Breakout

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Gold Hits 2012 Low as Gold Miners Show Signs of Reversal

Breakout

For those unfamiliar with the colorful lexicon of Wall Street, the term "never catch a falling knife" refers to the danger of buying stocks or commodities that are falling sharply in value. Also referred to as trying to call a bottom, attempts to take a position at the precise turning point of an asset's price trend tends to end very poorly.

Which brings us to Michael Purves, chief global strategist at Weeden & Co., and his suggestion to consider taking bullish positions in not only gold, but the disastrous-looking gold miners (GDX).

Purves' defense of the precious metal itself starts with the idea that gold has been in an uptrend for a decade. While true gold has fallen nearly 12% from April highs and has underperformed stocks dramatically for the last 6 months. These are mere hiccups for long-term holders but hardly an argument for new buyers today.

"The last time (gold) broke the 200-day moving average," says Purvess referring to another technical measure recently breached, "was back during the Lehman Brothers crisis in 2008, 2009."

Buyers at the time saw a 6-month consolidation leading to a double over the ensuing four years. Purves says today is "eerily similar."

As for the miners, Purves concedes the "path of least resistance is down in the senior or junior miners." As measured by the Market Vector Trusts (GDX) and (GDXJ) the frictionless path lower has led to declines of 23% and 44% respectively over the last year. If you're looking for a visual depiction of the aforementioned "falling knives" look no further.

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The buy argument is based on a study Purvess has done of the relationship between the value of gold and the share price of miners over the last 20 years. By that measure the mining related stocks have become radically, historically, undervalued relative to gold. In prior years that's been a set-up for enormous rallies in the mining stocks.

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Purves is making less a case for buying the miners here than for positioning oneself carefully on both the long and short side. For the shorts, the he cautions that they may be subject to a "violent whiplash."

Those thinking of playing miners "tactically from the long side" Purves would consider call options out in the 2 - 3 month range.

For those inclined to avoid the risk of getting speared, sitting on the couch and watching the drama unfold may be the best positioning of all.

Are you buying gold on the pullback? And what about the miners? Let us know in the comment section below or visit us on Facebook.

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