Mining Stocks May Be Leading Gold (Even) Higher

Based on the November 11th, 2011 Premium Update. Visit our archives for more gold & silver analysis.

One of our favorite authors, Nassim Nicholas Taleb, a professor of risk engineering at New York University Polytechnic Institute and author of “The Black Swan: The Impact of the Highly Improbable,” wrote about this topic last week in The New York Times.

He states off the bat that he has a solution for the problem of bankers who take risks that threaten the general public. It’s very simple – eliminate bonuses.

“I believe that “less is more” — simple heuristics are necessary for complex problems. So instead of thousands of pages of regulation, we should enforce a basic principle: Bonuses and bailouts should never mix.”

He notes that more than three years since the global financial crisis started, financial institutions are still acting irresponsibly. The latest, MF Global, filed for bankruptcy protection last week after its chief executive, Jon S. Corzine, made risky investments in European bonds. Taleb says that it is only a matter of time before private risk-taking leads to another giant bailout like the ones the United States was forced to provide in 2008. He writes that it is time for a “fundamental reform”:

Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed, should not get a bonus, ever…

The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accumulate in the financial system and become a catalyst for disaster. This violates the fundamental rules of capitalism; Adam Smith himself was wary of the effect of limiting liability, a bedrock principle of the modern corporation.

Bonuses are particularly dangerous because they invite bankers to game the system by hiding the risks of rare and hard-to-predict but consequential blow-ups, which I have called “black swan” events. The meltdown in the United States subprime mortgage market, which set off the global financial crisis, is only the latest example of such disasters.

Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust.

It will take time for the plot of this play to reach the denouement. There will be plenty of twists and turns, but the star of the show – gold – should continue to shine and push mining stocks higher.

To take a look at gold and silver mining stocks’ performance for the upcoming short term, let’s start this week’s technical portion with the Euro Index (charts courtesy by http://stockcharts.com.)

In the very long-term XAU gold and silver miners’ index chart, we still do not see a move to the level of previous highs. However, the index is well above the lower border of the very long-term rising trend channel so the outlook is still bullish at this time. No other important signals are seen here this week.

In the long-term HUI Index chart, the short-term trend appears to be up similarly to the situation in silver and gold despite a move down on November 9^th. Gold stocks moved to the 580-level resistance line and bounced back subsequently which seems to have verified the recent breakout. An additional rally is quite likely from here on. The RSI level is far from overbought. At this time, the RSI appears to indicate room for an additional period of rally in the index.

In the short-term GDX ETF chart, the short-term trend continues to be bullish. Last Wednesday’s decline was stopped by the 38.2 Fibonacci retracement level based on the September to early October decline and the miners appear to have verified a move above this level.

Prices are above the rising trend channel and this is bullish for the short term. Strong volume was seen on last Wednesday’s decline but this is not a bearish sign here. In early and mid-October, as well as early November, high volume levels were seen as local bottoms were reached. The next moves were to the upside.

The situation now seems to be consistent with what we wrote on November 11^th in our essay on the bullish outlook for gold:

(…) the short-term trend for gold remains up and Wednesday’s price decline was truly quite small in relation to the size of the recent rally and the daily upswings of the past week. This is a sign of strength especially when considering that the dollar was moving higher as well. It appears that the outlook for gold continues to be bullish for the short and long term.

Summing up, the trend for mining stocks continues to be bullish as is the case for gold and silver. Last week’s declines appear to be insignificant in terms of the bigger picture.

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