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Hedge Funds Are Piling Into This Key Commodity

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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Gold Stocks Press Higher

Gold

The gold miners’ stocks are still marching, grinding higher on balance in a solid upleg. While interest in this sector has faded since late February, it is nicely set up for a strong rally. After consolidating high and establishing a sturdy base, the gold miners are likely to soon report greatly-improved first-quarter results. Couple that with gold itself powering higher, and the slumbering gold stocks should surge substantially.

The gold stocks are mired in something of a psychological limbo these days. They aren’t exactly out of favor, but there’s little enthusiasm for this sector. Investors and speculators have largely lost interest for technical, sentimental, and fundamental reasons. It’s been 6 weeks since this gold-stock upleg surged to material new highs. The major gold miners have been mostly grinding sideways since, consolidating and basing.

Contributing heavily to traders’ apathy is gold’s own price action in that recent span. Gold overwhelmingly drives gold-mining profits, making these stocks leveraged plays on gold. Gold’s own latest upleg high of $1341 came back in mid-February right before gold stocks topped. Over the next 12 trading days gold fell 4.1 percent to $1285 during its usual pre-spring-rally-pullback period. Slumps invariably sap traders’ enthusiasm.

Gold’s seasonal spring rally launched right on schedule after that. By late March this metal had gained back 2/3rds of its pullback losses. The gold stocks surged right back up to challenge their late-February highs on that, but couldn’t break out decisively. Then gold rolled over again during these last couple weeks, revisiting those pre-spring-rally lows. That spooked gold-stock traders, so they sold in sympathy.

Gold’s problem is the great complacency and euphoria spewing forth from the massive rally in the general stock markets. Largely in Q4, the flagship S&P 500 broad-market stock index (SPX) plunged 19.8 percent from an all-time record peak to deep near-bear lows. But since then it has soared 22.2 percent higher in what looks like a monster bear-market rally. The SPX has regained an incredible 9/10ths of its severe-correction loss! Related: Africa’s First Unicorn IPO Is Coming To The NYSE

Gold is the ultimate portfolio diversifier, tending to rally when stock markets fall. Gold investment demand surges as traders rush to diversify stock-dominated portfolios. December was a key case in point, as gold powered 4.9 percent higher while the SPX plunged 9.2 percent. But complacency mushrooms after stock markets rally strongly, and prudent money management is quickly forgotten. So capital inflows into gold wither again.

While sideways-at-best technicals and deteriorating sentiment are the main reasons this gold-stock upleg has stalled, fundamentals played a role too. The major gold miners of the leading gold-stock investment vehicle, the GDX VanEck Vectors Gold Miners ETF, reported their Q4’18 operating and financial results between early February to mid-March. And they proved fairly lackluster due to lower prevailing gold prices.

Yet despite these considerable headwinds, the gold stocks are still marching higher on balance. This chart looks at GDX over the past several years or so. Despite the apathy traders feel, this young gold-stock upleg remains solid. The gold miners’ stocks are still gradually grinding higher in a well-defined uptrend channel. They are well-positioned to surge on any good news, which is likely right around the corner.

(Click to enlarge)

While indifference reigns in this small contrarian sector today, that’s actually a major improvement!  ack in early September GDX plunged to a deep 2.6-year secular low.  old stocks had just been crushed on cascading selling as stop losses were sequentially tripped. hat brutal forced capitulation was the direct result of gold getting hammered by all-time-record gold-futures short selling.  his sector was loathed then.

Those extreme gold-stock lows weren’t fundamentally righteous, so a big mean-reversion rebound higher was inevitable.  hat very week in my essay I argued “The technicals and sentiment spawned by capitulations are so extreme they usually birth massive uplegs and entire bull markets.”  s contrarians we aggressively bought gold stocks and recommended our newsletter subscribers load up near those lows.

The gold stocks indeed bounced and started recovering, gradually fleshing out the solid uptrend channel in this chart.  DX rallied to cross multiple major technical milestones.  simultaneous triple breakout above three major resistance zones was soon followed by a major Golden Cross buy signal.  riggered by a 50-day moving average climbing back above a 200dma after a major low, these herald big runs higher.

GDX rallied 33.0 percent over 5.3 months, regaining recent years’ large consolidation trend between $21 support and $25 resistance.  t its recent highs of $23.36 on February 20th and $23.35 on March 26th, GDX edged into the upper half of this range for the first time in 12.6 months!  he best gold-stock levels in over a year were something to celebrate, technical proof things are changing in this long-neglected sector.

Even better, GDX leveraged gold’s own gains over this upleg-to-date span by 2.8x.  hat’s strong, on the high side of the usual historical 2x-to-3x range.  old-stock gains hadn’t outpaced gold’s to such a degree in years, yet again showing this gold-stock upleg is impressive and robust.  DX’s recent high consolidation was just a normal and healthy mid-upleg drift entirely within its uptrend channel, nothing to fear.

Uplegs naturally flow and ebb, surging two steps higher before slumping one step back.  his rhythm is essential to keep sentiment balanced, which helps maximize uplegs’ ultimate durations and gains.  nce gold stocks blast higher fast enough to rekindle greed, that has to be bled away by subsequent selloffs or drifts.  ithout these retreats, too much buying too fast burns out uplegs prematurely truncating their potential.

So technically the major gold stocks are looking a lot better today than most traders give them credit for.  he consolidating pullback since late February has done its work brilliantly, heavily dampening sentiment while gold-stock prices remain relatively close to upleg highs.  ithout this critical perspective, it’s not too surprising traders are so indifferent.  ut enthusiasm can return fast with the right catalyst, and some are coming.

Without any doubt gold stocks will catch a strong bid when gold’s spring rally resumes.  n December as gold rallied 4.9 percent while the stock markets burned, GDX blasted 10.5 percent higher.  n late January gold surged 3.1 percent higher in a week, fueling GDX soaring 10.7 percent in that short span!  ll gold-stock traders really care about is gold, and rightly so. nce gold gets moving again, the gold stocks are going to surge sharply higher.

There are two big catalysts that could start pushing gold considerably higher any day now.  old-futures speculators drive much of gold’s short-term price action, and closely watch the US dollar’s fortunes for trading cues.  he US Dollar Index (USDX) hit a major 20.5-month high in early March, and is likely to roll over soon.  he Fed just kneecapped the US dollar by slashing its rate-hike outlook and prematurely killing QT!

Related: Positive Economic Data Weighs On Gold

Any meaningful dollar selling will drive big gold-futures buying, pushing the yellow metal higher.  good example of this just happened in mid-March.  fter hitting that major high, the USDX retreated 1.8 percent over the next couple weeks or so.  old bottomed the very day the dollar topped, then rallied 2.2 percent in that span on gold-futures buying.  DX amplified that with a solid 3.9 percent advance.  old stocks rally on a weaker dollar.

The US stock markets are way overextended and overvalued, also ready to roll over imminently.  his week the monster likely-bear rally in the SPX had carried it back within just 2.0 percent of late September’s all-time record peak!  ut such lofty levels aren’t fundamentally-justified.  he 500 elite SPX stocks left March trading at average trailing-twelve-month price-to earnings ratios way up at 26.4x, near bubble territory.

And even the Wall Street perma-bulls universally expect SPX earnings growth to be flat at best in 2019.  his is a colossal slowdown from 2018’s 20 percent+ driven by Republicans’ massive corporate tax cuts.  ery-expensive valuations aren’t sustainable without surging profits.  s the general stock markets start selling off again, investors will resume returning to gold.  heir capital inflows will drive its price higher, boosting the miners.

A great proxy for gold investment demand is the physical gold bullion held in trust for shareholders of the world’s largest and dominant gold ETF, the GLD SPDR Gold Shares.  ack in early October with the SPX still just under record highs and complacency extreme, GLD’s holdings fell to a deep 2.6-year secular low.  hey started climbing again the very day the SPX first plunged, as American stock investors remembered gold.

Their big differential-buying pressure on GLD’s shares drove its holdings up 12.8 percent to 823.9 metric tons by late January.  hat helped push gold 8.9 percent higher over that span, which GDX leveraged with a nice 17.8 percent gain.  old buying, whether from gold-futures speculators watching a flagging USDX or American stock investors worried about a rolling-over SPX, will push its price higher.  hat will bring traders back to gold stocks.

Gold’s upleg resuming is the key to reigniting gold stocks’ own upleg.  ut the major gold miners’ nearing Q1’19 earnings season should provide further fundamental justification for big gold-stock buying.  dds are their results will show big improvements over Q4’18, which should catch investors’ and speculators’ attention and entice them back.  he main reason is higher prevailing gold prices really boosting earnings.

Every quarter I dive deeply into the major gold miners’ latest fundamentals.  everal weeks ago I looked at the just-reported Q4’18 results from the top 34 GDX components.  hose were lackluster, with lower production, higher costs, and lower prevailing gold prices.  hile gold averaged $1228 per ounce in Q4, the major gold miners’ average all-in sustaining costs rose to $889 per ounce.  rofits were the difference at $339.

Q1 is going to look far better, which most gold-stock traders likely haven’t figured out yet given the apathy for this drifting sector.  hanks to the SPX’s severe near-bear correction largely in Q4, resurgent gold investment demand catapulted it a major 6.2 percent higher quarter-on-quarter to average over $1303 in Q1.  he considerably-higher prevailing gold prices should combine with flat-to-lower AISCs to greatly boost earnings.

All-in sustaining costs generally don’t change much regardless of gold’s action.  hey are largely fixed as mines are being planned.  perating them generally requires similar levels of spending on infrastructure and employees quarter after quarter.  ver the past 4 quarters, the GDX-top-34 gold miners’ AISCs have averaged $884, $856, $877, and $889 per ounce.  hat works out to a tight mean of $877, close to $875.

If the major gold miners produced gold last quarter at $877 per ounce, that implies $426 profits given the $1303 average prevailing gold prices in Q1.  hat would make for utterly-enormous 25.7 percent QoQ growth in gold-mining profits!  uch massive earnings growth would really catch investors’ attention, especially with general stocks’ profits expected to be flat at best.  old-stock fundamentals radically improve with higher gold.

And all this is happening during one of gold stocks’ strongest times of the year seasonally, their powerful spring rally.  explained this next chart in depth about a month ago in my latest spring-rally essay, and it’s important to remember.  old stocks have powered sharply higher on average between mid-March to early June in modern bull-market years.  e’re talking 12.2 percent average gains in the benchmark HUI gold-stock index!

(Click to enlarge)

t only is gold stocks’ spring rally underway, but it’s this sector’s second-strongest seasonal advance of the year.  E n if much-stronger fundamentals weren’t likely, even if gold wasn’t due to continue powering higher on a weakening US dollar and rolling-over stock markets, gold stocks tend to rally considerably in the spring.  G atly-improving earnings and stronger gold prices will really amplify this seasonal strength.

Strong seasonals act like tailwinds, boosting gold-stock uplegs fueled by improving technicals, sentiment, and fundamentals.  W n all these forces align, the gold-stock gains can be enormous.  T last major spring rally happened in 2016, part of a monster gold-stock upleg where GDX skyrocketed 151.2 percent higher in just 6.4 months driven by a parallel strong gold upleg.  G blasted 37.7 percent higher in that spring-rally span!

Although traders’ apathetic view on gold stocks in recent weeks is understandable, it isn’t justified at all.  T s sector has big potential to run much higher in the next couple months, which most traders aren’t yet ready for.  T time to get deployed is of course before gold stocks surge higher again, when they can still be bought at relatively-low prices.  T s consolidation-drift window won’t last long, as gold is due to rally.

While investors and speculators can ride gold stocks’ next move higher in GDX, that is suboptimal.  T largest gold miners dominating its weightings are really struggling with depleting production, retarding this entire ETF’s upside potential.  F -better gains will be won in the smaller mid-tier and junior gold miners.  P nty of them have superior fundamentals to the large majors, growing their outputs and driving down costs.

The bottom line is gold stocks are still marching higher despite the pall of apathy hanging over them.  T s upleg that excited traders back in February remains intact, with this sector simply pulling back within its uptrend.  T t has rebalanced sentiment, bleeding away greed.  T s basing has left gold stocks ready to rally to new upleg highs again, fueled by better gold prices greatly improving gold-mining fundamentals.

Gold-mining earnings are set to surge quarter-on-quarter due to gold’s own upleg powering higher.  I too is on the verge of accelerating again as buyers return.  A eaker US dollar and rolling-over stock markets will motivate speculators and investors to buy gold again.  A naturally the gold miners’ stocks will really leverage those gains like usual.  E ecially this time of year in the midst of their strong spring-rally season.

By Adam Hamilton

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  • Tom on April 08 2019 said:
    "Their big differential-buying pressure on GLD’s shares drove its holdings up 12.8% to 823.9 metric tons by late January. That helped push gold 8.9% higher over that span..."

    Adam, you've made the same claim many times in your past articles. This still contradicts data and even your own charts. In your previous charts comparing GLD's holdings with the gold price, you can see numerous periods where the gold price leads GLD's holdings rather than the opposite. So which data leads which data again? In Jan 2017, there was a 7.4% rise in the price of the GLD, which means people have been buying. Yet, since gold bottomed, GLD's holdings have fallen another 4.3%. It fails as both a leading and a lagging indicator. There are many other examples outside of this January example as well. This indicator is useless as proven by its track record. Also, the gold exchanges completely dwarfs GLD's movements. GLD's movements are so very insignificant compared to the overall gold market.

    "GLD’s holdings fell to a deep 2.6-year secular low"

    "Their big differential-buying pressure on GLD’s shares drove its holdings up 12.8 percent to 823.9 metric tons"

    "physical gold bullion held in trust for shareholders of the world’s largest and dominant gold ETF, the GLD SPDR Gold Shares"

    Again Adam? I still have yet to see any verifiable evidence to support any of these claims. How reliable are GLD's holding reports? GLD does not give retail investors the right to redeem for any of its mystery physical gold holdings. This fact alone ensures the GLD shares to be nothing more than paper at the end of the day. Daily, even in great detail, doesn't mean much when there is absolutely no way to verify any of it.

    GLD also has a glaring audit loophole in their prospectus that states they have no right to audit subcustodial gold holdings. To this day, I have not heard of a single good reason for the existence of this backdoor to the fund. For anyone interested but have not heard, I recommend looking into CNBC's Bob Pisani making a highly publicized visit to GLD's gold vault in a segment called Gold Rush: The Mother Lode. GLD's management organized this visit to show that GLD's gold actually exists. However, the gold bar held up by Mr. Pisani showed a serial number of ZJ6752 which did not show up on the latest bar list during that time. It was later discovered that this "GLD" bar actually belonged to ETF Securities.

    Note that even on the subject of GLD's insurance, they are not at all straightforward about it. Their representatives will not confirm nor deny the existence of GLD's insurance. I recommend anyone curious about this to confirm via calling GLD's publicly listed number for general inquiries at 866 320 4053 and ask about this clause from the GLD prospectus: "The Custodian maintains insurance with regard to its business on such terms and conditions as it considers appropriate which does not cover the full amount of gold held in custody." Exactly how much of the fund is insured? They will not give you a straight answer and might even throw in some bizarre excuse which I've experienced. Why hide this information from investors? The people behind GLD certainly do not seem like the most honest types.

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