The red-hot gold
stocks surged again this week in an apparent early-summer breakout.
This strong buying is defying their seasonally-weak odds this time
of year. Investors are flocking back to the miners as gold powers
higher on also-counter-seasonal strong investment buying. Such
unprecedented gold-stock strength in early June highlights how
undervalued the miners remain relative to gold, but is suspect.
Summers are
usually lackluster times for gold, and thus silver and their miners’
stocks. These summer doldrums exist for a couple reasons.
Gold simply enjoys
no recurring
demand spikes driven by cultural or income-cycle factors in June
and July unlike during most of the rest of the year. It’s before
the Asian-harvest, Indian-wedding-season, and Christmas gold buying
that flares up like clockwork in second halves.
And investors all
over the world shift their focus in the summer from markets to
vacations, so gold’s key investment demand usually stalls too. Thus
gold and the gold stocks rarely do anything of note in June and
July. They usually drift listlessly sideways to lower in a barren
sentiment wasteland. I’ve done a lot of research work on gold and
gold-stock
seasonality in the past, and summers are absolutely the worst
times.
Today’s gold-stock
bull only just ignited in mid-January out of extreme
fundamentally-absurd 13.5-year secular lows. So this is this young
bull’s first summer. But the last secular gold-stock bull ran from
way back in November 2000 to September 2011. During that 10.8-year
span, the flagship HUI gold-stock index blasted an astounding 1664%
higher! Great fortunes are won riding bull markets in gold stocks.
For my seasonality
work, I consider those bull-market years from 2001 to 2012. Only
the last 6 weeks of 2000 saw that gold-stock bull, so 2000 was
overwhelmingly a bear year. And gold stocks were consolidating high
in 2012 before
gross Fed distortions started crushing gold in early 2013. So
it’s interesting to see how gold stocks fared in summers between
2001 to 2012, the last bull-market years before 2016’s new one.
On average over
that 12-year span, the HUI exited June 0.6% lower from its May
close. And by the end of July, those average summer losses
quadrupled to 2.5%. That reversed sharply in August as that big
Asian-harvest gold buying came online, with average gold-stock
performance since the end of May surging to +3.9% per the HUI. But
June and July, the
summer doldrums, have always been weak on average.
As of this
Wednesday, the data cutoff for this essay, the HUI had rocketed
16.2% since its May 31st close! That is incredible, defying all
precedent. While the previous best early-summer performance by this
point in June was 2001’s +14.8%, the seasonal average is a
considerable 2.3% loss over June’s first couple weeks. Even good
gold-stock early Junes only see the HUI up 5% or so. 2016 is
proving a major outlier!
There are a couple
main reasons why this is happening. Gold stocks suffered an
uncharacteristically-weak May. Between 2001 and 2012, May was the
best calendar month of the year for gold stocks, as the HUI
enjoyed average gains of 6.9%. But in May 2016 the HUI plunged
13.8% in its worst bull-market May on record. And extreme up or
down months are usually followed by opposing mean reversions.
But more
importantly, gold itself has seen rare early-summer strong
investment buying. I wrote a whole essay last week exploring
this in depth. American stock investors are continuing to
aggressively buy GLD gold-ETF shares for a variety of reasons. This
ongoing massive
gold investment buying counter to normal weak summer seasonals
is forcing this metal higher so the gold stocks are naturally
following.
While I certainly
didn’t expect this record early-summer strength in precious-metals
land, I did realize there was a possibility gold investment demand
would remain stronger than normal coming off those deep secular lows
of late 2015. So I realized the big profits on 1/3rd of our
extensive gold-stock and silver-stock trading books in late May, and
decided to hold the remaining 2/3rds through summer just in case.
Worst case we’d
get stopped out preserving most of our huge gains, and the apparent
best case now unfolding exceeds my wildest hopes. So now the big
question is whether the gold stocks can sustain their enormous
early-summer gains through the rest of the summer doldrums that
typically end in late July. Many investors and speculators are
waiting, now anxiously, for the usual late-July seasonal buying op.
Technically and
fundamentally, there’s no problem at all with gold stocks’ recent
gains or current price levels. Gold stocks still remain quite low
in the grand scheme and very undervalued compared to prevailing gold
prices. This first chart examines today’s gold-stock technical
situation, looking at that leading HUI gold-stock index, its trends,
and its key moving averages. Gold-stock prices are far from
excessive.
Though the HUI has
skyrocketed 133.5% higher in just 4.7 months as of last week, these
gold-stock price levels are still quite low. This extreme
early-bull action erupted off that
fundamentally-absurd 13.5-year secular low in mid-January. When
prices in any market are forced to greatly-anomalous extremes, they
always soon mean revert sharply in the opposite direction. That’s
the whole story of this new gold-stock bull.
The flagship HUI
gold-stock index was actually climbing in a nice uptrend between
late 2014 and mid-2015 before an anomalous breakdown driven by
extreme
gold-futures shorting. Gold stocks have only returned to that
pre-breakdown uptrend rendered in this chart. They initially
shot up to support before consolidating in March prior to breaking
through. After that they blasted right up to resistance in April.
The HUI’s epic
31.0% surge in April catapulted it up to 233.5 as that month ended.
After such massive and fast gains, the gold stocks needed to
consolidate and they did in May. The HUI had drifted back down near
203.1 before a colossal miss on the US monthly jobs report on
June’s first Friday ignited enormous 2.7% and 11.6% rallies in gold
and the HUI! That was gold stocks’ biggest up day in 7.5 years.
The entire premise
of these strong gold and gold-stock rallies in June 2016 defying
normal behavior this time of year is based on the idea the Fed
won’t hike rates again anytime soon. That exceedingly-weak jobs
report, coming in at just +38k in May compared to economists’
expectations of +164k, was seen as tying the Fed’s hands. The
Yellen Fed has long claimed data-dependency, and that jobs
number was dreadful.
The idea that this
Fed’s joke of a new rate-hike cycle is on hold again is what ignited
these rare summer gold and gold-stock rallies. Even though
gold has thrived
in past Fed-rate-hike cycles with average gains of 26.9% in all 11
since 1971, traders irrationally fear them. So these summer
rallies’ Achilles heel is anything that resets market expectations
from dovish to hawkish on more near-future Fed rate hikes.
With that jobs
report making it all but impossible for the Fed to hike at its
latest FOMC meeting held this week, the HUI climbed to 235.2 late
last week. But that merely made for a trivial 0.7% gain in the 6
weeks or so since the HUI’s previous bull high in late April. The
gold stocks have been consolidating high, which is perfectly
normal after such a blistering run higher. And they’ve only
regained mid-2014 levels.
With the HUI only
at a 21.2-month high, it was still relatively low in the grand
scheme as this week’s FOMC meeting approached. So gold stocks’
absolute early-summer levels are far from excessive, they aren’t a
problem at all technically. Then the perpetually-dovish Yellen Fed
somehow managed to come across as even more dovish than
traders expected. So gold and the gold stocks caught another big
bid.
The Fed made no
hints of a rate hike coming at its next meeting in July, the FOMC
members’ projections of future federal-funds-rate levels dropped
from their last ones a quarter earlier, and the decision not to hike
was unanimous with no dissent from the FOMC’s rare hawkish members.
So futures-implied odds of the FOMC hiking rates at its late-July
meeting plunged from 21% before this week’s to just 12% after.
And that Fed
dovishness is why investors flocked to gold and gold stocks this
week, driving their anomalous intraday early-summer breakouts. And
that’s the major risk these strong summer rallies face. The Fed’s
modus operandi this year has been to talk tough between FOMC
meetings warning of imminent rate hikes, but cowardly fold when
the times to execute those decisions arrive. This will likely
happen again.
The elite central
bankers running the FOMC hate the fact that they have little
credibility left in the eyes of traders. Fed officials have
cried hawk so many times in recent years and failed to carry
through that no one believes them anymore. Nevertheless, they keep
trying to talk hawkish on rate hikes between FOMC meetings because
they want to jawbone those key futures-implied odds of federal-funds
rate hikes higher.
The Fed doesn’t
want to risk surprising stock markets and sparking a major cascading
selloff with a rate hike, so it has to first pave the way by talking
hawkish enough to get futures traders expecting a rate hike prior to
its execution. So there’s a high chance we’ll see plenty of hawkish
rate-hikes-are-necessary-and-imminent speeches by top Fed officials
this summer. Gold has suffered kneejerk selloffs on hawkish
talk.
There’s also a
good chance some economic data this summer will come in better than
expected, which will get traders worrying about Fed rate hikes
again. Since these rare summer surges in gold and its miners stocks
were psychologically driven by Fed dovishness, Fed hawkishness
is definitely a threat to their staying power. And with 6 weeks
until late July, we certainly aren’t out of the summer-doldrums
woods yet.
So it’s definitely
prudent to remain cautious until gold’s major seasonal lows
in late July arrive. If you’re already deployed in gold stocks and
silver stocks, enjoy these awesome summer rallies but make sure you
have stops in place. And if you’re looking to add positions in this
sector, there’s no rush despite the surprising strength of the past
couple weeks. This reminds me of some great Colorado highway signs.
As Interstate 70
drops out of the mountains coming into Denver from the west, there
are striking giant yellow signs. One reads, “TRUCKERS, DON’T BE
FOOLED, 4 MORE MILES OF STEEP GRADES AND SHARP CURVES”. Despite the
awesome gold action in recent weeks, June and July have long proven
historically no time to get excited about gold upside. We’re still
early in gold’s weakest time of the year seasonally.
In addition to
virtually no chance Fed officials won’t try to aggressively reset
traders’ expectations back to hawkish over the next 6 weeks,
American gold-futures speculators continue to maintain high longs
and low shorts. These guys are very bullish, which means a lot of
pent-up and potential gold-futures selling still exists that
would likely easily temporarily overwhelm any gold investment
demand. Be careful here.
Nevertheless, any
typical summer seasonal weakness is only a short-term concern.
Gold stocks remain very cheap relative to gold, which drives their
profits and hence ultimately their stock prices. This last chart
looks at the ratio of that HUI gold-stock index to the price of
gold. This HGR highlights how small gold stocks’ young new bull has
been compared to its potential, and why this sector still has a long
way to climb.
Gold stocks are
ultimately leveraged plays on the price of gold. Since their mining
costs are largely fixed during mine-planning stages, gold-price
increases translate directly into higher profits. These profits
rise far faster than gold prices, as I explained in a recent essay
on gold miners’
Q1’16 fundamentals. The HUI/Gold Ratio is a quick proxy to
distill down gold stocks’ crucial fundamental relationship with
gold.
As of the middle
of this week, the HGR was running at just 0.181x. While that’s
double the HGR’s all-time low of 0.093x first seen in late
September then again in mid-January, gold stocks still remain very
undervalued at today’s prevailing gold prices. Between 2009 and
2012, the last normal years sandwiched between 2008’s stock panic
and the Fed’s gross market distortions starting in 2013, the HGR
averaged 0.346x.
The gold stocks
still have a long ways to climb to mean revert back up to those
normal levels relative to gold. At $1250, $1300, and $1350 gold, a
merely-average 0.346x HUI/Gold Ratio implies this leading gold-stock
index would need to soar to 433, 450, and 467. That’s another 85%,
92% and 100% above this week’s levels! And these HUI price
projections are actually quite conservative for a couple key
reasons.
Gold itself is
mean reverting out of deep secular lows as well. Back in 2012
before the Fed’s QE3-driven
stock-market
levitation devastated gold investment demand and prices, gold
averaged $1669. Plug that into that 2009-to-2012 normal-year HGR
average, and the HUI target rockets to 577! And coming out of
extremes, mean reversions almost always overshoot proportionally
towards the opposite extreme before they end.
So both gold and
the HUI’s ratio to it are almost certain to surge way beyond those
average levels before their young bull markets fully run their
courses over the next couple years. While no one yet knows how big
those overshoots will eventually prove, the gold-stock price targets
they imply are breathtaking. So gold stocks’ young bull is far from
over, they still have massive upside regardless of what
happens this summer.
Those truckers
descending out of the mountains towards Denver risk being lulled
into complacency by the first relatively-flat stretch of highway,
which is far from the end of the steep risky part. Similarly
very-rare gold and gold-stock early-summer surges driven by dovish
Fed psychology doesn’t mean gold’s weak season has prematurely
ended. We’ve got 6 more weeks of steep grades and sharp
curves coming!
There’s certainly
a chance the strong gold investment buying will continue, pushing
gold and therefore its miners stocks even higher. This is
especially true if lofty and wildly-overvalued stock markets once
again start rolling over into their
long-overdue
cyclical bear. That possibility is why I held 2/3rds of our
gold-stock and silver-stock trading books this summer, with huge
gains protected by trailing stop losses.
But the odds of
gold investors continuing to perceive the Fed as
overwhelmingly-dovish until the end of July seem pretty
slim. At some point soon here, it’s very likely the hawkish
regional-Fed presidents are going to once again storm the podiums to
pound the table about the need for rate hikes soon. Enough of that
will spook the heavily-long gold-futures speculators into selling,
which will quickly weaken gold.
So while I’m
loving gold stocks’ anomalous early-summer rally adding to our huge
unrealized gains, decades of experience trading this sector have
made me wary of early-summer gold strength. Whether you want to
deploy into a leading gold-stock ETF like the GDX VanEck Vectors
Gold Miners ETF, or higher-potential elite individual gold and
silver stocks like we do, it’s probably prudent to first see what
late July brings.
That’s the last
major seasonal low ahead of the
big autumn
rallies in gold and gold stocks, which history has shown is the
ideal time to buy on average. While gold and gold stocks may very
well defy the odds to keep climbing over the next 6 weeks, chances
are they won’t. Their summer-doldrums upside from here is likely
modest at best, but the near-term downside risk out of record
early-summer strength is considerable.
Thus at Zeal we’re
eagerly looking forward to adding new gold-stock and silver-stock
positions closer to those likely late-summer seasonal lows. They
should prove a major buying opportunity, so we’re now researching
individual miners to find the elites with the best fundamentals to
buy then. Decades of experience and many hundreds of
precious-metals-stock trades have taught us to be wary of June and
July rallies.
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The bottom line is
gold stocks’ strong early-summer rally is very bullish yet somewhat
suspect. Gold stocks still remain relatively low technically and
super-undervalued relative to gold, their young new bull is far from
over. Yet early-summer strength is a very-rare anomaly, and it’s
hard to imagine the extreme Fed dovishness fueling it persisting for
the entire rest of this summer. So near-term caution remains in
order.
Despite gold
stocks’ sharp rally in recent weeks, we remain in the weakest time
of the year seasonally for gold and gold stocks in June and July.
History has proven the odds don’t favor sustainable summer rallies
until early August. Thus it’s not prudent to chase these rallies
and add new positions at this point. Enjoy the mounting gains in
gold stocks you already own, but wait until seasonals shift bullish
to buy more.
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