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The not-so-golden days of summer...might be ending soon

For those who assess exploration stocks, summer is a study in contrasts. Summer doldrums are a very real thing: investors go on vacation, gold makes a seasonal move down, volumes shrink, and prices slide.

But summer is also field season in the northern hemisphere. So analysts like me spend summer visiting projects, kicking rocks to really understand what is known and theorized and planned, so that when results start to flow we know what they mean.

It means site visit season takes me away from the office during the dog days of summer. It works out well, really.

I certainly continue to track the sector. The editorial in last Wednesday’s letter outlined my latest thoughts and is included below. Additional articles in the letter (not included here) commented on silver, zinc, Indian gold demand, and some recent reminders of jurisdictional risk.

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The Not-So-Golden Days of Summer...Might Be Ending Soon

(Snipped from The Maven Letter: July 12, 2017)

Gold certainly did not behave itself while I was away. I tried to disconnect from work but I still impulsively checked the gold price every day. And each day, I wished more and more that I had better impulse control.

Not that the slide has been so terrible. Yes, gold is down 6.3% in the last month. And by slipping below $1,220 per oz. it has violated this year’s pattern of higher high and higher lows.

But year-to-date gold is still up 6%. And in a brief summary of where we are right now…

  • Interest rates are rising, with the Fed having raised in December, March, and June.
  • The Fed is planning further tightening via balance sheet normalization. That is perhaps gold bearish, but should also slow the stock market and drag on bonds, which is gold bullish.
  • Inflation has slowed significantly.
  • GDP growth remains unimpressive. The first quarter managed just 1.4% growth year-over-year; the Atlanta Fed’s GDP Now is currently predicting 2.6% growth for the second quarter, which is supposed to be seasonally stronger. That means first half growth of just 2.2%.
  • Unemployment rates remain low, but wage growth is stagnant.

All told, it’s a mixed environment for gold, neither bullish nor bearish. But gold has done well, its 6% gain year-to-date almost matching the S&P 500’s 8% gain so far this year.

Part of the reason simply has to be relative value. This graph from Incrementum captures the idea nicely by plotting the ratio of commodities, as per the GSCI Commodity Index, versus the S&P 500. Commodities are cheap and stocks are expensive.

Yellen did her semiannual policy report to Congress today, specifically to the Committee on Financial Services. If you glossed over the statement, it seemed similar to previous ones. However, the details were considerably more dovish.

The key bit involved inflation. While she repeated her recent comments about how low inflation readings are likely transitory, she added that there’s “uncertainty” about how inflation will response to reduced slack in the economy.

In other words, she wavered in her inflation optimism.

It’s only one sentence, but it matters to me because it reinforces my outlook that gold should perform well whether the economy strengthens or not. In the simplest terms, either

  • The economy does well, creating inflation. Rates are hiked, but always a step behind inflation (simply because of massive government debt obligations). Real rates stay near zero, which lays the groundwork for gold to perform as an inflation hedge.

or

  • The economy falters. Perhaps the lack of real wage growth fails to create inflation. Perhaps the stock market turns down. Perhaps Trump fails to enact regulatory or tax reform. In this general instance, there is no inflation and therefore rates remain low. Real rates stay near zero and scared investors turn to gold as a safe haven.

After a few weeks of insistence from the Fed that we would see one more rate hike this year and three next, Yellen’s inflation waver is a good reminder that (1) we don’t know which scenario will play out and (2) gold should do well either way.

The worst case scenario for gold is the middle ground, which is where we have been for some time. The economy plows along, making progress but not in a convincing fashion. Inflation levels off. The Fed basically has discretion to hold rates here or increase further, what with employment and inflation numbers sideways. And alongside it all, US markets continue their long and impressive bull run.

The problem with the middle ground is that last point. If investors can keep just making money with low risk US stocks, the safe haven effect is much reduced. Yes, a bull market of this length always carries fear of a crash so there is some Risk Off buying, but not in a substantial way.

But nothing stays sideways forever. Of late bond prices have slid and yields risen. US markets have eased just a touch. The US dollar is off almost 7% year to date. And now Yellen’s inflation waver has given traders reason to believe rates will stay put for a while.

This could all change next week. I’ve had a raft of interesting conversations of late about what might happen next. One fellow suggested cryptocurrencies are playing a major role, in that the $70 billion that has flowed into Bitcoin and Ethereum is money that may well otherwise have gone into gold. Another postulated that Yellen’s rationale for raising rates is all about cooling the stock market, not keeping inflation in check, because she doesn’t want to preside over a market crash (I like that theory). A third brought up the long running idea that inflation is far higher than official stats say, which means real rates are still very negative, something that will manifest sooner or later.

Theories abound, and so they should as they mean people are thinking. My theories are more general.

Given all the unknowns, given the abundance of theories and arguments both bearish and bullish, and given that I remain convinced that real rates will remain near zero and therefore gold bullish in the medium term, I fall back on seasonal patterns.

45-year and 20-year averages for anything are significant and for gold they both, along with the 10-year line, show the metal staying sideways through summer and then starting a run in August. This year’s more pronounced summer slide doesn’t fail to fit this pattern – a sideways average is made up of some years of slide and some of gain.

So with no strong force pushing in either direction but with the basic foundation for gold still strong, I sense that gold will do what it usually does. That means we have a few weeks to prepare for a late summer-early fall run.

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