This piece originally appeared on Real Money Pro.
Gold and silver bulls need to lower their expectations and stand aside, because these futures contracts are setting up for lower prices in the first quarter of 2012. But those declines should eventually come to an end and offer excellent buying opportunities ahead of renewed uptrends that might last another three to five years.
Gold downside in the next few months should be manageable for positions opened in the past two years, with the yellow metal unlikely to break support between $1,400 and $1,500. However, silver remains stuck in broken-bubble mode following a parabolic thrust to $50 earlier this year; it could easily fall another 35% to 40% before turning higher and resuming its uptrend.
Precious-metals mining stocks have underperformed their physical and futures counterparts since 2010 and should continue to do so in 2012. As a result, I would avoid the group entirely when the buying opportunity finally comes, sticking with direct exposure (outright or through fund proxies) and saving equity capital for other stocks and sectors.
Gold hit the psychological $1,000 level (blue line) for the first time in March 2008, reversing gears immediately and selling off through $700. It returned to resistance in 2009, completing a picture-perfect cup-and-handle pattern followed by a powerful breakout in October of that year. The contract then entered a channel-bound uptrend that went parabolic in July of this year.
The vertical buying spike above $1,900 marked the rally's end, yielding a sharp reversal down to the 50-week exponential moving average followed by a choppy bounce that stalled in early November. Note how last month's turnaround took place right at the channel top that was broken to the upside during the final buying wave of the long uptrend.
This upper channel line was tested on Aug. 26, just after the first buying impulse above $1,900. The support level held, yielding a secondary thrust that also failed, carving out a small double-top pattern on the daily chart. The breakdown through the trend line on Sept. 26, followed by a failed bounce, now exposes the downtrend to a decline that tests channel support near $1,560.
Price action looks like an A-B-C correction, with the contract headed into a selloff that's proportional to the September decline. That would yield a downside target near $1,420. I also expect the channel bottom to break, shake out retail stops and retrace 100% of the final parabolic wave. Interested buyers can open positions once the blue line gets hit, or wait until the channel line is reclaimed with a buying thrust back above $1,600.
Owning silver into the first quarter of 2012 will be a risky proposition because it's working off a parabolic rally that started way down at $18 in June 2010. The buying frenzy up to $50 shows two subwaves, with interim support around $26. The bubble finally burst right at the top of the 1980 Hunt Brothers parabola, so it took more than 30 years for the contract to test that high.
The first selling wave after the April top carried into the 38% retracement of the 2008-into-2011 rally, with the second selling wave dropping price into the 50% retracement level. That zone also marks support at the 100% retracement of the January-into-April subwave. Put another way: Most folks who are holding silver with a 2011 purchase date are now losing money
The daily chart show a more ferocious selling pattern than gold, with two vertical declines interspersed with two choppy recovery waves. This is a typical setup for a five-wave flag pattern that won't hit bottom until the contract completes a third selling wave that's proportional with the May and September declines.
If time is proportional with price, that selling climax will occur about four months following the last decline, or sometime in the first quarter, and carry into the lower flag trend line near $20. That downtrend would bring price into the realm of strong 2010 support above $19, as well as the 62% retracement of the 2008-to-2011 rally -- an excellent spot to open new silver positions.