December 03, 2021
Gold declined -1.2% this week to US$1,769/oz, holding up quite well during an abrupt downturn in equity markets on indications by the Fed of a potentially more aggressive than expected taper, and another wave of global health crisis fears.
Given the market's dip, this week we look at instruments that gain when markets fall, including Short ETFs on gold and silver metals and miners, although these tend to have high tracking error, with the safest Short ETFs only on the S&P 500 overall.
Gold dipped this week -1.2% to US$1,769/oz, holding up quite well compared to the significant plunge in stock markets. The drop was driven by two issues, the broader driver of another wave of global health crisis fears, and the Fed indicating a potentially more aggressive than expected taper. The stock market decline was a test of the ability of the metals and metals stocks to withstand a market downturn and also showed which Canadian junior gold miners saw the most support from the market. This gives us some read across for which assets might hold up best if we see an extended market decline, especially given valuations for the S&P 500 at all-time highs. We urge all investors to at least consider the potential for downside in stocks, and be prepared to endure a market dip, even if gold itself holds up.
Gold dropped just -0.9% from November 24, 2021 to November 30, 2021, substantially outperforming copper, down -3.3%, and silver, declining -3.1% (Figure 4). The stock market decline was global, with both the S&P 500 and the MSCI World down -2.9%. Gold and silver producers saw similar declines, down -1.9% and -2.0%, respectively, while the copper producers declined -3.1%, as they are more exposed to a slowdown in global industrial production. The gold juniors took a substantial hit, down -3.1%, possibly because they had enjoyed a bit of a strong run over the past two months, in comparison to the silver juniors, which declined 2.5%. The producers tend to hold up better when markets are nervous, given their revenue and proven resources, while juniors tend to get hit, given their lack of revenue and need of continued capital inflow to continue exploration. The recent dip shows the relative risk the market is seeing for copper and the copper producers, which both were outperformed even by the risky gold and silver juniors. The weakest performance was from the global miners ETF, down -3.6%, which includes a large component of copper and base metals producers, likely on similar concerns of an industrial slowdown.
The decline also gave us a look at which TSXV junior gold miners are looking the most
resilient to a downturn, and which stocks the markets may be prepared to reduce
their positions in if an extended downturn started. To the upside, Rupert Resources,
which continues to see strong drilling results from the Ikkari zone of its Rupert
Lapland Project, held up the best, rising 8.0% from November 25 to December 2,
2021, after trending down since its initial mineral resource estimate in September
2021 (Figure 5). Orezone was also strong, up 4.0%, as it advances its low cost
Bombore project in Burkina Faso toward production, expected by Q3/22. Bluestone
gained 2.3% as it continues to show progress on its Feasibility Study for Cerro Blanco.
Two major underperformers were Pure Gold, down -14.5% and Mako Mining, down -10.0%, both of which have made the transition to production over the past year and are firmly out of the hype-on-drill-results phase for juniors, which often sees a substantial decline in share prices. Gabriel Resources also saw significant -12.2% decline, understandably, as it is mired in arbitration with the UNESCO and Romania, with the area covering its Rosia Montana project having been declared a World Heritage Site, preventing development of the asset and limiting any short-term drivers. Artemis, down -10.3%, and New Found Gold, declining -8.0%, had seen strong outperformances of the sector over the past year, and investors may have been locking in gains. Lion One dipped 8.0%, as it continues to drill at Tuvatu to expand its current resource, with the project still relatively small.
We still expect that the Fed taper, regardless of this recent head fake of aggressive action, will be much lighter than expected, and halted at the first sign of a major stock market contraction, at which point it will be right back to money printing. We can see this from the Fed's track record over the past thirty years in general, but especially over the past decade since the financial crisis, shown in Figure 6. There was much talk that the expansion of the Fed's balance sheet in 2008 would only be an emergency measure, and that a winding down of its assets would eventually happen.
However, the only time the Fed reduced its assets since the 2008-2009 crisis was a
brief period from early 2018 to mid-2019. The global health crisis expansion of the
Fed's assets absolutely dwarfed the level of 2008, and they have now maintained a
steady pace of balance sheet expansion, averaging a net US$105bn per month since
August 2020 (Figure 7). This is in keeping with its policy to purchase US$120bn in
bonds per month, which will be tapered by US$15bn per month with some analysts
saying the reduction could possibly rise to US$30bn.
The reason that the taper talk is making markets nervous, is that this steady flow of liquidity over the past year has been crucial in driving up the stock market, which has reached near all-time high valuations. While liquidity could conceivably be withdrawn from a stock market at more reasonable valuations without causing much mayhem, the US market is looking precarious. As the flow of new money from the Fed slows, equity gains could ease and this could start to concern some investors that a top is in, and they may begin to reduce positions.
If it becomes clear that the tapering is becoming more aggressive, or even worse, interest rates are hiked, signaling an actual reduction in the money supply, not just a slower expansion of it, the market could easily face a major correction given the currently elevated valuations. Fortunately, for the short-term, some of the immediate panicked reaction to the Fed's potentially more aggressive taper and new wave of the global health crisis seemed to have eased off.
While we expect that Fed is likely to step in with heavy liquidity following a market
correction, there could still be a period of many months of stock declines in the
interim. Investors should therefore consider an action plan if the Fed does spook
markets with a relatively aggressive taper. There are instruments which can generate
a profit in a downturn available to general investors, with Short ETFs among the
simplest and easiest to access. For a more detailed explanation of the full range of
options to profit from market downturns, see our Weekly from September 17, 2021.
While regular ETFs will rise as the index or asset underlying it rises, Short ETFs will decline as the underlying index or asset rises and rise at it falls. One major risk with these instruments is that they are targeted to give the inverse return only on a single day, but not over time. These instruments tend to have tracking errors from the target return on the day, and these compound over time, so that over a month or even a week, a -1% decline in the asset will not necessarily translate to a 1.0% rise in the Short ETF. The other issue is that many Short ETFs are designed to have a 2x or 3x inverse return, which means that an investor needs very strong conviction of the direction of the trade on a single day.
We can see issues with tracking error for some of these instruments even over short periods of a few days in Figure 8. Gold dropped -0.9% from November 25, 2021, to November 30, 2021, for a theoretical gain for a -2x gold ETF of 1.9%, and for a -3x gold ETF 2.7%. We can see that the Proshares -2x gold ETF has a very low tracking error, as it is up 2.0%, nearly exactly what we would expect. However, Velocity's -3x ETF is down -1.1%, when we would expect a 2.8% gain, because of high tracking error even over just a few trading days. For the silver ETFs, the Proshares -2x ETF gained 6.7%, overshooting the theoretical 5.4% expectation, as did the Velocity -3x Silver ETF, up 10.4% versus an expectation for 8.2%. In these cases, tracking error can work in investors' favor, but this tends to be short-term, and over long periods, it generally erodes returns.
We can see the longer-term effect of tracking error in the performance of Direxion's -2x gold miner and junior gold miner ETFs. The gold miner ETF intends to return -2x the return of the NYSE Arca Gold Miners Index on the day. Starting from a year ago, in December 2020, the tracking error is quite low even for three months, with the index down -13.1%, and the ETF up 24.8%, close to the 26.0% that would be expected, with no tracking error. However, within a year, the tracking error has eroded the gains, with the index down -10.6%, for an expected 21.2% gain, versus the actual increase of 1.7%. The situation is similar for the junior gold mining ETF, with the return through to February of 26.3% close to twice the inverse of the -14.8% decline in the index. However, by November, the index is down -21.6%, suggesting a theoretical 43.2% gain, but the inverse ETF is up just 13.7%.
This raises the question, are there any Short ETFs that have low tracking error, even over the long-term? They are rare, and we have found only two with a low tracking error over a year, the Proshares S&P 500 1x (SH) and 2x (SDS) Inverse ETFs. Obviously, these are not plays on the metals sector directly, but as a general hedge for downside movements in markets, can be considered beyond just a very shortterm gamble. Figure 10 shows the tracking error, with the S&P gaining 26% over the past year, and the -1x S&P 500 ETF returning -24%, near the -26% that would be expected. While the tracking error of the -2x S&P 500 ETF is higher, with a -42% return versus the -52% expected, it still generally captures the direction and magnitude of the move. Overall, the Short ETFs should be considered 'playing with fire' and only be used by investors with considerable understanding and caution, and only the SH and SDS at all are probably safe beyond very short holding periods.
The producing gold miners were all down on the decline in stock markets and gold (Figure 11). Agnico-Eagle announced that its merger with Kirkland was approved on November 26, 2021, and Kirkland Lake received a notice to investigate and resolve low-level frequency noise from the Fosterville Mine from the Environmental Protection Authority in Victoria, Australia. B2Gold completed its sale of its 81% holding of the Kiaka gold project in Burkina Faso to West African Resources (WAF) for cash of US$22.5mn, 22.19mn WAF shares and net smelter royalties. SSR Mining reported drill results from Copper Hill and Iamgold reported drill results from infill drilling at the Diakha deposit of the Diakha-Siribaya-Gold Project in Mali (Figure 13).
The Canadian juniors were nearly all down as equity markets and gold fell (Figure 12). For the Canadian juniors operating mainly domestically, New Found Gold closed its acquisition of three royalty interests for $3.9mn and Tudor Gold reported drill results from expansion and definition drilling at the Goldstorm zone of Treaty Creek (Figure 14). For the Canadian juniors operating mainly internationally, Rupert reported drill results from the Heina and Ikkari zones of its Rupert Lapland Project, Novo Resources reported new targets from geochemical sampling adjacent to Azure's Andover and Artemis's Carlow Castle. Lumina reported the results of its AGM, including the conversion of debt to equity by Ross Beaty, Mako Mining reported its Q3/21 results, including production of 8,280 oz Au, and Lion One reported results from an infill drill and re-sampling program on the near-surface portion of Tuvatu (Figure 15).
Disclaimer: This report is for informational use only and should not be used an alternative to the financial and legal advice of a qualified professional in business planning and investment. We do not represent that forecasts in this report will lead to a specific outcome or result, and are not liable in the event of any business action taken in whole or in part as a result of the contents of this report.