Gold and silver stocks tend to run in a pack

Technical analyst Brian Hoffman gives his advice on eight precious metals mining stocks and an exchange traded fund that tracks the share price movements of the big precious metals miners.

North American stock markets have continued to move higher. Although they're overbought from a technical perspective, the continued flight of overseas capital to the perceived safety of North American stocks, combined with seasonal strength, should minimize any pullbacks.

As a reminder, the capital flight to North America, particularly to the US, is a sign that investors are bracing for some challenges that could easily arise from a sovereign debt crisis, geopolitical manoeuvres and related shenanigans, or escalating social unrest throughout the world.

A sovereign debt crisis is likely to start with Japanese and European government debt before spilling into other parts of the world.

The US is perceived as safer and, as usual, investors will likely flock to US Treasury bonds. But given the US government's debt burden, its bonds could easily be part of a sovereign debt crisis.

For now, minor stock market pullbacks are considered healthy as they should support the continuing rise in stock prices. Eventually though, a large correction will turn into a bear market when enough uncertainty scares so-called investors out of their stocks.

A wall of worry or a cliff?

But the stock market always climbs a wall of worry. Actually, from a stock chart perspective, it walks up a hill that has many undulations, several ups and downs, along the way.

At some point, the market landscape will introduce a decline that investors will need to navigate. That dip on the horizon may be a small valley, but it could also be a cliff.

As a result, investors need to equip their portfolios with a parachute of some sort to soften the impact of any large corrections.

That involves diversifying into different stock market sectors and holding some fixed-income investments, chosen with the impact of rising interest rates and a potential sovereign debt crisis in mind.

Investors also need to watch the support levels on their stock positions very carefully and keep a shorter duration on fixed-income investments while minimizing government debt exposure. Investors should also consider some exposure to the precious metals sector. I offer some specific options in my update later in this article.

Technical indicators flashing warnings

Moving on to some technical analysis updates, Canadian stocks, as measured by the S&P/TSX Composite Index, have moved up about 10 per cent since August, when they were oversold.

In January, despite moving slightly higher, the S&P/TSX Composite Index was overbought and some key technical indicators were flashing warnings of an imminent pullback.

Unless the S&P/TSX Composite Index breaches support at about 15,000, a pullback would be considered healthy and provide the catalyst for a move higher.

US stocks on fire but decline inevitable

Meanwhile, US stocks are on fire-in a good way! A week when the S&P 500 Index doesn't set a new record high is considered a bad week.

Although US stocks are extremely overbought-even more that Canadian stocks-don't expect them to lose steam. Not yet anyway. That's because of the capital flight mentioned earlier.

US stocks are due for an imminent pullback, but it likely won't be as extensive as the pullback that Canadian stocks will endure. Perhaps the S&P 500 Index will experience a cute little three or four per cent pullback before resuming its climb.

US stocks will eventually experience a large decline. As the saying goes, the bigger they are, the harder they fall. When the S&P 500 Index does undergo a significant correction-perhaps sooner than later-you can expect it to turn ugly in a big way. Something like a 30 per cent drop-at minimum.

Relative to about the 2,800 level towards the end of January, a breach of 2,400 for the S&P 500 Index would be bearish.

Gold and silver in a spring-loaded trading range

Precious metals update: After completing a seasonal pullback into mid-December-almost on cue-the precious metals sector managed an impressive rally.

That's how it has been with the sector for more than a year. In fact, the cycle has lasted for the past two years. As soon as gold and silver bullion, as well as their mining stocks, are oversold, they turn on a dime and within a couple of months or so, they're overbought again and ripe for a pullback.

At some point, that tight, spring-loaded trading range will uncoil and a massive pullback or significant upward surge will emerge. In late January, at the time of writing this article, the precious metals sector appeared overbought and due for a correction.

In January, gold and silver bullion prices ran into resistance at about US$1,360 and US$17.80 an ounce, respectively. Give-or-take one or two per cent, they were treading water near those levels in late January.

Meaningful moves for gold and silver bullion prices above US$1,400 and US$18 an ounce, respectively, would further their bullish outlook. Not just moves above those levels, but moves well enough over those levels, where pullbacks would hold support at their prior resistance levels.

However, to the downside, tests of support at US$1,200 an ounce for gold and US$15.50 an ounce for silver are still possible. In fact, gold and silver prices are still stuck in significant downward trends since hitting high water marks in 2011.

In terms of gold bullion prices, a downward trend channel is marked with an upper resistance level drawn along the 2011 and 2017 highs, and a lower support level drawn along the 2013 and 2016 lows.

Currently, gold prices are attempting to break through the upper resistance level of the downward trend channel. As mentioned, to successfully break out, gold prices will likely need to make a meaningful move through US$1,400 an ounce and then hold the current US$1,360 resistance level on a pullback.

However, a significant drop in bullion prices could unfold if gold breaks support at US$1,200 an ounce. In that scenario, tests of lower support levels would then become a possibility.

The bearish case for precious metals, at least in the short term, rests in the share prices of the mining companies. That's because they generally lead the prices of gold and silver bullion.

On the other hand, since the massive run-up in the first half of 2016, the share prices of the miners have not kept pace with the rallies in gold and silver bullion prices, let alone surpass them.

In fact, despite gold prices almost returning to their 2016 high, the unit value of the iShares S&P/TSX Global Gold Index ETF (TSX-XGD), which tracks the share price movements of the big precious metals miners, is down about 25 per cent from its 2016 high.

Gold stocks likely to run in a pack

I'll conclude this article with some technical updates on the precious metals mining stocks that I've been profiling in my recent articles.

Although all of these companies are well-financed, managing production costs, and their share prices trade at reasonable valuations relative to their profitability, they will generally follow the fortunes of bullion prices and the broader precious metals sector.

The share price of Alamos Gold Inc. (TSX-AGI; NYSE-AGI), a Canadian gold producer operating in northern Ontario and Mexico, has continued to retreat and recently breached support at $8 a share, which is bearish. On a further pullback, the share price could test its $7 support level.

Next, shares of Kirkland Lake Gold Ltd. (TSX-KL; NYSE-KL), a gold producer operating in northeastern Ontario and Australia, have kept rising in value. As a result, the support level to now watch has moved up $3 a share to $18.

In my previous update, I had warned that a breach of $11 a share for gold producer SSR Mining Inc. (TSX-SSRM; NASDAQ-SSRM) could result in a significantly lower share price.

That support level breach has occurred. SSR Mining's share price bottomed at about $9.75 in December before staging a nice rally. Currently, the share price is flirting with another breach of $11, which is likely.

At this point, investors interested in taking positions in SSR Mining are probably best off waiting for the share price to stabilize after another pullback.

Meanwhile, Mexico-focused producer Argonaut Gold Inc. (TSX-AR) saw its share price stage a significant rally that started in mid-December. After reaching about $2.85, the share price is retreating and could find support at either $2.50 or $2.25.

Gold royalty streamer Sandstorm Gold Ltd. (TSX-SSL; NYSEAMERICAN-SAND) also saw its share price stage a big rally since mid-December, which may find support at $6.40. Should the price breach that level, then shares may find support at $6 each on a further pullback.

After finding support at $2 a share in December, Alacer Gold Corp.'s (TSX-ASR) share price rallied to $2.40 and may find support at $2.25 on a pullback, at least initially. Beyond that support level, a breach of $2 would be quite bearish.

Next, shares of North American gold and silver producer Premier Gold Mines Ltd. (TSX-PG), ran into resistance at just below $4 in December before pulling back. They could find support at about $3.25 once again, but a breach of that support level would also be bearish.

Finally, the share price of low-cost producer Silvercorp Metals Inc. (TSX-SVM; NYSEAMERICAN-SVM) held support at around the $2.75 mark in December before staging an impressive rally to $3.75. Since then, Silvercorp's price has retreated and another move below $3 a share is possible on a further pullback.

Brian Hoffman, CPA, CA, is a member of the Canadian Society of Technical Analysts. Based in Toronto, he can be reached at bk.hoffman@rogers.com.

This is an edited version of an article that was originally published for subscribers in the February 23, 2018, issue of Investor's Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor's Digest of Canada.

Investor's Digest of Canada, MPL Communications Inc.133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846