After an abysmal Q1, gold bounces into Q2
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The combination of the miners underperforming the gold price and a soaring U.S. equity market to begin 2021, gave miner investors little reason to hold gold stock positions heading into quarter-end last week. With investors being more focused on what seems to be forever rising equity markets and cryptocurrencies, they wanted nothing to do with the miners of gold.
As mentioned in this column two weeks ago, gold stocks relative weakness to the price of bullion heading into quarter-end foretold the move down to re-test the corrective low in the $1670-$1680 region last week. But with the safe-haven metal being off to the worst start to any year in 39 years taking sentiment and technicals to bearish extremes, a short-covering bounce from those lows was likely as hedge funds booked quarter-end profits on the last trading session of Q1 last Wednesday.
With news headlines declaring gold having the worst start to the year in almost four decades, along with the worst quarterly performance in more than four years, we also saw some follow through contrarian buying into the 3-day holiday week-end. This recent price action has formed a double bottom technical pattern on the daily chart of gold, which will be more convincing if the metal can muster a weekly close above strong resistance at $1775.
The gold move through resistance at $1752 yesterday was fueled by comments made by Federal Reserve Chair Jerome Powell during a virtual International Monetary Fund Seminar. When asked about inflation, Powell once again reiterated that there is a difference between a one-time price increase and persistent inflation. "Inflation is something that goes up year after year. The level of inflation is dictated by underlying inflation dynamics versus bottlenecks."
"We've had 25 years where inflation has been low. Some countries are fighting off disinflation. Now we have a situation where economies are reopening. There will be a surge in demand. There will be bottlenecks, perhaps. But they are unlikely to change inflation dynamics that have been in place for many years," Powell said. "Price increase will be temporary. There is no certainty in this. But if inflation expectations were to move up materially and persistently above 2%, we would react."
Even though gold's increased sensitivity to interest rates may remain a significant headwind to its performance in the short to medium-term, the recent sharp increase in interest rates has begun to level off with central banks continuing to use monetary policy tools to keep them in check.
Despite the intense focus on rising yields during Q1 that kept pressure on the gold price, 10-year T-Bond yields have begun to roll over to begin Q2, while the overall level of yields remains structurally low.
Although we are not out of the woods by any means yet in regards to the gold complex, bullion seems to be in the process of an important transition in sentiment, technicals, and fundamentals with investors likely to remain focused on rising inflation expectations.
When gold first struck the $1670-$1680 low during the first week of March, DoubleLine CEO Jeffrey Gundlach told Kitco that inflation will be above 3% within months. Gundlach is worth listening to, as investors have entrusted over $141 billion to his fund.
"The Fed chooses to be unconcerned about a period of time with inflation running above 3%," Gundlach said. "In my opinion, not only are they unconcerned, they welcome inflation being higher than interest rates. They like negative interest rates because they know that negative interest rates help to forestall the incredible deficit and unfunded liability problems the United States has."
There is even a chance that inflation could rise to 4%, which would "really spook" the bond market. "One could actually plausibly predict that headline CPI could go over 4% at some point in about four months from now," he added.
Hence, investor concerns over accelerating inflation, and the more gold friendly stagflation, could see capital rotating primarily into the precious metals complex instead of general equities in the not-too-distant future.
The first week of Q2 has also seen reports of retail dip buying during the first quarter of 2021. As the gold price was falling 10% in Q1, global retail demand increased with reports of strong buying coming from coin sales in the U.S and the Perth Mint in Australia, along with a record 321 tons of gold purchased in India during the first quarter, up from 124 tons a year ago.
Moreover, after a pause in central bank gold buying last year, there are signs of new activity in the space as Hungary tripled its gold reserves. Hungary's central bank raised its gold holdings to 94.5 metric tons from 31.5 tons, citing “long-term national and economic policy strategy objectives.” This marked one of the most significant central bank gold purchases in decades.
Meanwhile, the miners have begun to show some relative strength to the gold price to begin Q2, while many quality juniors that became oversold after strong moves into the August 2020 high are forming bottoming patterns.
Despite gold's 8-month pullback, many larger-cap gold mining stocks began to recover in early March, with larger-cap miners and royalty firms providing a positive offset to the more-riskier junior companies. Gold mining equity valuations have become more compelling to investors, after markets over discounted the sector's favorable operating and financial conditions.
With all-in sustaining costs (AISC) averaging roughly US$1,000 per ounce, miners continue to demonstrate that even in a lower gold price environment they can generate solid cash flow to pay dividends, maintain capital discipline, and sustain healthy balance sheets.
Additionally, quality precious metals juniors have seen some follow-through buying this week as well. While most quality juniors have already been “reflated” during this correction, investors losing patience and hitting the bid into quarter-end last month created a buying opportunity for patient speculators waiting for lower risk entry points in their favorite cashed up gold stocks.
With many quality juniors having corrected 50% after making huge moves into last August, this is a good time for precious metals stock speculators to position themselves into a basket of quality juniors before the next gold up-leg begins in earnest. If you require assistance in doing so, and would like to receive my research, newsletter, portfolio, watch list, and trade alerts, please click here for instant access.