Despite the insistence of some, precious metals have not been in a bull market. After a big pop at the start of 2016, the sector has trended lower. Sure, Gold has traded up towards a major breakout but Silver and the gold stocks have trended lower. When the US Dollar corrected significantly, the stock market outperformed precious metals. Does that sound like a Gold bull market to you? The moribund performance has left us wondering what could turn the tide. A quick study of Fed history with the context of current conditions is very instructive as to when Gold could begin a true bull market.
Fundamentally speaking, we know that Gold performs best when real rates are declining or will soon begin declining. That usually entails either accelerating inflation (surpassing the increase in nominal rates) or falling rates amid stable inflation. At this juncture we are leaning towards the latter as the eventual catalyst for Gold.
We were curious how Fed policy and policy changes impacted precious metals so we decided to plot the Fed Funds rate (above) along with gold stocks (middle) and Gold (bottom). We used the gold stocks (Barron’s Gold Mining Index) because they have a longer history than Gold. The vertical lines in blue mark lows in the BGMI that coincided with peaks in the Fed Funds rate (FFR) while the vertical lines in red mark lows in the BGMI that coincided with a bottom in the FFR.
Outside of the highly inflationary 1970s, the best bull markets in gold stocks began around the time the Fed Funds rate peaked (or in other words when the Fed ended its rate hikes). Lows in 1993, 1999 and 2016 coincided with the start of a new hiking cycle. However, unlike the lows in 1972 and 1976, inflation did not accelerate enough to drive more than a rebound.
Does that signal that gold stocks (and precious metals at large) need an end to the rate hikes?
The period from 1999 to 2001 is very instructive as there are several similarities between 1999-2000 and 2016-2017.
Like 1999, 2016 followed a nasty bear market in Gold and hard assets.
Also, the 1999 bottom in precious metals and commodities occurred around the time the Fed began a new cycle of rate hikes. Sound familiar to 2016?
As the Fed continued to hike into 2000, Gold and gold stocks trailed off but commodities were able to make higher highs until the very end of 2000. Commodities have not been quite as strong this time but they have outperformed precious metals which have trailed off since the initial rebound.
Gold and gold stocks ultimately bottomed and began spectacular rebounds around the time the Fed moved from a pause in rate hikes to rate cuts at the very start of 2001.
Unless there is an acceleration in inflation, the turning point for precious metals figures to be around the time the Fed ends its rate hikes. That would likely coincide with Gold regaining outperformance against the stock market, which we have noted as Gold’s missing link (from an intermarket perspective). Weakness in the economy and stock market would lead to an end to the rate hikes and then rate cuts. That would be the time Gold and gold stocks begin a major move higher. In the meantime we continue to focus on and accumulate the juniors that have 300% to 500% return potential. To follow our guidance and learn our favorite juniors for the balance of 2018, consider learning more about our service.
Gold was enjoying a solid spring rally until a couple weeks ago, nearing major upside breakouts. But its nice advance has crumbled since, really weighing on sentiment. Gold fell victim to a rare major short squeeze in US Dollar Index futures. The surging USDX motivated gold-futures speculators to flee rather aggressively. But this will likely prove a short-lived anomaly, after which gold’s assault on highs will recommence.
Gold’s seasonally-atypical weakness over the past couple weeks is very important for speculators and investors to understand. It had nothing at all to do with fundamentals, but was completely driven by the hyper-leveraged gold-futures traders. These guys have long been fixated on the US dollar’s fortunes, looking to its benchmark US Dollar Index for trading cues. That can slave gold’s price to the dollar at times.
Six weeks ago, gold slumped to a major seasonal low of $1310 the day before the universally-expected 6th Fed rate hike of this cycle. The gold-futures traders fervently believe Fed rate hikes are very bearish for gold, so they usually sell leading into FOMC meetings with potential hikes. This has happened before every Fed rate hike of this cycle. The theory is higher US rates boost foreign investment demand for US dollars.
The ironic thing is modern history proves the opposite! Fed-rate-hike cycles are bearish for the US dollar and bullish for gold. The last cycle ran from June 2004 to June 2006, where the Fed hiked 17 times in a row for 425 basis points. Despite those aggressive and relentless rate hikes, the USDX still slipped 3.8% lower over that exact span while gold rocketed 49.6% higher! Clearly futures specs’ theory is sorely lacking.
The Fed’s current rate-hike cycle out of extreme zero-interest-rate-policy lows got launched in December 2015. Gold was hammered to a 6.1-year secular low leading into it, as futures specs were absolutely certain higher rates were bearish for gold and bullish for the USDX. Yet again they were proven dead wrong, wrong, wrong! As of the middle of this week, gold is up 23.0% since then while the USDX fell 5.5%.
You’d think after some market thesis fails to work over and over again for decades, traders would try something else. But not futures speculators, they are a stubborn lot. So leading into every likely Fed rate hike, they bid up the USDX and dump gold. Then immediately after those rate hikes the dollar fails to surge and gold doesn’t plunge, so they reverse those excessive trades driving the dollar down and gold up.
So like clockwork after the Fed’s latest rate hike in late March, gold started rallying as gold-futures specs bought back in. Gold enjoys a strong seasonal spring rally in April and May, which I discussed in depth last week. By mid-April, that propelled gold within spitting distance of a major bull-market breakout. Gold regained its $1365 bull-to-date high from July 2016 on an intraday basis on April 11th, but failed to push through.
Ironically futures speculators’ irrational obsession with the Fed was again to blame. That day the FOMC released the minutes from its March 21st rate-hiking meeting. Traders interpreted them as hawkish, so the USDX was bought and gold was sold. For 24 trading days in row between mid-March to mid-April, gold simply did the opposite of whatever the USDX did on every single day but one. The dollar ruled gold.
Gold managed to hover near $1350 multi-year-horizontal-resistance breakout territory for another week after those Fed minutes. But that started changing on April 19th. That day the USDX rallied 0.3%, which was actually its biggest up day in a couple weeks. USDX-futures speculators were excited because the yields on benchmark US 10-year Treasury notes crested 2.9%. Higher yields are great for the dollar, right?
For decades I’ve closely followed speculators’ collective gold-futures positions every week in the famous Commitments of Traders reports published by the CFTC. I discuss them and their implications for gold’s near-term price action in every weekly newsletter. But I haven’t had the time to dig deeply into USDX futures. The analysts who traffic in that realm said USDX short positions were the largest seen in several years.
The leverage inherent in currency speculation is extreme beyond belief. Since major currencies tend to move slowly, the margin requirements equate to maximum leverage of 50x, 100x, or even 200x! That compares to the decades-old legal limit in the stock markets of 2x. At 50x, 100x, or 200x, mere 2.0%, 1.0%, or 0.5% currency moves against traders’ positions would wipe out 100% of their capital risked. It’s crazy!
So when currency speculators are wrong, they have to exit positions fast or risk getting obliterated. The traders short USDX futures had no choice but to buy. The more long USDX futures they bought to offset and close their shorts, the faster the dollar rallied. That forced still more traders to buy to cover even if they were running more-conservative leverage. This self-reinforcing dynamic feeds on itself, fueling short squeezes.
As the USDX buying mounted, the dollar’s rally accelerated in subsequent days. Traders continued to use 10-year Treasury yields as a fundamental excuse for their purely technical trading, as within a week they crossed the psychologically-heavy 3% threshold to 3.03%. That was the highest seen since the very end of 2013! The USDX rallied 0.3%, 0.5%, and 0.7% in the initial few trading days of that buying to cover.
It had already become the biggest dollar short squeeze since soon after Trump won the election in late 2016. That heavy futures buying forced the USDX to surge 1.5% in those first 3 trading days. Although that sounds trivial, at 50x, 100x, or 200x leverage it hammers speculators to catastrophic 75%, 150%, or 300% losses! I wonder how these guys can sleep at night bearing such ridiculous and unforgiving levels of risk.
Gold-futures speculators run extreme leverage too, but much less than currency traders. This week a single gold-futures contract controlling 100 troy ounces of gold worth $130,500 only required speculators to keep $3100 cash margins in their accounts. That equates to 42.1x maximum leverage! For traders running at the edge, every 1% adverse move in gold would wipe out an insane 42% of their capital risked.
So these guys nervously watch gold on a minute-by-minute basis. And in a fascinating confirmation that gold is indeed a currency, they look to the US dollar for their trading cues. They started selling their gold-futures positions as the dollar started rallying. That drove gold 0.2%, 0.7%, and 0.9% lower in the first 3 trading days of that USDX short squeeze that ignited on April 19th, forcing gold down 1.9% overall to $1324.
Our lone chart this week looks at gold during this current Fed-rate-hike cycle superimposed on the long and short positions large and small speculators hold in gold futures. Again these are published once a week in those Commitments of Traders reports. All 6 Fed rate hikes of this cycle are also highlighted, to show how gold is bludgeoned lower leading into them which spawns strong rebound buying in their wakes.
While the weekly CoTs are current to each Tuesday, they are released late Friday afternoons. Thus the newest-available CoT when this essay was published covers the week ending April 24th. That includes those initial few trading days of that USDX-futures short squeeze. And it’s very illuminating, showing why gold was pummeled back down from major-breakout levels and its strong spring rally was short-circuited.
For pre-dollar-rally baselines, on Tuesday April 17th speculators held 284.2k long and 98.9k short gold-futures contracts. These were running 27% and 15% up into their own past-year trading ranges. Thus these traders had the capital firepower and room to still do about 3/4ths and 6/7ths of their near-term long buying and short selling. Of course buying gold-futures longs is bullish for gold, while shorting is bearish.
When gold-futures shorts are low, there’s always the risk speculators will aggressively sell on the right catalyst coming along. That forces gold’s price lower. And this unlikely dollar short squeeze erupting out of the blue proved that triggering event. On seeing the USDX surge, the gold-futures specs were quick to start jettisoning longs and ramping shorts. Thus gold fell 1.2% on the 1.4% USDX rally over that CoT week.
The magnitude of this initial gold-futures selling became evident in the next CoT report current to April 24th. During that CoT week, specs sold 7.9k gold-futures long contracts while adding another 15.6k on the short side. That made for big total CoT-week selling equivalent to 73.0 metric tons of gold. That is simply far too much for normal buying to absorb. Thus the only possible outcome was a lower gold price.
Just this week, the World Gold Council released its latest Gold Demand Trends report for Q1’18. That’s the definitive source for world gold fundamental supply-and-demand data. In Q1, global gold investment demand averaged 22.1t per week. So heavy gold-futures selling easily overwhelms that. Gold always falls when the futures specs get on a selling kick. They flood the market with too much short-term supply.
That dollar-short-squeeze reaction left specs’ collective long and short gold-futures positions running up 22% and 30% into their past-year trading ranges. So these traders still had room to do about 4/5ths of their likely near-term long buying, but expended a significant chunk of their shorting firepower. That left total spec shorts at a 12-CoT-week high of 114.5k contracts. The higher spec shorts, the more bullish gold gets.
Short positions in futures are bullish because they necessitate proportional near-term buying. In selling short, speculators essentially borrow futures from other traders to sell. The specs are legally obligated to buy back those contracts relatively soon to close out those trades and repay those effective debts. So futures shorts are guaranteed near-future buying, whether they are in the USDX, gold, or anything else.
This essay was penned and proofed Thursday, and then published Friday morning. The newest CoT data current to this Tuesday May 1st won’t come out until late Friday afternoon about 4 hours after this essay went live. So while I can’t wait to see the latest CoT, I can only speculate about it at this point. During this latest CoT week, the USDX-futures short squeeze continued which drove more spec gold-futures selling.
The dollar rally actually accelerated in this newest CoT week ending Tuesday, as shown by the sharp 1.9% rally in the USDX. Thus gold’s CoT-week selloff also grew to 2.0%. That was 2/3rds larger than the prior CoT week’s 1.2%. So odds are the gold-futures selling ballooned significantly in this latest CoT week. That implies another 35k to 40k gold-futures contracts were dumped, with the majority likely on the short side.
Assuming the prior week’s spec gold-futures-selling mix of 1/3rd long and 2/3rds short holds, total spec longs could’ve dropped another 12.9k contracts while shorts could’ve soared 25.8k. If that proves true, total spec longs and shorts could have been running near 14% and 54% up into their past-year trading ranges as of this Tuesday. That would mean the majority of the likely gold-futures shorting is already done!
While I don’t have the USDX-futures data and background to analyze in depth, odds are the USDX is in a similar opposite place. I suspect the majority of the dollar short covering has already run its course. That paves the way for this sharp dollar rally to at least peter out and probably reverse. Trade-war fears are going to flare again soon as the distraction of stocks’ Q1 earnings season passes, which is bearish for the dollar.
If you look at the chart above, the green line shows specs’ total gold-futures long contracts. Note even a CoT week ago that was trading below bull-market support. There is big room for these traders to flood into gold on the long side when the USDX inevitably stalls or reverses. They likely now have the capital firepower to do about 6/7ths of their potential near-term buying! That portends big gold upside in coming weeks.
While gold’s strong seasonal spring rally was interrupted by this surprise USDX-futures short squeeze, I doubt it was killed. Gold was driven to a new seasonal low of $1304 this week, under its previous $1310 of mid-March. Thus all the usual spring-rally buying in April and May will likely be compressed into this month alone! That means gold could enjoy a major mean-reversion bounce rally in the coming weeks.
During the 10 trading days as of the middle of this week since the dollar’s sharp rally started, gold has moved inversely proportionally to the USDX on every trading day but one. 8 of these trading days of the past couple weeks saw the dollar rally, and gold’s biggest losses of 0.9% both occurred on the dollar’s best up days of 0.7%. Gold’s down days were all about the same size as the dollar’s up days, mirror images.
But in the 2 trading days of the past couple weeks when the USDX retreated modestly, gold surged way out of proportion to the dollar’s weakness. These trivial 0.2% and 0.1% USDX slides allowed gold to rally a relatively-outsized 0.6% and 0.5%! Gold wants to rally, and will likely quickly surge back up near major-breakout levels soon after this dollar-rally pressure abates. And that’s likely going to prove very soon.
The mounting US/China trade war has been pushed out of the financial-media spotlight by Q1 corporate earnings, which have soared on the big corporate tax cut. But earnings season is winding down just as major trade-war deadlines are looming for the US to implement recent tariff announcements. The dollar looks far less attractive to foreign investors if tariff threats become reality, their capital will seek refuge elsewhere.
And though the extreme leverage inherent in gold futures enables their speculators to wield outsized influence on short-term price action, investors’ capital massively dwarfs the speculators’. So when investors’ vast funds start bidding on gold again, likely on the next major stock-market selloff driving demand for prudent portfolio diversification, gold-futures specs’ influence will be overwhelmed and drowned out.
Add in strong spring seasonals to all this, and gold has a fantastic foundation for a strong rebound rally. Speculators’ low gold-futures longs are very bullish, as they will rush to buy back in to ride any upside momentum in gold. Speculators’ mounting gold-futures shorts are increasingly bullish, as these will have to be covered and closed by buying offsetting longs. And investors’ super-low gold allocations are wildly-bullish.
So odds are gold’s atypical counter-seasonal drop in the last couple weeks driven by the surprise USDX short squeeze will soon reverse hard. It won’t take much buying to drive gold back up near those major bull breakout levels around $1365. And gold powering higher again will quickly turn sentiment around, with buying begetting more buying. The dollar depressing gold prices leaves this metal more bullish, not less so.
While investors can ride gold’s coming mean-reversion rebound in physical bullion itself or shares in the leading GLD SPDR Gold Shares gold ETF, far-better gains will be won in the stocks of its leading miners. They are already radically undervalued at today’s prevailing gold prices, and their profits tend to amplify underlying gold gains by 2x to 3x. This small contrarian sector’s upside is vast, dwarfing everything else.
With gold still so near a major bull-market breakout, it’s ironic gold stocks remain so deeply out of favor. Between our weekly and monthly newsletters, we have 30 open gold-stock and silver-stock trades added in the past year. As of this week near gold’s lows, fully 25 had average unrealized gains of 18%. One gold miner added in late November is already up 95%! The 5 other trades had average unrealized losses of just 5%.
When gold inevitably rebounds, these unrealized gains are going to explode higher. Buying low first is necessary before selling high later to multiply wealth. That means adding gold stocks when you least want to, when they’re hated. That’s what we do at Zeal. We spend all our time relentlessly studying the markets so you don’t have to, and share our acclaimed research through our popular financial newsletters.
They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks. As of the end of Q4, we’ve recommended 983 stock trades in real-time to our newsletter subscribers since 2001. They’ve averaged big annualized realized gains of +20.2%, well over double stock markets’ long-term average! For only $12 per issue, you can learn to think, trade, and thrive like contrarians. Subscribe today and get deployed!
The bottom line is gold’s recent weakness is the result of a rare major short squeeze in US Dollar Index futures. The resulting dollar rally spooked gold-futures speculators, who rushed to sell to avoid getting slaughtered by their extreme leverage. While that short-circuited gold’s spring rally, this anomaly won’t last. Gold-futures speculators and gold investors are far too bearish and under-allocated, with big room to buy.
The USDX short covering is likely running out of steam, which will clear the way for gold’s big seasonal spring rally to resume. All that delayed buying will likely be compressed into May, and drive gold back up near recent major-bull-breakout levels. Any dollar/gold reversals will force gold-futures specs to quickly buy to cover their ballooning shorts. The resulting rally will entice in long-side traders, then gold is off to the races.
Adam Hamilton, CPA
May 4, 2018
Copyright 2000 – 2018 Zeal LLC (www.ZealLLC.com)
The gold miners’ stocks have mostly been consolidating low this year, exacerbating bearish sentiment. Even with gold grinding higher in a solid uptrend and nearing a major upside breakout, the gold stocks just can’t get any love. But that may be about to change, with gold and its miners’ stocks in the midst of their spring rally. Strong seasonal tailwinds make May one of the best months of the year in gold-stock bulls.
Gold-stock performance is highly seasonal, which certainly sounds odd. The gold miners produce and sell their metal at relatively-constant rates year-round, so the temporal journey through calendar months should be irrelevant. Based on these miners’ revenues, there’s little reason investors should favor them more at certain times of the year than others. Yet history proves that’s exactly what happens in this sector.
Seasonality is the tendency for prices to exhibit recurring patterns at certain times during the calendar year. While seasonality doesn’t drive price action, it quantifies annually-repeating behavior driven by sentiment, technicals, and fundamentals. We humans are creatures of habit and herd, which naturally colors our trading decisions. The calendar year’s passage affects the timing and intensity of buying and selling.
Gold stocks exhibit strong seasonality because their price action mirrors that of their dominant primary driver, gold. Gold’s seasonality generally isn’t driven by supply fluctuations like grown commodities experience, as its mined supply remains fairly steady all year long. Instead gold’s major seasonality is demand-driven, with global investment demand varying dramatically depending on the time within the calendar year.
This gold-demand seasonality is well-known and heavily studied. The seasonal gold year starts in late July as Asian farmers begin reaping their harvests. They plow some of their surplus income into gold. That’s followed by the famous Indian wedding season in autumn, with its heavy gold buying for brides’ dowries. That culture believes festival-season weddings have greater odds of yielding long, successful marriages.
After that comes the Western holiday season, where gold jewelry demand surges for Christmas gifts for wives, girlfriends, daughters, and mothers. Following year-end, Western investment demand balloons after bonuses and tax calculations as investors figure out how much surplus income the prior year generated for investment. Then Chinese New Year gold buying flares up after that heading into February.
These understandable cultural factors drive surges of outsized gold demand between summer and late winter. But interestingly there is one more gold-demand spike in spring. Over the years I’ve seen a variety of theses explaining this April-and-May seasonal gold rally, but nothing definitive like for the rest of the year’s gold seasonality. As silly as it sounds, I suspect spring itself is the reason for this demand surge.
Sentiment exceedingly influences investing, which requires optimism for the future. Investors won’t risk deploying their scarce capital unless they believe it will grow. And the glorious expanding sunshine and warming temperatures of spring naturally breed optimism. The vast majority of the world’s investors are far enough into the northern hemisphere that spring has a major impact. This seasonality extends to stocks too.
Since it’s gold’s own demand-driven seasonality that fuels the gold stocks’ seasonality, that’s logically the best place to start to understand what’s likely coming. Price action is very different between bull and bear years, and gold is absolutely in a young bull market. After being crushed to a 6.1-year secular low in mid-December 2015 on the Fed’s first rate hike of this cycle, gold powered 29.9% higher over the next 6.7 months.
Crossing the +20% threshold in early March 2016 confirmed a new bull market was underway. Gold corrected after that sharp initial upleg, but normal healthy selling was greatly exacerbated following Trump’s surprise election win. Investors fled gold to chase the taxphoria stock-market surge. Gold’s correction cascaded to monstrous proportions, hitting -17.3% in mid-December. But that was shy of a new bear’s -20%.
Gold’s last mighty bull market ran from April 2001 to August 2011, where it soared 638.2% higher! And while gold consolidated high in 2012, that was technically a bull year too since gold just slid 18.8% at worst from its bull-market peak. Gold didn’t enter formal bear-market territory at -20% until April 2013, thanks to the crazy stock-market levitation driven by extreme distortions from the Fed’s QE3 bond monetizations.
So the bull-market years for gold in modern history ran from 2001 to 2012, skipped the intervening bear-market years of 2013 to 2015, and resumed in 2016 to 2017. Thus these are the years most relevant to understanding gold’s typical seasonal performance throughout the calendar year. We’re interested in bull-market seasonality, because gold remains in its young bull today and bear-market action is quite dissimilar.
This chart averages the individually-indexed full-year gold performances in those bull-market years from 2001 to 2012 and 2016 to 2017. 2018 isn’t included yet since it remains a work in progress. This chart distills out gold’s bull-market seasonal tendencies in like percentage terms. Quantifying gold’s bull-market seasonal tendencies requires all relevant years’ price action to be recast to be perfectly comparable.
That’s accomplished by individually indexing each calendar year’s gold price action to its final close of the preceding year, which is recast at 100. Then all gold price action of the following year is calculated off that common indexed baseline, normalizing all years regardless of price levels. So gold trading at an indexed level of 105 simply means it has rallied 5% from the prior year’s close, while 95 shows it’s down 5%.
This methodology renders all bull-market-year gold performances in like percentage terms. That’s critical since gold’s price range has been so vast, from $257 in April 2001 to $1894 in August 2011. Finally each calendar year’s individually-indexed gold prices are averaged together to arrive at this illuminating gold-bull seasonality. Gold has always tended to enjoy strong rallies in the spring months of April and May.
During these modern bull-market years from 2001 to 2012 and 2016 to 2017, gold’s spring rally tended to start in mid-March on average. From that major seasonal low following the winter rally, gold often starts grinding higher before its gains accelerate through April and most of May. This spring rally has generally run its course by late May. Across the 14 bull years in this study, gold averaged nice spring rallies of 3.7%.
This spring rally unfolds rapidly, with an average duration of just 2.2 months. That makes it the smallest and shortest of gold’s three major seasonal rallies, falling way behind the champion 9.5% winter rally that precedes it and strong 6.6% autumn rally that follows the summer doldrums. Nevertheless, it is still well worth trading. 3.7% gains still really make a difference, and naturally about half of years exceed this average.
This year gold’s spring-rally bottoming came on March 20th, when gold closed at $1310 the day before the Fed was universally expected to hike for the 6th time in this cycle. That was March’s 14th trading day this year, right in line with gold’s average seasonal low on March’s 10th trading day. And so far gold has largely followed the spring-rally seasonal pattern since, gradually grinding higher from late March to mid-April.
Climbing the typical 3.7% from that spring low into May’s spring-rally topping would propel gold to $1358. That’s right on the verge of being a major decisive breakout from the horizontal $1350 resistance line that gold-futures speculators watch like hawks. And it isn’t far from new bull-market highs above July 2016’s $1365 bull-to-date peak. As I wrote last week, this spring rally really ups the odds gold is nearing a bull breakout!
And given its performance in April, gold ought to see a bigger May rally than usual this year. On average in these 14 modern bull-market years, gold climbed 1.8% in Aprils then another 1.3% into its late-May spring-rally toppings. But as of the middle of this week, gold was actually down 0.1% month-to-date in April. That’s poor performance by April standards, setting up this May for a strong mean-reversion rally.
Historically this spring-rally April-May span is often self-equalizing. If gold materially underperforms or outperforms its seasonal averages in April, its May performances tend to mean revert and overshoot in the opposite direction. Back in 2009 for example, gold fell 3.4% in April but then blasted 10.0% higher in May! In 2016 gold surged 5.1% in April before dropping 6.1% in May. Weak Aprils often lead to strong Mays.
If gold is bid too aggressively in April, the resulting excitement entices in and exhausts all available near-term buying before the summer doldrums. That certainly hasn’t happened this year. Gold rallied into mid-April, but reversed sharply on a strong short-covering rally in US Dollar Index futures. Thus gold has largely drifted sideways on balance this month. So the usual spring buying likely hasn’t even started yet!
That leaves traders with full capital firepower to flood back in in May, likely as the sharp USDX rally runs out of steam. The delayed spring-rally gold buying this year can all be compressed into May, which really increases the odds of outsized gains. While nothing is guaranteed in seasonals since they merely use multi-year averages to reveal trend tendencies, strong Mays are definitely more likely following weak Aprils.
And as goes gold, so go gold stocks. Gold stocks also exhibit strong seasonality, which is of course the direct result of gold’s own seasonality. Since gold-mining costs are largely fixed when mines are being planned, fluctuations in gold’s price flow directly into amplified moves in gold-mining profits. Higher gold prices drive much-higher earnings for the gold miners, which attract in more investors to bid up stock prices.
The ironclad historical relationship between the price of gold, gold-mining profitability, and therefore the gold-stock price levels is exceedingly important to understand. If you need to get up to speed, I wrote an essay looking at gold-stock price levels relative to gold early last month. Fundamentally gold stocks are leveraged plays on gold. Thus they really outperform in the spring due to gold’s strong seasonal rally.
This next chart applies this same bull-market-seasonality methodology used on gold directly to the gold stocks. It looks at the average annual indexed performance in the flagship HUI NYSE Arca Gold BUGS Index in these same bull-market years of 2001 to 2012 and 2016 to 2017. Because of gold’s dominant influence over gold-mining earnings, gold-stock seasonality naturally mirrors and amplifies gold’s own seasonality.
Gold stocks’ seasonal spring rally is much stronger than gold’s, buttressing that spring-optimism-drives-stock-buying thesis. Between mid-March and early June, the gold stocks have averaged hefty 12.8% rallies in these 14 modern bull-market years. That makes for exceptional 3.5x upside leverage to gold’s 3.7% seasonal spring rally! Interestingly this is gold stocks’ best seasonal leverage to gold’s gains by far.
While the HUI averaged 15.5% surges during gold’s winter rally, that only made for 1.6x upside leverage to gold’s big 9.5% gain. And the HUI’s 10.5% average gain during gold’s autumn rally also only amplified gold’s 6.6% gain by 1.6x. So while the gold-stock spring rally’s 12.8% average gains rank second out of these three seasonal rallies, it offers the most bang for the buck in gold-stock upside compared to gold!
This year the gold stocks’ spring-rally bottoming happened on March 20th, the same day as gold’s. The HUI slumped to 169.2 that day. Since then this leading gold-stock index has recovered 6.9% as of the middle of this week, trouncing gold’s 1.0% spring-rally gains so far. A merely-average spring rally would take the HUI to 190.9 by late May or early June, which is another 5.6% higher from here. That’s worth riding.
But if gold’s seasonal spring rally is compressed into May, and strong buying forces it over $1350 or even better its $1365 bull-to-date high, the gold miners’ stocks have far more near-term upside potential. For the most part gold stocks remain deeply out of favor, forgotten or ignored. But they will explode back on to speculators’ and investors’ radars if major new gold highs attract the financial media’s interest and attention.
Again as I discussed last week, gold’s nearing bull breakout will work wonders for not only psychology but hard gold-mining profits. The gold stocks are radically undervalued today compared to their actual underlying fundamentals. In Q4’17 gold averaged about $1276 per ounce, but the major gold miners of the leading GDX VanEck Vectors Gold Miners ETF reported average all-in sustaining costs of just $858 per ounce!
So they were already collectively earning fat operating profits of $418 per ounce. And these are going to soar in Q1’18, because the average gold price surged 4.1% quarter-on-quarter to $1329. Since mining costs are largely fixed, all-in sustaining costs will likely stay flat from Q4. That means major gold miners’ operating profits are likely to rocket 12.7% QoQ to $471 per ounce! That will delight contrarian investors.
The gold miners will be releasing these latest Q1 results between now and mid-May, right when gold is powering higher in its seasonal spring rally. So the gold stocks are certainly set up for an outsized spring rally this year! The potent combination of absurdly-cheap gold-stock prices, surging earnings forcing their valuations even lower, and higher gold prices attracting financial-media attention should really stoke traders’ interest.
This last chart breaks down gold-stock seasonality into even-more-granular monthly form. Each calendar month between 2001 to 2012 and 2016 to 2017 is individually indexed to 100 as of the previous month’s final close, then all like calendar months’ indexes are averaged together. Slicing up seasonal tendencies this way shows May has averaged the second-strongest monthly gold-stock gains in modern bull-market years.
During these 14 Aprils in modern gold bull-market years, the gold stocks as measured by the HUI saw average gains of 1.6%. But the lion’s share of the spring-rally gains came in May, where average gains more than tripled to 5.0%! For decades if not longer, May has been one of the best and most-important months to be heavily long gold miners’ stocks. Only February proved better seasonally at a +5.4% average.
The key to gold stocks’ spring rally is to get your capital deployed in mid-March, when gold stocks swoon to their spring-rally bottoming. In intra-month terms the initial gains are often fast in late March as gold stocks rebound out of oversold lows. But then the spring rally tends to slow down in April, discouraging impatient and short-sighted traders. The real gains come in May, and next month’s setup is exceptionally bullish.
Of course the standard seasonality caveat applies that these are mere tendencies, not primary drivers of gold or gold stocks. Seasonal tailwinds can be easily drowned out by bearish sentiment, technicals, and fundamentals. Seasonality doesn’t always work, especially when it doesn’t align with the primary drivers of sentiment, technicals, and fundamentals in that order. Thankfully that certainly isn’t the case this year.
The gold miners’ stocks aren’t entering their second-strongest month of the year overbought after a big rally. Quite the contrary, they have really underperformed year-to-date on excessive bearishness. This week the HUI was actually still down 6.0% so far in 2018, far behind gold’s modest 1.6% gain! Since gold-mining profits amplify gold price moves, gold-stock prices tend to leverage gold by 2x to 3x much of the time.
Thus spring rally aside the HUI should already be up 3.1% to 4.7% year-to-date, or trading between 198.3 to 201.4 compared to this week’s anomalously-low 180.8. That’s another 9.6% to 11.3% higher from here even if gold merely stays near $1325. The gold stocks are overdue to mean revert higher no matter what gold does! Gold’s spring rally will simply hasten and enlarge gold stocks’ long-delayed next upleg.
The farther gold rallies in May in one of its strongest spans of the year seasonally, the closer it will get to major breakouts and new highs. The higher gold climbs, the more attention it will get from the financial media, investors, and speculators. As their sentiment turns bullish again, capital will flood back into the beaten-down gold stocks. The gold miners’ coming surging earnings in their Q1 results are icing on the cake.
While investors and speculators alike can certainly play gold stocks’ coming spring rally with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals. Their upside will trounce the ETFs’, which are burdened by over-diversification and underperforming gold stocks. A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.
At Zeal we’ve literally spent tens of thousands of hours researching individual gold stocks and markets, so we can better decide what to trade and when. As of the end of Q4, this has resulted in 983 stock trades recommended in real-time to our newsletter subscribers since 2001. Fighting the crowd to buy low and sell high is very profitable, as all these trades averaged stellar annualized realized gains of +20.2%!
The key to this success is staying informed and being contrarian. That means buying low before others figure it out, before undervalued gold stocks soar much higher. An easy way to keep abreast is through our acclaimed weekly and monthly newsletters. They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks. For only $12 per issue, you can learn to think, trade, and thrive like contrarians. Subscribe today, and get deployed in the great gold and silver stocks in our full trading books!
The bottom line is gold stocks experience a strong spring rally seasonally. This is driven by gold’s own seasonality, where outsized investment demand arises at certain times during the calendar year. Gold usually enjoys a strong spring rally likely driven by the universal optimism this season brings. And since gold drives gold miners’ profitability, their stock prices naturally follow it higher while amplifying its gains.
And gold stocks’ already-strong spring rally is likely to prove exceptional this year. Gold stocks have really lagged gold so far in 2018, despite fat earnings rapidly growing with higher gold prices. Once gold nears breakouts, traders are going to remember the gold miners and be amazed by their dirt-cheap stock prices wildly disconnected from fundamentals. They will flood back into this small sector catapulting it higher.
Adam Hamilton, CPA
April 27, 2018
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