Thursday, November 21, 2013

Dow Theory Special Issue: Assessing the primary bear market signal for gold and silver miners ETFs.

As I wrote yesterday, the Dow Theory has just signaled a primary bear market for SIL and GDX (the silver and gold miners ETFs).

Here you have a chart depicting recent price action. The red lines are the secondary reaction lows that once they got violated by both ETFs flashed a primary bear market signal.

Anatomy of a primary bear market signal
 As promised, I’d like to delve further into this primary bear market signal and its implications for investors. 

To begin with, let’s go back to January 26, 2013. On that date, when a vicious bear market was just getting started, I echoed FOFOA’s skepticism as to the gold and silver miners and paper gold by writing:

[r]enowned blogger FOFOA is of the opinion that gold will go up but to such a huge extent that it will become too precious. So valuable that the miners will face governmental confiscation (or something akin to this like a 95% tax on windfall profits). FOFOA doesn’t rule out gold going as high as $ 55,000 (in current value terms). However, such massive revaluation of physical gold will spell trouble for silver and for all kinds of gold and silver miners. If the FOFOA scenario plays out, then the primary bear market signal is the real thing.

So far FOFOA's view has been proven right.

The failure of the last primary bull market signal and the inability of paper gold to even get a short-lived primary bull market signal shows us strong selling pressure in the precious metals arena. In any instance, hope springs eternal and the permabulls like Sinclair are being proven repeatedly wrong.

As far as we are concerned, there was a primary bull market signal which has been reversed. I don’t fight the trend, and, thus, I’ll operate under the assumption that there is a primary bear market in gold and silver miners.

What I wrote on January 26, 2013 remains fully applicable to the new primary bear market signal:

“If Sinclair is right mining stocks should go up manifold ($ 3500 gold as he predicts, would imply mining stocks going up at least four fold from current prices). Should stocks prices go up four fold, then we shouldn’t worry about realizing some minor losses (or getting back aboard a bit late), since they pale by comparison to the huge rewards waiting for us. To some extent, I see the small realized loss or the likely small gain lost in the future by re-entering the trade later when a new primary bull signal is announced as the small risk premium to pay in case mining stocks take a big nosedive. If eventually Sinclair is right, the Dow Theory will give us ample opportunity to extract a good chunk of the future bullish trend. However, if something nasty is around the corner for such stocks, the best thing to do is to heed the primary bear market signal and get out.”

How much would have an investor lost with the failed signal?

A suicidal investor could have lost -24.48% (SIL) and/or -20.38 (GDX). This is the loss incurred from the entry point (August 14, 2013) to the exit point (November 20, 2013). You can gather more details from the spreadsheet below.

However, I used the word “suicidal”, because on August 15, 2013, I made two caveats, namely:

1)     The risk reward ratio was not the best one.

2)  Given the ample initial stoploss, a modest commitment was advised. In other words, I was in favor of trading very small.
Here you have the details:

“Thus, this particular primary bull market signal and its concomitant setup (primary bear market lows, secondary reaction, pullback, breakup) is not the best one in terms of reward risk ratio. We don’t know how much we stand to make, but we know how much we stand to lose if the market suddenly reverses without any intervening secondary reaction. Such initial ample stops of -45% for SIL and -29.16 for GDX warrant caution, which means that I would never make a commitment that could entail such a big loss. Personally, I’d never allow a loss greater than 10% of my total trading/investing equity. While this is very personal, this necessarily implies a commitment of modest proportions for GDX, and an even smaller one for SIL. Thus, if I had USD 100,000 cash to invest right now, I would merely invest roughly 34,000 in, i.e., GDX which implies a potential loss of ca. USD 10,000 if our Dow Theory stoploss is hit. For those favoring SIL, I would even make a smaller commitment of roughly 22,000. Of course, position sizing is an art and depends very much on the risk tolerance and the investor psychological make up. I am just giving my readers food for thought.”

Thus, I think I was clear enough as to how to trade the signal and my lack of enthusiasm for it.

Assuming that out of 100,000 cash one would have elected GDX, one would have invested USD 34,000. A 20.38% loss implies:

            34,000 x 0.2038= USD 6929.2, which amounts to 6.93% of the USD 100,000 available for investment, since a sizeable chunk would have remained in cash (not invested).

What would have happened to a position in SIL? I reasoned that an even smaller position (due to a poorer setup) was warranted. Thus, one could have invested USD 22,000 out of a USD 100,000 stack. A 24.48% loss implies:

            22,000 x 0.2448 =  USD 5385.6, which amounts to 5.38% of the USD 100,000 available for investment, since a sizable chunk would have remained in cash (not invested or available for other trades with tighter stops like those seen with the SPY).

Thus, my suggestion to trade very small given a setup that was not ideal, would have resulted in contained losses.

As legendary trader Paul Tudor Jones said: “Don’t play macho with the markets”. This failed primary bull market signal epitomizes Jones’ dictum. 

So far, and in spite, of this failed signal the Dow Theory has clearly outperformed buy and hold for GDX and SIL. Thus, as was explained here, monstrous losses were avoided by the primary bear market signal that preceded the now failed primary bull market signal. 


Bull market started
06/26/2013 10.59
Bull market signaled
08/14/2013 15.36
Last close
11/20/2013 11.6

Realized loss Tot advance since start bull mkt

-24.48% 9.54%


Bull market started
06/26/2013 22.22
Bull market signaled
08/14/2013 28.7
Last close
11/20/2013 22.85

Realized loss Tot advance since start bull mkt

-20.38% 2.84%


The Dow Theorist

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