hit much harder than Gold when recessions hit. Since physical Gold is easier to hoard, doesn’t spoil or hurt others when it’s hoarded, and does well with unstable forms of inflation or deflation (i.e. monetary chaos of any kind), it is the safest and most reliable investment over the long term right now. I believe

between 25% and 100% of one’s long-term savings or investment money should be in the form of physical Gold. Of this, 5-50% should be invested in physical silver. Now, these are wide ranges to be sure and anyone who chooses 100% physical Gold allocation doesn’t need this trading service. It depends on one’s risk tolerance and investment goals and everyone is different. Investing is like life: one shoe does not fit all. I personally hold more than 50% of my savings in physical metal, with a 90% Gold and a 10% silver weighting. However, when the action is good, I would rather trade in paper silver on both the long and short side. The Dow to Gold ratio will reach 2 before this secular cycle is over, and we could well go below 2. Holding Gold means you are becoming richer in common stock terms just by hoarding a shiny piece of metal. What could be easier? Now, I am not a doom-and-gloom or end-of-the-world type investor despite being neckdeep in the precious metals space. Life will go on despite a not-so-rosy economic outlook and money is only one part of life. There is nothing wrong with being prepared for any disaster, whether man-made or natural, but I am optimistic regarding the future of our economic world, not pessimistic. It is always darkest before the dawn, as they say, but dawn always arrives. 2. INTERMEDIATE TERM PICTURE (weeks to months) People bothering to read this probably already understand the longer term picture, and the intermediate term is where I feel I have something to offer for those crazy enough to try to trade through these uncertain times. As I recently commented upon in my blog rant “Bearish Whispers,” I didn’t like the way many stock markets around the world were acting and I still don’t. This Bearish Whispers blog entry is the kind of analysis that will be filling the pages of this newsletter. I am rarely a common equity bull with my trading money right now, as I tend to go long Gold, silver, or Gold stocks when I think things are bullish. However, it is important to understand what other markets are doing, as it can affect performance in the precious metals and commodities sectors. For example, if we are going into another recession (I think we are), silver will likely under perform Gold. Also, as traders, we have to be wary of big downdrafts in the stock market, which tend to take down most equities including Gold stocks. I think the equity correction could have further to go over the next few weeks. Independently, silver had its parabolic move terminated and that means consolidation is needed and to be expected. This is healthy and necessary for the silver bull market. Gold is likely also headed slightly lower but has held up better so far during this correction. I would not be adding to existing bullish Gold or silver positions right now and would avoid adding to bullish Gold stock positions right now, individual opportunities aside (I don’t trade individual Gold stocks, only the Gold stock indices/ETFs).

The U.S. Dollar is likely about to bounce higher, which will drag equities and precious metals lower as well. Friday’s action was telling, with the US Dollar down significantly but the stock market and precious metal sector performing poorly. This tells me that things could get ugly if the Dollar starts to strengthen on a short-term basis. 3. TRADE RECOMMENDATIONS I am short silver right now and think this is a trade with some miles left on it. Here’s the current silver chart (using the SLV ETF as a proxy, since I don’t play in the futures markets when I trade) with my thoughts:

And here’s a 2008 chart of the SLV ETF after the last parabolic-type move ended in silver:

Putting this all together, I will be getting out of my short silver trade once the SLV gets below 31.97, which was the previous low on May 12. That is a 9.5% move or at least 15% using the double bearish ZSL ETF when allowing for slippage in this instrument. I think this trade will pay-off in full within 2 weeks. Now, as I pointed out in my first chart above, I think silver hits 30 at some point. However, that could be months from now and

I am interested in a quick trade here using a double leveraged ETF, which is not suitable for longer term holding in this setting. If I can get 15% profits out of this trade over the next 1-2 weeks, that is plenty! Being overly greedy can be an expensive vice when trading. Here is a more detailed analysis of the trade I already entered using a 60 minute intraday chart:

Please keep in mind that I would not be buying ZSL at current levels even though I think it would be a winning trade. If SLV gets above 35.75, I would start buying ZSL. Because I am shorting a bull market, I will be conservative with this trade when it comes to taking profits. Once SLV gets below 31.97, I will start taking profits. I tend to enter and exit a trade in stages. This helps with minor timing mistakes - one can volume-average into the top and/or bottom of a trade. I usually allocate 1/3 to ½ of my planned buy order when I

think the best entry point is at hand. If I am wrong and a slightly better entry point comes along, I have more cash to deploy into the trade. If I was right in my timing, then I can still add to the position as it moves in my favor and/or after the first countertrend bounce against me. Notice also that I am using the underlying silver chart to guide my decisions, not the ZSL chart. Granted, it is the paper ETF SLV chart and not the true silver (i.e. futures) chart, but the point is that the double and triple-levered ETF charts get distorted over time and the price points of support and resistance are less reliable on such charts. For those subscribing to this service, I will give specific price points for buying and selling. Currently, my recommendation for potential subscribers is as follows:

BUY the ZSL ETF with a limit price of 17.60 (i.e. don’t buy unless ZSL
drops to 17.60 or lower). Either use a limit order when placing the trade or watch along and only buy if ZSL gets to 17.60 or lower. If the trade triggers/is entered, use a

stop loss with a price of 16.93, meaning the maximal loss on this trade would be
3.8%. Stop losses should be entered immediately into your broker’s order system after the initial buy order is completed/filled, to allow emotion to be taken out of the equation. More experienced traders can do what they already know how to do, which is manage risk.

Keeping losses small is key. They are bound to happen sometimes and it is best to get out early when a trade is not going as planned. If the ZSL trade triggers, and keep in mind that it may not, we will be looking to take profits once SLV makes a new lower below the 31.97 level. If you are a subscriber, I will send you an email alert as the time draws near in order to give you plenty of time to place the sell order. If the trade never triggers, that’s OK. There will be another trade soon. And another one after that. Patience will be rewarded. I also think Gold stocks, as a sector, will decline with silver. I actually have a small position in the double bearish DUST Gold miner ETF, also with a 1-2 week time horizon. Gold itself may lose the least of all, but it will also likely correct over the next 1-2 weeks. Here’s a recent 60 minute intraday chart with my thoughts on this, the chart showing a plot of both the GDX Gold stock mining ETF and the GLD Gold ETF over the past 1 month:

Now, keep in mind that I am a precious metals bull over the long term! This short term stuff is setting us up for a big bull trade later this month. I would much rather be long based on fundamentals, but fundamentals aren’t relevant in the short term. Anyone who talks about a 2 month swing trade and cites fundamentals (e.g., the Chinese are buying

hand over fist) doesn’t get it. In the short-term, fundamentals are IRRELEVANT. Heck, they’re usually even irrelevant in the medium term. I am thinking that the next low in Gold stocks will be the low for the year, whether a double bottom with the January, 2011 low or a slightly lower low than January. More on this (with charts) for subscribers in a future letter. The next bottom in the precious metals sector will be when I will be placing a big trade from the long side using the double bullish NUGT miner ETF and/or the double bullish UGL Gold ETF. This is something I look forward to, for sure. It is easier to be a bull on something than a bear, both in terms of the way the markets are set up and psychologically. Happy trading. Adam