The
gold miners’ stocks suffered a rough late summer this year. A rare
forced capitulation walloped them to deep new lows, short-circuiting
their usual autumn rally. That’s left this sector anomalously low
as the subsequent winter rally gets underway, gold stocks’ strongest
seasonal surge of the year. Starting from beaten-down levels after
skipping the prior seasonal rally gives gold stocks
exceptionally-bullish upside potential.
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 year-round.
Instead gold’s major seasonality is demand-driven, with
global investment demand varying dramatically depending on the time
in the calendar year.
This gold
seasonality is fueled by well-known income-cycle and cultural
drivers of outsized gold demand from around the world. And the
biggest seasonal surge of all is just now getting underway heading
into winter. As the Indian-wedding-season gold-jewelry buying that
normally fuels this metal’s
big autumn rally
winds down, the Western holiday season ramps up. The holiday spirit
puts everyone in the mood to spend money.
Men splurge on
vast amounts of gold jewelry for Christmas gifts for their wives,
girlfriends, daughters, and mothers. The holidays are also a big
engagement season, with Christmas Eve and New Year’s Eve being two
of the biggest proposal nights of the year. Between a third to a
half of the entire annual sales of jewelry stores come in
November and December! And jewelry historically dominates overall
gold demand.
According to
the World Gold Council’s latest data,
between 2013 to 2017 jewelry accounted for fully 60%, 58%,
56%, 47%, and 53% of total annual global gold demand. That averages
out to 55%, which is far bigger than investment demand. During
those same past 5 years, that weighed in at just 18%, 20%, 22%, 37%,
and 30% to average 26% of the world total. Jewelry demand is
over twice as large as investment demand!
That frenzied
Western jewelry buying heading into winter shifts to pure investment
demand after year-end. That’s when Western investors figure out how
much surplus income they earned during the prior year after bonuses
and taxes. Some of this is plowed into gold in January, driving it
higher. Finally the big winter gold rally climaxes in late February
on major Chinese New Year gold buying flaring up in Asia.
So during its
bull-market years, gold has always tended to enjoy major winter
rallies driven by these sequential episodes of outsized demand.
Naturally the gold stocks follow gold higher, amplifying its gains
due to their great profits leverage to the gold price. Today gold
stocks are now once again heading into their strongest seasonal
rally of the year driven by this annually-recurring robust winter
gold demand.
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 remains 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 March 2016 confirmed a new bull market was underway.
Gold corrected after that sharp initial upleg, but normal healthy
selling was greatly exacerbated after Trump’s surprise election
win. Investors
fled gold to chase the taxphoria stock-market surge. Gold’s
correction cascaded to mammoth proportions, hitting -17.3% in
mid-December 2016. But that remained 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 2018. 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 stalled bull today and bear-market
action is quite dissimilar.
Prevailing gold prices varied radically throughout these modern
bull-market years, running between $257 when gold’s last secular
bull was born to $1894 when it peaked a decade later. All these
years along with gold’s latest bull since 2016 have to first be
rendered in like-percentage terms in order to make them
perfectly comparable. Only then can they be averaged together to
distill out gold’s bull-market seasonality.
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
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
bull-market-seasonality methodology reveals that gold’s strongest
seasonal rally by far is its winter one which tends to start
in late October. That portends big gains in coming months from
still-beaten-down gold stocks.
During these modern bull-market years, gold has enjoyed a pronounced
and strong seasonal uptrend. This whole concept of seasonality
relies on blending many years together, smoothing away outliers to
reveal underlying core tendencies. On average by year-ends, gold
has powered 16.0% higher from the prior-year-final-close 100
baseline! And the majority of these major gains accrue during
gold’s winter rally.
On
average gold’s winter rally starts powering higher in late October,
right after the seasonal correction following gold’s autumn rally.
This major winter-rally bottoming has technically averaged out to
arrive on that month’s 16th trading day, which was October 22nd this
year. But in 2018 gold bottomed early after getting blasted
lower by a wild frenzy of extreme all-time record gold-futures short
selling by speculators.
Initially ignited by a sharp rally in the US dollar, that incredible
leveraged shorting soon took on a life of its own and snowballed.
So gold’s usual autumn rally was obliterated this year, it
didn’t even exist! Instead of climbing the typical 6.6% between
mid-June to late September, gold was hammered a serious 9.1% lower
in that autumn-rally span. Both gold-futures speculators and
gold-ETF
investors dumped it aggressively.
Seasonality defines mere tendencies over long spans, not primary
drivers. So seasonal tailwinds can sometimes be drowned out or
bucked entirely when sentiment, technicals, or fundamentals get
sufficiently bearish. That just happened to an extreme degree this
year, as negating an entire seasonal rally is fairly rare. But the
bright side of this is seasonals often exhibit strong
mean-reversion patterns after price extremes.
So
much-smaller-than-normal seasonal rallies like 2018’s
missing-in-action autumn one generally lead to larger-than-normal
subsequent ones. Gold powers higher faster to make up for lost
ground! Thus this year’s young winter rally enjoys good odds for
growing exceptionally large. On average in these modern bull-market
years, gold’s winter rally ran 9.5%. That already dwarfs the spring
and autumn rallies’ 3.7% and 6.6%.
Gold’s winter rally is so powerful because November, January, and
February see some of its best average monthly gains. This month
clocks in at 2.9%, making it gold’s 2nd-best calendar month. That
peters out in December which averages just 0.7% upside. But January
more than makes up for it with really big 3.1% average gains, which
is gold’s best month of the year seasonally. February ranks 5th
with 2.1%.
So
gold’s 4.2-month winter-rally span enjoys its best average seasonal
performance of the entire year. This is the time witnessing peak
seasonal tailwinds. So if gold is already heading higher for
sentimental, technical, or fundamental reasons, this strong
seasonality will amplify its gains. And that is certainly the case
this year. Both gold futures and gold ETFs suffered serious
late-summer selling that needs to be unwound.
Gold’s autumn rally vanished this year because extreme
record
gold-futures shorting way overpowered it. Between mid-June and
late-August which is the majority of that normal autumn-rally span,
speculators added an astounding record 156.4k gold-futures short
contracts! Since shorting gold futures effectively requires
borrowing them first, these excessive shorts must soon be closed by
buying offsetting long contracts.
Speculators’ collective gold-futures positions are reported weekly
in the famous Commitments of Traders reports. The latest-available
CoT data before this essay was published is current to October
23rd. At that point speculators still had another 93.6k
contracts of short-covering buying necessary to bleed off their
huge bearish bets back down to mid-June levels. That’s the
equivalent of 291.2 metric tons of marginal demand!
All
that remaining covering buying out of those epic record shorts will
almost certainly occur in this year’s winter rally. That’s on top
of normal strong seasonal demand. And that extreme speculator
gold-futures shorting blasting gold sharply lower really tainted
investor psychology too. So they started fleeing in sympathy and
dumping gold-ETF
shares. That was readily evident in the leading GLD SPDR Gold
Shares’ holdings.
Between mid-June and early October they collapsed 11.9% or 98.6t!
As of this week, investors still had to buy enough GLD shares to
push its holdings another 74.7t higher in order to mean revert back
up to those early-summer pre-gold-selloff levels. So speculators
and investors alike have far more gold buying than usual to
do in this year’s winter rally. That odd outsized autumn-rally
selling all needs to be reversed.
Normally gold’s winter rally starts with gold up an average of 10.9%
year-to-date in late October. But this year’s extreme selling
anomaly had hammered gold down 9.9% YTD at its mid-August lows.
While it did recover some to -6.7% YTD by late October, that still
left a massive negative seasonal divergence around 18%. All
that lost ground needs to be regained, giving this year’s winter
rally far-larger-than-usual upside potential.
And
the bigger gold’s winter rally, the better the gold miners’ stocks
will perform over this same coming seasonally-strong timeframe. The
gold stocks enjoy powerful sentimental and fundamental boosts when
gold rallies consistently. Higher gold prices start shifting
psychology back to bullish in this small contrarian sector,
restoring capital inflows. And the resulting gold-stock price gains
are also justified fundamentally.
Gold-mining profits really leverage underlying gold gains.
The higher gold prices flow directly through to bottom lines, as
production costs are largely fixed when mines are being planned.
Gold miners’
profits leverage to gold is really important to understand,
illuminating why gold stocks are the best way to ride gold’s major
seasonal rallies. Recent real-world data illustrates the
fundamental impact of higher gold prices.
The
leading gold-stock investment vehicle is the GDX VanEck Vectors Gold
Miners ETF. It includes the world’s biggest and best major gold
miners. Every quarter I analyze the latest operational and
financial results from GDX’s elite gold stocks. While this current
Q3’18 earnings season is well underway, it won’t be finished until
mid-November. So the latest full results available are still
Q2’18’s, which proved quite strong.
The
GDX gold miners reported average all-in sustaining costs of
just $856 per
ounce, which is what it costs them to produce and replenish each
ounce of gold. AISCs don’t change much regardless of prevailing
gold prices, as mining still requires the same levels of
infrastructure, equipment, and employees quarter after quarter.
Between Q3’17 to Q2’18, the GDX gold miners’ AISCs averaged $868,
$858, $884, and $856.
That
makes for a past-year average of $867. Gold-mining profits are the
difference between prevailing gold prices and AISCs. At gold’s
$1174 low in mid-August driven by that record gold-futures shorting,
the major gold miners would’ve earned $307 per ounce. Assuming
gold’s winter rally is merely average at +9.5%, that would carry
gold back to $1286. Gold-mining profits would surge 36.5% higher to
$419 per ounce!
This
example shows gold-mining earnings leveraging a garden-variety gold
winter rally by 3.8x. This core fundamental relationship between
gold-mining profits and gold levels is why gold-stock prices tend to
amplify gold’s gains by 2x to 3x. That leverage grows larger
after gold stocks are
wildly
undervalued and deeply out of favor. In roughly the first half
of 2016, GDX soared 151.2% on a 29.9% gold upleg for 5.1x upside!
So
gold stocks’ own strong bull-market seasonality is fully
justified fundamentally. This next chart applies this same
seasonal methodology to the flagship HUI NYSE Arca Gold BUGS Index.
We can’t use GDX for this study since its price history is
insufficient, it was only born in May 2006. But since GDX and the
HUI hold many major gold miners in common, they
closely mirror
each other. Gold stocks see big winter rallies.
During these same modern gold-bull-market years of 2001 to 2012 and
2016 to 2017, the gold stocks as measured by the HUI enjoyed average
gains of 15.5% between late October to late February. That also
makes the gold stocks’ winter rally their largest seasonal one of
the year, besting both the spring rally’s 12.8% gain and autumn
rally’s 10.5% upside. But gold stocks’ average winter-rally
leverage to gold is lacking.
Their 15.5% seasonal rally on 9.5% gold gains makes for
relatively-weak leverage of only 1.6x. That’s well behind the 2x to
3x expected based on historical precedent. Even in
full-calendar-year terms, the 28.9% average gold-stock gains per the
HUI only amplify gold’s 16.0% by 1.8x. This is the result of gold
stocks dramatically underperforming gold in recent years,
which dragged down and skewed their average gains.
That
was mostly the result of
euphoric record
stock markets retarding gold investment demand. Gold is the
ultimate portfolio diversifier since it tends to rally when stock
markets weaken. So as stock markets appeared to do nothing but
rally indefinitely for years on extreme central-bank easing and
later massive US corporate-tax cuts, investors felt little need to
own counter-moving gold and the stocks of its miners.
That’s starting to change though. When the US stock markets plunged
5.3% out of the blue in two trading days in mid-October, frightened
investors
suddenly remembered gold and bid it 2.8% higher. The gold
stocks blasted up 9.1% on that, making for excellent 3.2x upside
leverage! Because gold miners’ profits are fully dependent on
prevailing gold prices, they can defy major stock-market selloffs
to power higher with gold.
So
if the stock markets are rolling over into their long-overdue next
bear market driven by the
record Fed
tightening under full-speed QT, gold and gold stocks will return
to favor in a major way. That ought to at least restore gold
stocks’ normal leverage to gold, if not boost it well above
historical precedent for quite some time in a mean-reversion
overshoot. This could very well begin in coming months in this
year’s winter rally.
Also
after gold stocks’ autumn rally was short-circuited by that record
gold-futures shorting, their winter-rally upside potential is much
greater than usual. Between late July and late September, the gold
miners’ stocks as measured by the HUI typically climb 10.5%. But
this 2018 period was an unmitigated disaster. Gold stocks plummeted
26.4% between mid-June and early September when a brutal
forced
capitulation climaxed!
Normally when gold stocks’ winter rally is getting underway in late
October, the HUI is already up 20.3% YTD on average. But this year
on October’s 19th trading day which is the average winter-rally
bottoming, the HUI was still down a colossal 25.4% YTD. So gold
stocks are entering their strongest seasonal period of the year at a
gigantic 46% negative divergence! That’s a mountain of lost
ground they still need to make up.
And
you could argue that gold stocks’ winter rally isn’t really
righteous until they’ve first mean reverted back up to normal
year-to-date levels. So this small contrarian sector’s upside
potential in the coming 4 months or so is truly exceptional. Gold
being driven much higher by speculators’ enormous gold-futures
buying and investors returning will act like rocket fuel catapulting
a major gold-stock upleg much higher.
This
last chart slices gold-stock seasonality into months instead of
years, which offers a more-granular perspective. Each calendar
month in these same modern bull-market years is individually indexed
to 100 as of the previous month’s final close, then all like months’
indexes are averaged together. Gold stocks’ winter-rally period
encompassing November to February enjoys some of this sector’s
strongest months of the year.
Between 2001 to 2012 and 2016 to 2017, the HUI averaged hefty 4.2%
gains in November. That ranks as their 4th-best month of the year.
Then like and because of gold, there is a winter-rally lull in
December which retreats to 2.4% average gains. But gold stocks tend
to power higher early in new years, with a return to strong 3.9%
average gains in January. The winter rally is finally capped by
February’s beast-mode surge.
February’s massive 5.4% average gold-stock gains per the HUI across
all these bull-market years win out as their best month of the
calendar year! This unbroken winter-rally streak is what makes this
period between late October and late February the best time of
the year to be heavily long gold stocks. There is no other
seasonal span with such unparalleled consistency of big gold-stock
gains, it is remarkably strong!
And
this year’s winter-rally setup is way more bullish than most. Both
gold and gold stocks got bashed far below where they ought to be
this time of year. These enormous negative-divergence anomalies
need to be unwound with majorly-outsized winter rallies. And with
both gold-futures speculators and gold-ETF investors
needing to do
massive buying to normalize their wildly-bearish positions, fuel
abounds to drive them.
The
gold miners may have a sentimental and fundamental ace up their
sleeve as well. According to WGC data, global gold production
surges dramatically quarter-on-quarter from Q2s to Q3s. The
past 5 years have seen gold mined in Q3s surge 9.0%, 9.1%, 7.4%,
7.1%, and 4.8% QoQ! This 7.5% average growth is huge. I suspect it
is timed to maximize stock gains into year-ends, when most bonuses
are calculated.
While gold miners’ quarterly tonnage throughput doesn’t change much,
mine managers decide what kinds of ore grades to feed into mills.
They seem to prefer to process lower-grade ores in years’ first
halves, then move on to higher-grade mixes in second halves. The
gold miners’ Q3 earnings season will wrap up over the next couple
weeks, and this typical higher production should lead to
proportionally-lower AISCs.
Average per-ounce costs naturally fall when there are more ounces
mined to spread the big fixed costs across. And there’s nothing
that warms gold-stock investors’ contrarian hearts more than growing
production and its accompanying lower costs. So gold-stock
sentiment could improve considerably soon independent of gold’s
recovery upleg as collective Q3 results look better fundamentally
fueling nice buying.
The
greatest gains in this coming winter rally won’t be won in the
popular ETFs like GDX and GDXJ, as they are far-overdiversified and
burdened with way too many underperforming gold miners. So it’s
much more prudent to deploy capital in the best individual gold
miners with superior fundamentals. Their gains will handily trounce
the ETFs, further amplifying the
already-huge
upside potential of this sector as a whole.
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The bottom line is
gold stocks are just entering their seasonally-strongest period of
the year. Their big winter rally is fueled by gold’s own, which is
driven first by outsized demand from holiday jewelry buying and
later new-year investment buying. So both the metal and its miners’
stocks have strong tendencies to rally between late October and late
February in bull-market years. It’s the best calendar span to own
gold stocks!
And this
year’s coming winter rally
looks exceptionally bullish with far more upside potential than
normal. Gold and the gold stocks both skipped their usual autumn
rallies on record gold-futures shorting and the sympathetic investor
flight. So they have huge lost ground to make up as traders
normalize excessively-bearish positions with big mean-reversion
buying. That should soon catapult the gold stocks sharply higher. |