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Will History Repeat?

Posted by Eric Coffin

on Tuesday, 10 July 2018 13:17

Q2 was not a lot of fun in the resource space.   After a strong Q1, gold started falling in April and, by the end of June, had given up all its gains from its January low, finding itself again below $1250.   While there were companies bucking the trend, including several followed by HRA, a broadening weakness meant that drill results and economic study results, even good ones, became “liquidity events” and financings became rarer and rarer.   So, was that it?  Is the gold sector destined to suck for the rest of the year, if not longer? I don’t think so, for several reasons.  I certainly can’t guarantee a good outcome, but if history is any guide we may be in the midst of a good short term buying opportunity.

The first and most important reason is “seasonality”.  The chart below shows the average gains or losses for gold each month of the year for the past 20 years.  While I need to add the caveat that these are averages and that each monthly figure is subject to wide variability, the positive or negative trend shown for each month has been pretty reliable year to year.  As you can see from the chart, June is the worst month on average and it certainly lived up to that this year with a loss of 4%.  Note that all three months of the third quarter are, on average, positive and that the gains strengthen as we move through the quarter. Based on seasonality alone there are good odds that we see improving gold prices as we move to and through September.

ericjuly18-1

By the end of June, however, gold was deeply oversold, and most sentiment measures were horrible.  That’s good news in this case.  Market sentiment is mean reverting, meaning it tends not to occupy extreme highs or lows for very long. For that reason alone, we’re overdue for a bounce.  As we finish the holiday shortened first trading week of July it looks like we may be seeing the start of one.  We’re in the summer doldrums which doesn’t produce much drama, but there was a notable lightening up of selling and decrease in offered stock for many companies on my watch list.  While we may not see a big runup right away, the worst of the selling may be over for the time being.  We’re also just starting to get to the point where we’ll see exploration news from northern hemisphere explorers.  The heavy news flow won’t come until mid-August but if there are a couple of good discoveries in the mix that will help everyone.

ericjuly18-2

Another reason for optimism is the relative outperformance of gold producer stocks against the gold price.  The one-year chart above of the GDX, the gold miners’ ETF, shows only a mild fall and a quick bounce back in the past couple of months, a much stronger performance than the gold price displayed.  At current levels, the GDX is trading where is was when gold prices were $60 higher and isn’t that far from its 2018 high – though that admittedly isn’t that impressive.  As importantly, GDX refused to break down the way gold prices did in the second half of June.  Historically, gold miner stocks often lead the gold price.  It’s a positive sign that it fell less and, so far, bounced harder.

A big part of gold’s fall is blamed on real or perceived strength of the US Dollar, or perhaps fear that there is much more strength coming.   I haven’t found that explanation very satisfying as the chart of the USD doesn’t seem to support it.  Nonetheless, if that is the reason traders are doing what they do, we can’t ignore it. 

Fear of a stronger USD certainly factored into things in the second half of June.  The US Federal Reserve meeting included somewhat more hawkish comments from FOMC governors and “dot plots” that indicate the Fed is planning four rate hikes this year and perhaps another extra one next year.  That, combined with a dovish ECB meeting a day later, saw the Euro get pummelled and gold taken down with it.

But.  For all the continued worries about a strong USD, that’s not the story of the tape.  The chart below shows the USD trading for the past year.  I’ve noted before that the USD Index has been unable to break convincingly above the 95 level it rallied to last November.  To be sure, the initial surge through the second half of April and May was a strong one.  It’s not surprising gold had a rough time.  Even so, USD has rallied three times to the 95 level and been unable to push past it.  I’m not counting it out just yet, but I view the failure to break through as a bearish omen for the US Dollar.

ericjuly18-3

The latest drop in the USD came after the release of a positive, above consensus jobs report for June that – again – shows no acceleration in wages for non-supervisory personnel.  The continued failure to generate serious wage gains with a 4% unemployment rate again calls into question the “inflation surge” in the US that keeps getting predicted but not materializing.   I’ve touched on this topic several times in the past couple of years in the HRA newsletters.  Q2 economic growth in the US should be strong but I’m not sure how the pace is kept up if we don’t see rising wages. 70% of the US economy is consumer driven.  If you want 4% growth that sticks, someone must be getting paid more.   That, plus the chart pattern above, keeps me skeptical about an immanent second surge in the USD so many have predicted.  Without that happening soon we could see a return to the downtrend and that would help all commodities, especially precious metals.  We’re indeed in the summer doldrums but you should be looking for stories that will deliver strong news flow through Q3 and into Q4 and be positioning yourself. A repeat of gold’s history of good performance in Q3 seems like an odds-on favorite.

Good luck and good trading. 

Eric


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