Gold stock mean-reversion in progress
Despitelong-term interest rates continuing to move upwards, the precious metal’ssector has been steadily finding buyers since late September. Previously,rising bond yields acted as a factor for selling both gold and silver, payingno dividends or coupons. I believe the main reason for the recent dis-connectis investors viewing inflationdifferently sincethe end of September.
Never-endingsupply chain problems, high energy prices, and accelerating wage growth hasbeen amplifying pro-inflationary factors. This trend shows no sign of slowingdown anytime soon and has investors questioning the world’s largest centralbank’s “temporary” argument regarding inflation.
Last week,the U.S Bureau of Labor Statistics released the inflationary numbers forSeptember, which showed U.S Consumer Price Inflation (CPI) accelerated by awhopping 5.4% from a year ago - its largest increase since July 2008.
Just likethe U.S., every economy around the world is experiencing a rapid surge in inflation.Canada’s CPI rose 4.4% YoY in September, according to a report released byStatistics Canada on Wednesday. This marks the fastest pace of growth sinceFebruary 2003. Excluding gas, CPI rose 3.5% YoY, while monthly CPI hasincreased for the past nine consecutive months. Prices in every major sectorsaw gains, with transportation seeing the most notable increase at 9.1%.Shelter prices rose 4.8%, while food prices rose 3.9%. Basic living expenses,such as food, continue to rise.
According tomany leading economists, the actual global inflation figures are likely muchhigher than being reported, because of the obvious understatement in housingand food costs buried in recent Consumer Price Index stats.
As the gold pricecontinues to trade in a tight $80 trading range over the past six weeks, withan upward bias, a major mean-reversion catch-up rally is in the process ofunfolding in the mining space due mostly to inflation fears.
Thecombination of the miners underperforming the gold price and an elevated U.S.equity market since mid-June had given resource stock speculators little reason to hold under-waterpositions headinginto Q4. Gold stocks began to be sold for tax-loss in mid-June, as nervousnessregarding the expectation of future tightening of monetary policy increased.
Althoughtax-loss selling season generally takes place during the tail end of the year,with the tiny gold sector being an under-performing boat in a sea ofout-performing ships in 2021, junior gold stocks became hated to the point ofearly tax-loss fueled capitulation. Many gold stock bag-holders who chasedjuniors making 5x to 10x moves higher, in the space of less than 5 months intoAugust of 2020, began to capitulate positions at the start ofH2/2021.
However, Fedtightening fears set up the perfect storm for contrarianmoney patientlywaiting to pounce on tax-loss selling deals in quality juniors heading into Q4.During this secular gold bull that began at the turn of the century, theprecious metals sector routinely pendulum swings from extreme greed, whenspeculators should be trimming profits; to extreme fear, when cashed-up contrariansshould be buying at lower-risk/reward entry points before the next up-legbegins.
Gold miningstocks have a solid history of outperforming gold prices on the upside as wellas to the downside. Gold Futures hit an all-time high of $2,089 on early Augustof 2020 and are down 15% from that level, trading at $1,781 per troy ounce asof Thursday. Shares of GDXJ are down 33% during the same period, closingThursday at $44.
Looking at a 15-year monthly chart of the GDX, the VanEck Gold Miner ETF took7-years to breakout of a huge 7-year accumulative base above $31. After themove in 2020 became extreme overbought above $45, a healthy 14-month consolidationof a 4.8-month surge higher came down to test this breakout level last month.
Into the endof Q3, GDX broke below $31 on a monthly basis, but that breakdown may have beena bear trap. Prices have since recaptured this critical support level, and hasthe potential for a significant bottom if the global miner ETF can maintain $31at the end of October. A sustained breakout back above the 18-month movingaverage at $35.50 could signal the beginning of the next leg higher.
If the Fedgives us the "soft taper" as expected after the next FOMC meetingconcludes on November 3rd, I expect a "buy the news" reaction fromthe gold complex based on the over-reactive pullback due to "taper-talk" thathas taken place over the past four months. Between mid-June to late September,the VanEck Junior Miner ETF (GDXJ) dropped over 30% in anticipation of the Fedstarting to slow its colossal fourth QE money-printing campaign, while the goldprice dropped 10%.
Over thepast few weeks, while most investors remain more focused on rising equitymarkets and cryptocurrencies, cashed-up contrarians have already beenbottom-fishing deeply oversold precious metals juniors. With both the mining sector and the silver price continuing to showrelative strength tothe price of gold over the past few weeks, one-by-one, quality junior gold andsilver stocks have been breaking out of 14-month bullish falling wedge chart formations.
Althoughboth GDX and GDXJ have become short-term overbought on a daily basis, I expect weaknessto continue being bought quickly in quality juniors which became deeplyoversold into Q4. With the mining complex beginning to mean-revert to the priceof gold, this is a great time to begin scaling into quality precious metalsjuniors on weakness before the next up-leg is confirmed in this secular gold bull market. If you require assistance in doingso, and would like to receive my research, weekly newsletter, portfolio, watchlist, and trade alerts, please click here for instant access.
By David ErfleContributing tokitco.com
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