The junior bag holder nightmare is a contrarians dream

What a difference a year makes! At this time last year, the gold price was comfortably trading at all-time highs above $2000 per ounce, and even serial gold detractor Warren Buffet had taken a position in the barbarous relic. But once the news of the world's most famous eternal gold bear taking a position in a major gold miner had been priced into the market, there were no more buyers.  

After the safe-haven metal had doubled in price to nearly $2100 per ounce last August, from its low of $1050 in late 2015, a much-needed correction has been taking place for the past year. In March, Gold Futures printed a double bottom at $1675 on its daily chart, which is the 38.2% Fibonacci retracement level of the four-year doubling of the gold price and marked a 20% correction from the high at $2089.

However, since the return of the Gold Summer Doldrums in June, after a two-year hiatus, the glaring relative weakness of gold stocks in relation to the price of bullion has been signaling the metal still had some downside remaining during the year-long consolidation of its out-sized gains.

When U.S. Non-Farm Payrolls (NFP) data released last Friday showed accelerating employment and wage growth in July, along with upward revisions to June's data, this news brought the start date of the unwinding of support programs from the Federal Reserve closer to fruition. Once the better-than-expected NFP was released, gold quickly fell over $40 to close the week just above support at $1760.

Robust employment and wage growth are removing the last formal obstacles before the Fed starts cutting back on its asset purchase program. Expectations have increased that these first cuts in QE could come as soon as September, and may even be telegraphed by the Fed at the annual Jackson Hole conference of central bankers on August 26-28.

In my weekly update to Junior Miner Junky subscribers last Friday, I wrote the following, "After Friday's selloff, the gold price is in a danger zone right now. But with the minersbouncing into the close on Friday, we should see some buying come in ifstrong support at$1,750 is tested next week. However, if that level breaks, the $1675 level may quickly come into play."

I also issued a similar warning regarding the silver price, stating that, "Meanwhile, silver has lost strong weekly support at $25, which was also the metal's uptrend line support level during itsmulti-monthascending triangle pattern. With the price breakingdown below the hammer from the previous week, a move below $24 in silver could bring strong support at $22 into play very quickly."

Although these levels were indeed tested earlier this week, the manner in which the moves lower in both gold and silver took place was surprising to say the least. Once the aforementioned strong support lines were breached near the open in Asian trading on Sunday evening,a liquidity black hole, exacerbated by a Japan and Singapore holiday, saw gold plummet over $87 to test critical support just above $1675 during a stop-loss and algorithmic selloff.

The trigger was a breach of long-term support at $1750 in gold after Comex futures margin servers were turned on at 7am Tokyo time. The silver price was also hit hard, moving down to nearly visit multi-month support at $22.

Technically, the critical measured inflection of the gold price at $1,675 is shown in a complex descending triangle chart created by FXStreet here. It is clear that gold prices reversed sharply from the inflection point, while this strong level also serves as the support for a complex descending triangle.

On the downside, a break of the now triple bottom critical support at $1,675 could trigger another algorithmic sell-stop move down to $1550-$1575 region, which is the 50% Fibonacci retracement area after the doubling of the gold price from $1050.

On the upside, a weekly close above $1760 might be the first sign of a bottom, as this level of support indicates a significant inflection point. Further out, if the $1900 level breaks decisively, then gold prices may go much higher.

Meanwhile, the GDXJ has been pricing in lower gold prices by selling down towards long-term support at $41, a level that was strong resistance previously when gold was attempting to break above $1550 in 2019. But if the $1675 level is broken soon, we could see a capitulation ending to this correction down to the $35 level in GDXJ, which would most likely clean out the last of the stale longs.

With strength in the junior miner ETF being sold more quickly since June, junior precious metal stock speculators have been using news releases as liquidity events to capitulate losing positions.

As the stock market continues to make all-time highs, gold stocks are already being sold for tax-loss as nervousness regarding the expectation of future tightening of monetary policy increases. Many gold stock bag-holders who chased juniors that made 5x to 10x moves higher, in the space of less than 5 months into August of 2020, began to capitulate positions in June after gold failed at $1900 for the fourth time during this correction.

Although the year-long selloff in the gold complex has been a frustrating affair for participants, capitulation selloffs are what cashed-up, seasoned junior resource stock speculators dream of, as one investor's tax-loss trash, becomes another long-term investor's treasure. With many of the quality junior babies being thrown out with the life-style junior bathwater, opportunity is knocking on the cashed-up, contrarians' door.

Typically, the mindset of the seasoned junior resource stock speculator holding a quality junior with a mis-timed entry point, is to sell for tax-loss then buy the stock back after 30 days. Once a position is sold for a loss, the U.S. and Canadian Wash-Sale rule states an investor must refrain from buying back a position for 30 days to claim a tax-loss on capital gains.

Although tax-loss selling season generally takes place during the tail end of the year, with the tiny gold sector being an under-performing boat in a sea of out-performing ships in 2021, junior gold stocks have become hated to the point of early tax-loss fueled capitulation.

Since the 2020 Covid-19 crisis began in Q1/2020, the Federal Reserve has been pumpingliquidityinto the financial system at an alarming rate by adopting Modern Monetary Theories (MMT), however, there has been little growth in GDP as a result.

In October 2020, U.S. debt had already zoomed past 100% of GDP for the first time since World War II. We have a debt crisis that cannot be paid and the accumulative interest expenditures have risen to reach at times even 70% of the national debt.

Furthermore, the U.S. government on Wednesday posted a July budget deficit of $302 billion, a record for that month, as COVID-19 relief spending stayed elevated while receipts returned to a more normal pace after a delayed July tax deadline last year. A Treasury official declined to comment when asked whether the July budget results would alter the department's forecasts on when the federal government would exhaust extraordinary measures to continue borrowing under the statutory debt limit of $28.4 trillion.

The next round of spending involves U.S. President Biden's $1 trillion infrastructure bill,just passed by the Senatebut not yet approved by the House, along with a $3.5 trillion anti-poverty and climate plan Senate Democrats hope to get passed this fall.No matter how much the Fed jawbones about the recent surge of inflation being "transitory”, we are now at peak liquidity and continued rising inflation is the likely outcome.

By David Erfle

Contributing to kitco.com

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