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Gold surges above $1600 but leaves the miners behind

Commentaries & Views

When I began to invest heavily into the junior resource equity space just after the turn of the century, it did not take me very long to figure out that a surging gold price due to a geopolitical event rarely benefited the miners. When speculating in precious metals stocks, a slow steady climb in the metals due to perceived global central bank recklessness is much more gold equity friendly, not to mention more sustainable.

While the gold price was rising towards long-term resistance at the $1550 level into year-end, the miners led the move due mostly to U.S. dollar weakness along with the Fed’s headline-grabbing liquidity injections into the “Repo” market. But once the GDX reached critical long-term resistance near the $30 level, the global miner ETF began to sell-off when Wall Street's worst fears of a year-end funding squeeze never materialized.

The injection by the world’s largest central bank of a quarter-trillion dollars was enough, for the time being, to prevent the short-term interest rate from rising as it did to 10% on September 17th, 2019. If the Fed did not intervene, then short-term rates would have risen and instead of the consumer paying 20% on a credit card, the rate would have jumped as much as 10% more.

Moreover, once gold began a blow-off move due to the escalating crisis in the Middle East, smart money decided to take profits in the miners despite the price of gold going parabolic. The lack of relative strength in the miners to begin the new year, along with lagging silver, foretold a strong sell-off was fast approaching in the gold complex.

After rising for a blistering 10 consecutive sessions, February Gold surged over $30 higher into extreme overbought territory during the Asian trading session on Tuesday evening, following news that Iran had sent ballistic missiles into Iraq targeting a U.S. airbase. Needless to say, barring an all-out retaliation with an airstrike by U.S. forces in the Middle East, the smart money knew gold was due for a major pullback.

When later news of no U.S. casualties along with Iran stating that they had sent a proportional response to the killing of their top military leader, the safe-haven metal whipsawed sharply lower and ended Wednesday’s session with an outside day to the downside. The volume of contracts on the Comex market in New York for February Gold reached the equivalent of 78.7m troy ounces by late afternoon (vs annual global gold production of ~100m ounces). This equaled roughly to $124 billion worth of paper gold traded in a single session.

In fact, Wednesday’s reversal in U.S. dollar priced bullion was one of the worst trading sessions in gold market history, with the gold price dropping to $1,553 an ounce in afternoon trade – down 3.7% or $60 an ounce from the 7-year peak above $1,613 reached in after-hours trading on Tuesday. The trading action formed an ugly reversal pattern during an extreme overbought condition and has led to a further selloff in prices as sentiment has changed.

With no clear advantage to the U.S. administration in getting embroiled in a full-scale Middle Eastern conflagration, least of all during an election year, President Trump stated earlier this week that he will respond by imposing further economic sanctions on Iran. Consequently, its risk-on again in the marketplace for the foreseeable future. U.S. benchmarks have rallied to fresh all-time highs, making gold less desirable as U.S. 10-year Treasury yields continue to rally.

Furthermore, the latest Commitments of Traders (CoT) report showed record open interest with the commercial traders at a historic long position. With sentiment changing, the managed money crowd has been locking in some profit during this gold price reversal that could escalate the move enough to trigger an apparent trend change. Selling can beget selling and gold could easily correct back under $1,500 or lower.

Unfortunately, there is a three-day lag between the release of the Gold CoT report and the actual positioning of traders. Even though the next report will be issued this afternoon, it will not contain trading data during and after the reversal in the gold price on Wednesday. For this most pertinent managed money trading information, we will have to wait until January 17th to find out how many commercial short contracts have been covered this week.

Although Gold’s trouncing mid-week was the biggest single day fall in dollar terms since 2013, when the precious metal was trading at today’s levels in the mid-$1,500’s, the current economic climate should keep the gold price above strong support at $1480 during this pullback.

Emerging market debt has now exceeded $50 trillion, along with nearly $17 trillion in negative-yield European debt, which had global central banks buying record amount of gold in 2019. According to Deutsche Bank, the total level of debt to GDP has increased from 225% in 1999 to 319% in 2019, as many in government no longer believe that inflation is a concern.

Along with increased uncertainty about the direction of the economy, even as equity markets continue to reach new all-time highs, negative rates should continue to drive up the price of gold as an asset class that famously offers no yield. More rate cuts, forward guidance, inflation targeting and increased asset purchases could all be on the table in 2020, as the Fed looks to support this recovery and remains focused on financial markets.

Additionally, the Fed must continue pumping tens of billions per day into the repo market through at least the end of this month. The central bank’s ability to exit from this market after January will depend on how long it takes the Fed to make its balance sheet large enough so there are adequate reserves in the banking system, making the repo operations no longer necessary.

Last week we saw hints of the repo market situation becoming an international crisis, when Richmond Fed President Thomas Barkin said that in addition to a standing repo facility, long-term fixes providing more liquidity could include adjusting regulations and setting restrictions on other programs, such as the foreign repo pool.

Meanwhile, the recent action in the miners has brought even more frustration for precious metals stock investors into the new year, as the GDX was turned back sharply with rising volume after being on the brink of a major breakout near multi-year resistance at the $30 level last week. Although caution is advised in the short to medium term, the nearly four-year bullish monthly cup & handle pattern is still intact unless we see a monthly basis close below $26 on the global miner ETF.

The recent weakness in the mining sector is creating opportunities to buy weakness in quality gold and silver juniors. Over the past few years, I have positioned Junior Miner Junky (JMJ) subscribers in the best in breed precious metal juniors well ahead of the summer surge higher in the complex. The JMJ real money portfolio gained 35% in 2019, while being up 160% since its inception in 2016. If you would like to receive my research, newsletter, portfolio, and trade alerts, please click here for instant access.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.