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May 30, 2016

May 30th, 2016

Gold did not have a great last week. The worst day was Tuesday when, following news that new home sales in the United States increased 16% month-over-month, gold declined as much as 1.7% in intraday trading before regaining some ground to close down 0.7% at US$1,237 per oz.

New home sales should not pack that much punch. New homes make up only 10% of the housing market and new homes sales is notoriously revised, with a margin of error almost as large as the number itself.

But the market is rate-obsessed and so any data suggesting economic strength sends traders running to the dollar, while signs of weakness boost gold.

The overall market’s response – a gain of 1.2% for the S&P – is a bit more confusing. Yes, economic strength is good for the market, but in recent years any data suggesting the Federal Reserve should tighten would have sent QE-dependent markets down. The fact that they gained yesterday supports my hypothesis that stimulus, while still important, is no longer the only factor driving market movements.

Also very interesting is what went on the next day. Gold was pretty flat on Wednesday: it slid to start the day but then stabilized, to close down just $1.20 at US$1,225.70 per oz.

The GDX, on the other hand, gained 4%.

Why would gold miners gain when gold loses?

There are technical analyst answers and fundamental answers. On the TA side, the GDX has established a clear pattern of rebounding the day after a drop of 5% or more. As tracked by the Energy and Gold website (article here), the last four times the GDX has lost more than 5% it has gained the next day. And while that sample only extends back to mid-February, going back four years we see that 17 of the 27 times the GDX has dropped 5% it gained the next day.

On Tuesday the GDX lost 5.5%. Wednesday it gained despite gold’s slight slide. To me that – in fact, the entire pattern – speaks to gold’s attraction in tumultuous times.

Taking data on new home sales for what it really is – barely significant – no one has the slightest clue what Janet Yellen is going to do in 20 days. Because of that, no one knows whether to place their short-term bets on gold or the dollar. The broad market is equally confused: it doesn’t know whether the US economy is recovering, which could continue the bull run or at least maintain levels, or stalling, which bodes badly for US stocks.

Amidst that uncertainty, interest in gold continues to build. And the interest is broad. I talk to Vancouver brokers who are getting million-dollar cheques from clients who had put barely a dollar into resources for years. Those clients are likely getting confidence from that fact that mining’s superstars are moving on opportunities: Ross Beaty, Lukas Lundin, Frank Guistra, and the like are laying down big bets, announcing without reservation that the next gold run has begun. Moving alongside them are a slew of prominent generalist investors, the likes of George Soros and Stan Druckenmiller, who are emphasizing their conviction in gold with words and dollars. Amplifying their moves are big hedge funds that are increasingly turning to gold as the Go To investment in this ultra low interest rate, sluggish economy world.

That is a lot of different groups gaining interest in gold.

I have spoken at length since gold started rising this year about golden momentum feeding itself. Investors remember making money in other gold markets. They leave when gold turns down, but when the yellow metal starts to attract positive attention again they come flooding back.

That flood explains why the GDX rebounds every time it loses more than 5%: there are always gold speculators waiting for an opportunity to enter. Even during the bear market, it seems, there were enough investor interested in gold opportunities that the GDX gained following every 5%+ loss.

Now the bear market is over and we are in the first significant correction of the new bull. No one knows how much gold will correct. As of Friday’s low it had lost 6.6% versus its early May peak of US$1,294. Based on a wide range of analytical techniques, historic references, crystal balls, and smoke signals, prognosticators estimate gold could correct anywhere from zero (wrong already) to 25% (highly doubt it).

The GDX, meanwhile, has lost 14% since early May. Given that gold miners offered 5.5x leverage to gold on the way up (GDX gained 107% while gold gained 19%), miners are doing better on the way down, only levering gold’s decline 2.1-fold.

What does it all mean?

I see GDX’s outperformance on the way up and reduced leverage in the correction as added evidence that (1) the investors rotating into gold have long-term vision and (2) the rotation is far from over. Of course some money is being taken off the table – so it should be when positions are up 100%. However, GDX’s resilience suggests that many investors still want to establish positions in gold equities before the metals starts to run again.

If this is correct, the GDX will once again outperform gold handsomely when the correction is over and gold starts to climb again.

For that, we have to wait until Janet Yellen makes her move in mid-June.