The January headline consumer price index (CPI) came in at 2.5%, which is
near a 5-year high. What happened to deflation? As a result, real interest
rates declined deeper into negative territory or in the case of the 10-year
yield, went from positive to negative. No this isn't a commodity-driven story.
The core CPI (ex food and energy) has been above 2% since the end of 2015 when
commodities were in the dumps. Inflation is perking up and couple that with
a Fed that pursues rate hikes at a glacial speed and that is very bullish for
precious metals.
The chart below is what I refer to as our master fundamental chart for Gold.
It plots Gold along with the real fed funds rate and the real 5-year yield.
In short, negative and/or declining real interest rates drive bull markets
in Gold while rising real rates or strongly positive real rates (like in the
1980s and 1990s) drive bear markets in Gold. Since the middle of 2015 both
the real fed funds rate and the real 5-year yield have declined by +2%. The
real fed funds rate has declined from a fraction above 0% to now almost -2%
(-1.88%). Meanwhile, the real 5-year yield has declined by roughly 2.5% in
the past two years from nearly 2% to now -0.60%.
Fundamental analysis can be backward looking and that is why it is so important
to verify fundamentals through the lense of technical analysis. While there
are numerous charts we could show we want to present a fresh look at some sector
relationships which help confirm the strong fundamentals currently supporting
the sector.
In the chart below we plot the gold stocks (both the seniors and juniors)
against Gold and we plot the juniors against the seniors. During a healthy
bull market in precious metals, the miners should show strength relative to
the metals and secondarily, the riskier and more volatile stocks should also
show relative strength. First, we note the GDX to Gold ratio appears poised
to break its 10-year downtrend this year. Second, we see that the GDXJ to GDX
ratio (juniors versus the seniors) is one month short of a 4-year high.
Turning to the short-term, we note that Gold successfully tested its support
at $1220/oz while the miners decline on Friday suggests they may need more
time to digest recent gains.
With negative real interest rates in place and the gold stocks trading well
above their rising 400-day moving averages while showing relative strength
against Gold, it is quite clear the gold stocks are in the early stages of
a new bull market. It's also difficult for us to argue that Gold and Silver
are not in a bull market. The technical setup is potentially in place for the
sector to make an explosive move higher over the next 9 to 18 months. Pullbacks
in 2017 need to be bought due to the upside risk over the intermediate term.
