Are Gold & SP500 Topping Out Here?

Prices continue to churn as traders and investors try to figure if they want their hard earned dollar in cash or investments. The market is very jittery simply because no one wants to get caught on the wrong side of the market if it makes another 30-40% move, which is why we are seeing money rotate in and out each with very little commitment and follow through. Until a major trend looks to be in place most investors will not me holding many positions over night or through the weekend.

Here are a couple charts on what I think is most likely to happen in gold and the sp500.

GLD - Gold ETF Daily Chart

Last week we saw gold move higher by 1% but I cannot help but think a sharp sell off is only days away from being triggered. Either we get a another pop into resistance which would eventually trigger a wave of sellers and cause a sharp drop or the price of gold will drift lower to eventually break a key support level and trigger stop orders. Once the stops start to get triggered I would expect follow through selling for a couple days which will pull the price of GLD back down to the $113-116 area.

Also there is a possible head and shoulders pattern forming on this chart which is not picture perfect one but, it’s important to be aware as a neckline break could trigger massive selling and pull GLD down to the $100 area. But that would not unfold for several weeks if not months.

SPY - SP500 ETF

SP500 broke down from the support trendline two week ago and has since been trying to bounce. Last week we did see a two day pop but was given back Thursday. As you can see there is a possible mini head & shoulders pattern forming and the current price is testing the neckline. A breakdown below this should trigger a move to the $102 level.

Weekend Trading Conclusion:

In short, the market is trading at a key support level and this week should be exciting. Looking at several large cap stocks I am seeing bear flags on a large percentage of charts. Seeing these forming makes me think lower prices are just around the corner.

It looks like low risk trading setups are about to start popping up across the board and if we get a powerful trend going into the year end there will be some good money made for those on the proper side.

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Risk Comparison: Options Versus Equities - Part 1

While future articles will return to focusing on the option Greeks, a recent comment regarding risk really piqued my interest. The age old discussion about risk versus reward, equities versus options, and the fundamental difference between Nassim Taleb’s “Black Swan” risk and what most people perceive as ordinary risk.

In a perfect world, financial markets are by design a discounting mechanism of a cash flow stream, risk versus reward, and a psychological environment where the difference between profits and losses is merely perception. In the end, trading is all about the mastery of risk mitigation and leveraging probability.

I am an options trader, not because I do not like equities or futures, but because I fear the perception of their so-called safety. Most academics and the average investor believe that financial markets, specifically individual stocks follow a Gaussian, or log normal distribution. While various economists and statisticians have argued this point for decades, to understand that price distributions are in fact not strictly Gaussian.

Price distributions are capable of exhibiting more than the predicted occasions of price inhabiting the extreme regions of the distribution curve. Understanding these concepts is critical in order to have a robust understanding of risk. This type of phenomenon is called “fat tail” risk; statisticians refer to it as leptokurtosis. It is this degree of risk well beyond the normally distributed range to which Taleb has characterized as “Black Swan” risk.

In financial markets, having accepted that these fat tails do in fact exist and exist with a frequency far beyond what is intuitively apparent, risk becomes significantly harder to quantify. When risk becomes more difficult to quantify it can be said that investors and traders have significantly more exposure to a catastrophic event than they realize.

In basic terms, the financial world we live in today is wrought with fat tails. Government integration and manipulation of financial markets, the Federal Reserve’s (supposedly independent) direct engagement into the bond market, and specifically treasuries and mortgage backed securities creates an environment in those markets where distributions are not statistically normalized. Geopolitical risk such as the potential for an Israeli air strike against Iran places unconditional risk on a variety of risk assets, at the forefront light sweet crude oil.

If one considers all the various risks extant, risk today seems excruciatingly high. Professors on Minyanville have recently called into question whether paper assets like the Gold ETF GLD is accurately priced. It is widely believed that there is significantly less physical gold versus gold-backed paper. This adds yet another element of uncertainty to an increasingly uncertain environment.

What would happen to the gold ETF GLD if an analyst announced that the GLD ETF no longer had access to physical gold? What would happen to the valuation? How can they maintain adequate capital levels inside the ETF if gold demand rises while physical supply diminishes? The answer is contraction in the NAV price of the gold ETF. In real terms, the ETF owns less gold than the paper supposedly represents and price must come down to indicate this discrepancy. Make no mistake, the market will be happy to provide the swift and unforgiving necessity of adjusting to parity.

While the above offers basic examples of fat tails, the increased statistical variation has a name. The name of this type of condition where fat tails surround us and atypical logarithmic distribution takes place is called kurtosis. As a side note, since recent and forthcoming articles are going to focus on the Greeks, kurtosis comes from the Greek word meaning υρτός, kyrtos, or kurtos. (Just thought I’d throw that in there for a synergistic moment)

A scenario similar to the condition in which we find financial markets today could likely be summarized as a period of time where Leptokurtosis has become prevalent. Leptokurtosis is a statistical phenomenon where a population’s distribution, in our case equities, has a rather pronounced peak around the average. This peak is representative of a population that is rife with fat tails, higher variance, and a propensity for abnormally large swings in the standard deviation of returns.

What does all this mumbo jumbo mean? It means that when fat tails are present within a leptokurtic distribution, risk literally can become infinite. Fat tails and leptokurtosis are just a few of the many statistical economic studies that have caught the eye of many academics, specifically in the areas of advanced statistics, mathematics, and . . . economics. Distributions, kurtosis, and fat tails are the science behind behavioral finance. To most people this subject matter is boring, however it is only boring if you have never experienced the gut wrenching expression of these phenomena in the market; after that experience, the subject becomes transfixing.

The average investor believes that when they buy a stock the likelihood of it declining significantly in a short period of time is relatively minimal. We have been conditioned by Wall Street snake oil salesmen that due to inflationary pressure, over long periods of time equities must rise as a function of inflation. Everything is a buy in the long term, plus it makes for a great story to build a business model around that the retail crowd buys into. While this may be true in the long run, we live finite lives which do not have the luxury of allowing behavioral mean reversion over geological periods of time.

Right now risk is excruciatingly high. We have a variety of risks and uncertainties that are plaguing financial markets. The statistics behind the market today would likely exemplify the excessive risk built into the current system. So how exactly does this relate to options you might be wondering? I trade options instead of individual stocks to reduce risk. Options offer a variety of ways to hedge risk, even after a trade has been initiated. Options allow for manipulation where as with stocks and futures there is little one can do besides fully hedge a position.

The reason I utilize options instead of futures or equities for swing trades is because by definition they are insulated from outlying events such as an unexpected act of war or a natural disaster which could interrupt the flow of commerce for an extended period of time. Options are inherently less risky than stocks because of the leverage built into them. Since all moneys invested in the market are subject to Black Swan risk, the ability to control an equivalent position with dramatically less capital commitment is a core risk reduction strategy.

Yes, a trader can lose his/her entire investment if they own an option naked. Experienced option traders that buy and sell calls or puts naked and then hold them for extended periods of time is likely an anomaly. Experienced option traders will use some form of a spread to mitigate their risk further. Additionally, most online brokers offer option traders access to contingent stops which are based on the underlying asset’s intraday price.

Fat tails and leptokurtosis are the result of financial markets reacting violently to unexpected events, similar to what happened this week when the jobs number was much worse than expected or to the still unknown factors which precipitated the recent “flash crash”. Large price swings similar to what we have seen recently are usually attributed to higher volatility. Higher volatility for prolonged periods of time is just another symptom that points to fatter tails and leptokurtic distributions. Reliance on the Gaussian, log normal distributions likely have some of the “machines” on Wall Street in a situation where their models do not work.

Option traders leaning long into the close on Wednesday that utilized specific types of spreads had limited risk. They did not have to worry if the market gapped their stop. Their risk was limited from the moment they initiated the trade. In contrast, an equity trader that went long before the close on Wednesday could have exited if they had access to the premarket, however if they didn’t the gap down found them losing more than they originally set out to lose. The market gapped over their stop, leaving them vulnerable to further downside. The unquestioning reliance on stops to close positions in times of Black Swan events is flawed at its core because it denies the very existence of unknown and unknowable risk.

This is just one example of how equity traders who routinely hold positions overnight are exposing themselves to potentially unidentifiable levels of risk in today’s market. If we are in a period where leptokurtosis and subsequent fat tails in the distribution prevail nothing is impossible when risk is being calculated. By statistical definition, a period where a fat tail(s) exist indicates a period where risk is extremely high.

Log normal modeling software will significantly underestimate the true risk in financial markets. What trading software and price models are you using in your analysis? If you are using a gut feel or one type of stock chart to help guide your decisions about risk, you could potentially be mischaracterizing risk by as much as 5-7 standard deviations. 5-7 standard deviations is scary my friend, the kind of scary that days that have nicknames that start with “black” are made of.

Learn how to buy gold and make great money doing it! Gold mining stocks is the best investment in ANY economy!

Learning How Delta Creates Profits When Trading Gold

Last week’s articles focused specifically on the option Greek Theta. This week we will shift gears and adjust our focus on Delta, another fundamental tenet of option trading. The official definition of Delta as provided by Wikipedia is as follows:

Δ, Delta - Measures the rate of change of option value with respect to changes in the underlying asset’s price.

Delta has a significant impact on the price of an option contract(s). When a trader is long a call contract, Delta will always be positive. Likewise, if an option trader owns a put contract long, Delta will always be negative. As option contracts get closer to the money their Delta increases causing the option contract to rise in value rapidly as the option gets closer to being in the money.

Clearly Theta has an adverse impact on a trader who is long a single options position (own options long with no hedge or spread), however Delta is extremely dynamic and is one of the major factors directly responsible for option pricing as the price of the underlying changes throughout the trading day.

If an option is deep in the money, the option contract will have a higher Delta and will generally act similarly to actually owning the individual stock. For a deep in-the-money GLD call that has a Delta of +.80, the first dollar GLD rises by then the value of the GLD call options increases by roughly $0.80 or $80.

If the delta is 0.80, this essentially means that the GLD call option will increase in value 0.80 ($80) for every $1 that the GLD ETF increases. As the GLD option goes deeper into the money, the Delta will typically rise until it nearly produces the same gains as the GLD ETF until the delta asymptotically approaches 1.00 and the option moves in lockstep with the underlying. While my next article will continue to help explain Delta, it is important to understand how Delta can enhance a trader’s return when trading options with a specific directional bias.

While options exist for the gold futures contract, typically if I want to trade gold I utilize the GLD ETF. The primary reason is that the ETF offers liquid options, which makes it easier to initiate spreads and multi-legged orders. If options are thinly traded, the bid ask spread is almost always wide making it more difficult to get a good fill and a good overall price. Most option traders stay away from underlying stocks that have illiquid options.

In order to better illustrate how an options’ Delta can create profits, I will use GLD as an example. Keep in mind, I am not advising any traders to buy or sell options naked. I only trade options using strategies that help mitigate various risks to my capital. Theta (time) risk, volatility risk, and market risk are not being considered as this is merely an example to illustrate the power of Delta.

Recently Gold and subsequently GLD suffered a pretty significant pullback. GLD broke down through a major horizontal trend line and the daily chart was extremely bearish. Just when a lot of traders were preparing to get short GLD, buyers stepped in and pushed GLD’s price back above the support area. The GLD daily chart listed below illustrates the breakdown and subsequent failure and a powerful rally followed.

Let us assume for contrast that an option trader and an equity trader each want to get long GLD. The equity trader buys 200 shares of GLD at $115/share. Assuming the equity trader does not use margin, the total trade would cost around $23,000 not including commissions. The option trader decides to utilize delta and purchases 5 October 107 calls which in our example cost $900 per contract for a grand total of $4,500 not including commissions.

We will assume the October 107 calls have a Delta of 1.00. When a call option has a delta of 1.00, it essentially means that the owner of the call is going to get 100% of the move reflected in the premium of the option he/she owns. Thus if GLD increases by $1, the value of the option would increase $1 all things being held constant.

This is where Delta really shines; it shines even brighter than gold in this illustration. Both the equity trader and the option trader have a profit target of $118/share. A few days later GLD reaches $118/share and both traders close their trades with profits. The equity trader made $3/share which relates to a total gain of $600, or around 2.60%.

The option trader realized roughly 95% of the move, meaning around $2.85. The option trader had five total contracts for a total gain of $1,425 less commissions. The total gain for the options trader was over 31% less commissions.

Keep in mind, the option trader only had $4,500 of maximum risk while the equity trader was risking over $20,000. The option trader made over 100% more money, while risking only 25% of the total capital required by the equity trader. Behold, the power of Delta!

Learn how to buy gold and make great money doing it! Gold mining stocks is the best investment in ANY economy!

Meet the New Goldilocks

Back in the glory days of 2008, the mainstream press, political pundits, and various government officials talked about the idea of the Goldilocks economy. Not too hot, not too cold, but just right. Of course the analogy ended when the bears chased Goldilocks out of the cottage. While the same outlets aren’t trotting out the fairy tale this time around, it is clear that the US has hit phase two of the Goldilocks economy and it is my guess that most folks will like this one even less than the first.

And again, there are three major bears that are threatening to once again drive Goldilocks deep into the forest.

Bear #1 - A Jobless Economy

Month after month, the Bureau of Labor Statistics releases Employment Situation reports that continue to befuddle even the most casual of observers. They have become Newspeak in the truest sense of the word. Take last Friday’s report for example.

BLS reported that 54,000 jobs had been lost in August. The media immediately jumped on the fact that private sector payrolls were up by 67,000 and immediately blamed the entirety of the negative report on the fact that it was only bad because some census workers got laid off. Talk about having your cake and eating it too. Back in the spring when the census workers were being hired, it was the same press that counted those temporary jobs as if they were actually created by a recovering economy.

But it actually goes a lot deeper than just the 67,000 jobs gained in the private sector. Let’s analyze:

331,000 people became underemployed for economic reasons, meaning that they desired full time work, but were only able to find part time work. 331,000 full-time jobs lost. That takes out total up to 385,000. Left completely uncounted are those folks who lost one full time jobs and managed to find another, but at a much lower wage.

BLS’ CESBD Birth/Death adjustment assumed that 115,000 full-time jobs were created by new businesses in August. This ‘adjustment’ has been a source of great consternation by labor market analysts and real economists for some time now. In what turned out to be a vain attempt at getting a look at the methodology used to derive this number, I contacted BLS and had email communications with no less than a half dozen staff economists in its Continuing Employment Statistics group. Not a single one of them could or would give me any information on how this metric was arrived at other than to point me to the website. At this point, we are left to assume that the Birth/Death adjustment is probably more arbitrary than anything based in reality. So for argument’s sake, let’s back out half of those fictitious jobs. Our total is now at 442,500 full-time jobs lost.

Finally, in order to keep pace with demographics, the economy needs to create 150,000 full-time jobs each month just to break even. Creating that many will not result in a reduction in unemployment but is the working equivalent of treading water.

Taking all this into account, August saw a deficit of 592,500 full-time jobs. And this was carried as a ‘good’ report? Former Labor Secy. Robert Reich actually came out and declared the report in its totality to be ‘awful’.

Keep in mind that the mediocre (at best) and lately awful jobs reports are AFTER nearly a trillion dollars in direct stimulus and over another trillion in palliatives by the Fed in the form of purchasing mortgage-backed securities to stimulate the housing/construction sector. This reality alone should serve to underscore how dire the situation is. Unfortunately, this will likely be the status quo moving forward. Meet the new Goldilocks.

Bear #2 - An Unending Bear Market

It has been a cruel twist that the bear market which has been firmly in place since 2007 came precisely as the baby boomers began having serious thoughts about retirement. There have been countless stories of folks who retired in late 2007 or early 2008, either by choice or because they lost jobs and decided to retire, then had their portfolios halved over the next 18 months.

Sure the markets have recovered somewhat, but so many individual investors bailed out at Dow 8000 to 6500 and never got back in for the upswing. This market certainly has many folks perplexed. This is one of the reasons we have focused nearly exclusively on income producing investments, opting to lock in returns in the present rather than gambling on an uncertain future.

What many still have not realized is that the investing paradigm changed in a big way back in the year 2000. Stocks had seen an 18 year Supercycle of solid gains. One could quite literally pin the Sunday business section up on a wall, throw darts blindfolded and have a better than average chance of picking a winning portfolio. Precious metals languished for nearly two decades. That all changed in 2000 and as we entered a new century, we entered a new paradigm. Gold has surged fourfold and change and stocks have gone absolutely nowhere.

These Supercycles are generally 16, 18, or 20 years, so at a minimum, the current paradigm has another 6 years to go. Given all the distress in the economy from both a macro and fiscal perspective, it is entirely possible that we’re only halfway through this cycle. That means another 6-10 years of the stock market bear and another 6-10 years of strength in precious metals. At least in this case, there is a silver lining - pun intended.

Bear #3 - Leverage in All the Wrong Places

Perhaps the most ferocious of all the bears set to battle this new, unimproved Goldilocks is leverage or lack thereof. We have heard plenty about the leverage in the banking system and how it has been used to enhance bank and brokerage profits over the past few years. We’ve also talked plenty about how leverage has helped destroy the consumer, which is absolutely true. What is not being talked about, however, is the lack of leverage that we have as a nation in terms of righting the ship.

There have been many calls for the US to reassert itself as the premier manufacturing nation in the world. This would serve the dual purpose of diminishing our reliance on foreign goods as well as helping the unemployment situation by bringing jobs home. While I am a huge advocate of doing exactly this, there are several major problems that need to be dealt with along the way should we as a nation decide to pursue this path.

First and foremost is the fact that many American goods are not price competitive with their foreign counterparts simply because of the cost of labor. Placing tariffs on imported goods is an obvious solution proposed by many, but keep in mind the role that just the Chinese have played in keeping our economy afloat over the past decade in particular through vendor financing - the purchase of US debt.

Secondly, shifting manufacturing back to the US would require the rebuilding of the manufacturing infrastructure including the railroads and likely the power distribution grids in many areas as well. This is a huge capital investment and isn’t even on the radar of most policymakers. The mindset isn’t there at this time. For the most part we are content to convert old railways into biking paths instead of trying to figure out how to revive them.

A third area where the US lacks the leverage to reassert herself is in the area of energy. With peak oil on the immediate horizon, we are doing precious little other than burning a lot of corn to prepare for yet another paradigm shift. As long as we’re dependent on foreigners for one of the most important staples of economic growth, we will not be able to affect meaningful changes.

There are other areas as well, but I think the point has been made. A stagnant labor market, lack of individual wealth growth, and a lack of economic and tactical leverage to change key areas are conspiring to create this new Goldilocks economy which will plod along as long as trillions of new dollars are pumped in on a regular basis. Can anyone say unsustainable?

Next week we’ll finish up our analysis of proposed new gasoline taxes from a partial equilibrium perspective.

Learn how to buy gold and make great money doing it! Gold Mining Stocks is the best investment in ANY economy!

HUI Bull Seasonals 3

Precious-metals stocks really haven’t had a great summer by any means. After rallying initially in June, they started relentlessly drifting lower in July. The net result of this lackluster summer trading is a lethargic drift sideways. Naturally this listlessness has weighed on sentiment among this sector’s traders.

At the end of May just before the dawn of the financial-market summer, the flagship HUI gold-stock index closed at 454. Since then, it has generally been flat averaging just 458 on close. At best so far this summer, the HUI was up 8.8% in mid-June. At worst, it was down 4.7% in late July. For a sector accustomed to wild volatility and exciting action, 10 weeks of drifting can feel very discouraging.

But it shouldn’t be. Gold stocks almost always tend to drift sideways to lower in the PM summer doldrums. Such uninspiring behavior is par for the course this time of year. I wrote an essay explaining the research behind the PM summer doldrums that was published the very day the HUI peaked this summer (June 18th). At that time when traders were pretty excited about PM stocks’ prospects I concluded…

“The bottom line is summer isn’t a great time for precious metals. Led by gold, the entire PM complex tends to drift sideways to lower in the summer doldrums in June, July, and August. This listless price action is driven by the combination of no seasonal gold-demand surges and the general lack of investor interest that plagues all markets in the summer months. Sun, sand, and surf simply provide too much competition for traders’ attention this time of year.”

But today a couple months later, the financial-market summer is starting to wane. We’re on the verge of emerging out of the wilderness that was the summer of 2010. After forming a relentless headwind retarding gold stocks’ progress this summer, the major seasonal influences affecting this sector are shifting back towards a favorable tailwind. The HUI bull seasonals are looking up, a very bullish omen.

Yes, believe it or not seasonals do affect gold-stock price levels! This probably sounds counterintuitive initially. Investors and speculators can buy and sell gold stocks anytime regardless of the passing of the calendar year, so why does the time of year matter? The answer is quite logical. It matters because calendar seasons greatly affect gold investment demand, and the gold price is the primary driver of gold stocks’ ultimate profits. When it rallies, they rally. And when it falls, they follow.

Gold seasonals are extremely important for all PM-stock traders to understand. Read my latest essay discussing them in depth if you are not up to speed. In a nutshell, deeply-ingrained income-cycle and cultural incentives drive big gold demand spikes in the autumn, winter, and spring. But in the summer, there is nothing to drive above-average capital inflows into gold. Thus it tends to grind sideways to lower, and the gold stocks trail in sympathy.

These gold-driven seasonal trends are readily apparent in the HUI. Since markets behave quite differently in secular bulls and bears, I like to start my seasonal analysis when today’s secular gold-stock bull was born in 2000. To distill out the HUI bull seasonals, I individually index each calendar year’s HUI action from the first day of that year. This ensures percentage changes within each year are perfectly comparable across years despite the HUI trading at progressively higher levels as its bull marches on.

Finally I average together all these individual-year HUI indexes and chart the results. This process reveals the HUI bull seasonals rendered below, which are very valuable for traders to understand. Regardless of everything else going on in the markets, gold stocks tend to be consistently strong and weak at certain times of the calendar year. These tendencies can be used to help investors and speculators execute superior trades.

It’s been two-and-a-half years since I last updated this thread of research, with an epic discontinuity defining the period since. During that crazy once-in-a-century stock panic we weathered in late 2008, gold stocks were ripped to shreds in the belly of the beast. Between July and October 2008, the HUI plummeted a jaw-dropping 67.7%! And around half these losses accrued in this span’s final month alone! It was not a fun time to own PM stocks.

Then between its brutal October 2008 lows and the end of that year, the HUI rebounded 99.5% higher. This index has never witnessed anything remotely like that panic span, so I was really curious about how such wild swings would alter the HUI’s seasonals. Surprisingly though, the blue HUI seasonal line in this chart didn’t change too much at all. This shows the value in averaging over a decade’s worth of years. No one year, even one as crazy as 2008, wields an outsized influence.

On average since 2000, the HUI has rallied around 27.6% per year (from an indexed level of 100.0 to 127.6). These are stupendous gains over an ugly decade where the general stock markets have languished in a secular bear. As a matter of fact, on the day the HUI bottomed in November 2000 the flagship S&P 500 stock index closed at 1383. Today a decade later it is 21% lower while the HUI is 1151% higher! Gold stocks have been a spectacularly-lucrative investment since 2000!

In this secular bull the HUI has tended to trade in the well-defined seasonal uptrend channel shown in this chart. It hits its seasonal support four times a year, in mid-January, mid-March, late July, and late October. These are the best times of the year seasonally to add new gold-stock and silver-stock positions for investors and speculators alike. Your odds of “buying low” around these support approaches are far better than they are the rest of the year.

Out of these major seasonal lows, the HUI’s largest seasonal rallies of the year emerge. The first runs from mid-March to early June and has averaged 14.5% over the course of this gold-stock bull. As long as gold stocks aren’t radically overbought in March, we diligently play this strong spring gold-stock rally every year. Our subscribers have made lots of money over the years buying PM stocks with us around mid-March and then selling them in late May or early June.

After this first big seasonal rally, the PM stocks enter the dreaded summer doldrums. They tend to drift sideways to lower for much of the summer. The summers are, without any doubt, the weakest time of the year for the gold stocks seasonally. Every year in May I warn our subscribers about these dangerous PM summer doldrums. They not only result in real trading losses and even bigger opportunity costs, they can really devastate traders’ psychology and confidence.

The second big seasonal rally of the year erupts out of exceptionally-oversold HUI lows in late July. It tends to run 15.1% higher on average between late July and late September. Of course right now, in mid-August, we are early on in this HUI seasonal rally. This is very encouraging and ought to excite PM-stock traders bummed out from weathering the summer doldrums. PM stocks almost always rally big heading into autumn, and statistically this seasonal rally is probably already underway.

If you follow our research work at Zeal, you are probably scratching your head at this point. I imagine you thinking, “But Adam, you often write about a mid-August seasonal low. Doesn’t this late-July HUI seasonals data contradict this?” Yes, it certainly does. But this apparent contradiction highlights the supreme importance of broad and well-rounded research. Indicators must be considered in concert, not isolation, to optimize trade timing.

Remember that gold stocks (and silver as well) are ultimately driven by the fortunes of the gold price. If gold is weak, the entire gold complex has a tough time rallying. And gold seasonals bottom in mid-August. Of course silver seasonals dutifully follow gold, bottoming between mid-August and mid-September. And just last week, my business partner Scott Wright published some landmark research on junior seasonals. Junior gold stocks are hyper-sensitive to gold sentiment. And when do they bottom? You guessed it, mid-August!

So if you want to buy PM stocks in late July due to these HUI bull seasonals, your odds for success are high. And indeed this year, the HUI’s 432 low on July 27th may indeed prove to be summer 2010’s closing low. But I’ve seen plenty of really ugly HUI selloffs into mid-August, like 2007’s sharp 13.6% loss over 6 trading days ending August 16th. So personally, I feel more comfortable waiting for the probable mid-August gold lows before adding new long positions. Gold is gold stocks’ primary driver.

The HUI tends to see another seasonal pullback in October. Provocatively, the wicked-sharp plunge in October 2008’s stock panic stretched this seasonal tendency considerably. Prior to that anomaly, the HUI tended to bounce in the middle of its seasonal uptrend in mid-October, not near support as this latest seasonal chart shows. Since that panic was such an exceedingly-rare event, I certainly wouldn’t hold out for a seasonal support approach in Octobers in general. But an early-October pullback is still highly probable.

The third big seasonal rally launching out of October’s low actually lasts until late February of the following year. All together it accounts for a 17.6% average HUI rally over this past decade, which makes it the seasonally-strongest time of the year for gold stocks. So as long as gold’s fundamentals remain bullish, and neither gold nor the gold stocks have just rapidly spiked to very-overbought levels, it is prudent to be heavily long gold stocks in the winter. Throw in autumn and spring as well, for the other two big seasonal rallies.

So boiled down, these HUI seasonals are really pretty simple. Expect weakness in summer since there is nothing then to drive gold investment-demand spikes. If you are an investor, just gird yourself psychologically for this weakness and don’t get caught up in it or worry about it. If you are a speculator, you can sell long positions between late May and early June and then redeploy between late July and mid-August. And then stay long and deployed for the rest of the other three seasons.

This simple truth is so powerful and really highlights the value of expert market research for all traders. Every year without fail, I receive tons of e-mails from discouraged PM-stock investors and speculators in this late-summer timeframe. They are frustrated, discouraged, and have either given up on PM stocks or are considering capitulation. Yet if you study the markets, or spend a little time and money learning from those who do, there is nothing to fear in the summer. Don’t expect too much, and you won’t be let down.

This next chart takes an alternative view of HUI seasonals, this time dissected monthly. Every calendar month of this gold-stock bull is individually indexed, and then each month is averaged with the same months across all other calendar years. In addition, as in the first chart above, standard deviations are rendered in yellow. The smaller inset charts show the full range of these standard deviations.

Standard deviations, of course, are measures of dispersion. When you are running averages for market-analysis work, the tighter the underlying data the higher the probability your average is meaningful. The narrower the yellow bands (closer to the core blue average), the less dispersed the underlying data is. The sequences 4, 5, 6 and 0, 2, 13 both average 5, but obviously the tighter first one is more likely meaningful.

In calendar-month terms, November, May, and September are the best months for the HUI on average. We are talking gains of 9.2%, 7.7%, and 4.6% respectively. The worst months of the year for gold stocks on average are October and July. This is skewed by the panic October and November of 2008, however. While these two months were still weak and strong pre-panic, they weren’t as extreme as they look above.

The 2008 panic and its 2009 aftermath had a much more-pronounced impact on the smaller monthly seasonal datasets than it did on the annual ones. It flattened January, March, and August while extending October and November. If you want to see the panic changes with your own eyes, compare this chart to the last one I built before the panic with data current to February 2008.

These monthly seasonal tendencies reinforce the annual analysis. Summers, especially June and July, tend to be weak during the PM summer doldrums. August looks strong above in monthly terms, but realize most of these gains merely offset July’s big losses. The result is the flat late summer seen above on the annual chart. But once summer passes, gold stocks tend to rally on balance in most months except October. While they can drift lower other times, these non-summer pullbacks tend to be trivial.

So once again the core thesis of the HUI bull seasonals emerges. Write off summer, but make sure you are deployed in high-potential gold and silver stocks for the autumn, winter, and spring gold rallies. Thanks to summer’s dampening effect on sentiment among naive PM-stock traders, this time of year almost always sees nice bargains in PM stocks. August is the perfect time to stock up and prepare for the highly-probable large autumn gold rally.

Gold tends to rally sharply in autumn because of big Asian buying. After harvest, farmers can invest in gold once they know how big their profits are. And gold demand in India in particular, the world’s largest consumer, rockets higher during autumn’s festival season. If you have any Indian friends, ask them about Indian wedding season. It is fascinating and often drives big gold rallies which PM stocks leverage.

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The bottom line is precious-metals stocks have exhibited very definite seasonal tendencies over the course of their secular bull. This is largely the result of gold demand spikes driven by income-cycle and cultural factors that are tied to the calendar year. While PM-stock seasonals are often secondary drivers that can be temporarily overridden by short-term technical and sentimental extremes, prudent traders still pay close attention to these headwinds and tailwinds.

HUI bull seasonals show investors and speculators when they have the best odds of buying low and selling high. They reveal that summer tends to be a poor time of the year for PM stocks, but the rallies in autumn, winter, and spring far more than make up for these summer doldrums. They also show that our current mid-August timeframe is one of the best times of the year to add new long positions.

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