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Global central bankers add more stimulus to gold miner bull

Commentaries & Views

Shares of the global gold miner fund GDX rallied 40% in April as the coronavirus crisis rocked global markets and investors raced to buy safe-haven assets. While investors debate whether the lasting effect of the Covid-19 virus will be deflationary or inflationary, gold has emerged as the safe asset of choice after the dash to cash subsided in mid-March.

Meanwhile, gold is consolidating recent gains as central banks scramble to introduce more stimuli to boost the economy. Global central banks remain under pressure to do more to support their economies through the coronavirus recession, even after driving interest rates to record lows and pledging to spend trillions of dollars on asset purchases.

The U.S. Federal Reserve, Bank of Japan (BOJ) and European Central Bank (ECB), which together cover almost half of global output, all convened in meetings of policy makers this week. The pandemic-driven freezing of economies by global governments have propelled them into action to provide ever more monetary stimulus to their respective economies.

The BOJ set the tone Monday by scrapping a limitation on buying government bonds and ramping up its purchases of corporate debt. The central bank revised down its GDP forecast to a range of -5.0% to -3.0% from the +0.8% to +1.1% outlined in January. The BOJ has effectively destroyed its bond market and owns between 70% and 80% of ETF bonds in Japan, which has ended free market determination of interest rates for the municipal level.

Then on Wednesday, the Federal Reserve projected an air of confidence in the face of economic data pointing to the worst downturn in economic activity since the Great Depression. After announcing the central bank will keep interest rates near zero until the economy has "weathered recent events", Fed chairman Jerome Powell stated in the Q&A session which followed the prepared statement that the Fed will continue to "Forcefully, proactively, and aggressively" support lending markets.

Powell also said he expects next Friday’s unemployment rate announcement for April to spike to around 10% compared to the pre-pandemic historically low level of 3.5%. With the rate expected to range from 15% to 20% in the medium term, the Fed is all but certain to be very active through 2021 and probably into 2022. Over 30.3 million Americans have lost their jobs over the past six weeks, according to new data released by the Labor Department on Thursday.

New unemployment filings reached 3.84 million last week due to the coronavirus crisis impacting nearly every business sector. The crisis in unemployment is now more apparent than ever and in contrast, 8.7 million jobs were lost during the 2008 financial crisis. Rising unemployment and uncertainty has led to a drastic decrease in consumer spending, which composes two-thirds of U.S. GDP. Chairman Powell stated that he sees consumer spending continually declining and called the current situation the worst crisis he has seen in his lifetime.

The world’s largest central bank has already exceeded its rescue effort in the 2008 financial crisis to soften the blow of the pandemic and continues to buy assets like never before. The Fed’s balance sheet has already ballooned $2.41 trillion since the end of February, with total assets of $6.57 trillion last week—a figure that is expected to exceed $10 trillion by the summer.

Next up, the European Central Bank (ECB) reaffirmed its commitment yesterday to supporting the European economy. After the central bank decided to keep interest rates unchanged, ECB President Christine Lagarde stated the committee stands ready to increase its coronavirus stimulus program if needed, as the euro zone faces a much deeper economic crisis than the U.S.

The ECB said it would make loans to banks even cheaper, but kept the terms of its hallmark asset purchase scheme unchanged, disappointing investors who had bet on even more money-printing and bringing some profit taking into the gold complex at month-end.

Nevertheless, the unprecedented monetary stimulus actions by global central banks are playing into gold equity strength, as the GDX continues to consolidate its gains above the recent breakout of its 7-year base.

Although the gold complex sold off on the last day of April, as fund managers booked profits with some month-end book squaring yesterday, the outlook for the miners going into Q1 earnings season next week is mostly positive. While the gold price rose to fresh 7-year highs from a $1550 base last quarter, miners who have been able to maintain production during the pandemic will be reporting nice profits beginning next week.

Furthermore, sell side analysts have been raising target prices on many of the late stage junior developers as the market has begun to price in a new $1550 floor in the gold price. As mentioned last week in this column, the junior sector has been catching up to the miners this week and have also begun to show relative strength to large cap firms.

With the over-bought GDX in the process of testing its monthly breakout line near the $30 level early this morning, I expect weakness to continue being bought in the undervalued junior space. Although many of the more speculative developer/explorers and early stage juniors have risen considerably over the past few weeks, most remain well off their 2016 highs and have yet to regain losses from the recent sell off.

Despite the GDX having broken out of a 7-year base and being back to a leading position relative to other sectors, the junior space remains cheaper relative to gold than at almost any other point in the last ten years. When combining the undervaluation of this tiny sector with the unprecedented monetary stimulus measures from global central banks continuing for the foreseeable future, the junior sector should outperform the miners over the next few years as has been the case during previous gold stock bull markets.

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