Contributed Commentaries
The junior gold stock fire sale may be ending soon
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Despite the highest inflation figures since 2008, along with a stock market sell off, gold has been consolidating its outsized gains from last week. Buy stops were triggered once the gold price broke out to the upside above the wall of technical resistance at $1800 per ounce and quickly moved towards the next resistance zone at $1850 into Monday's Comex session.
Then after technically becoming short-term overbought to begin the week, bullion has come under pressure in response to higher-than-expected inflation data. On Wednesday, U.S. Consumer Price Index (CPI) data for April came in far above expectations, with prices rising 0.8% on March, and up 4.2% year-on-year.
These figures came in just after China's Producer Price Index (PPI) also showed a staggering increase of 6.8%. This number raised fresh concerns about the prices consumers in the west will be charged for goods over the year, ahead of a rise to manufacturing costs that will likely be passed on to consumers.
Bond yields rose on the news as investors sold them off in favor of the U.S. Dollar, and these two factors dampened any gains that precious metals could have received from the news on inflation.
Then on Thursday, the U.S. PPI showed a 0.6% rise in April, double the average estimate from economists. This number stretches the one-year rise in the gauge to a whopping 6.2%. Also ahead of economist's consensus was the core PPI figure, the more volatile food and energy components of the index, which was up 0.7% in April and 4.6% year over year.
The prospect of higher inflation has the marketplace speculating on a tightening of monetary policy ahead of the current Fed mandated "dot-plot", giving the U.S. Dollar a boost and triggering some backing and filling of gold's recent move of
outsized gains over $1800.
With the gold price down after the CPI data on Wednesday, then up on PPI data the next day, markets continue to debate on how much of a risk inflation is, against when central banks will tighten fiscal policy in response to the Federal Reserve insisting it is "transitory." But central banks will likely continue to stick to this transitory stance for some time yet, while it will take a few months before any conclusions can accurately be drawn.
The Federal Reserve needs "several more months of data" to ensure recent weak job growth and high inflation are temporary before considering changes to its ultra-easy monetary policy, Fed Governor Christopher Waller said on Thursday.
In terms of the labor market, the Fed has said it would not alter its $120 billion in monthly bond purchases until there has been "substantial further progress" in putting people back to work, with an increase in the current near-zero benchmark overnight interest rate even further down the road.
The May and June Non-Farm Payrolls (NFP) reports "may reveal that April was an outlier, but we need to see that first before we start thinking about adjusting our policy stance," Waller said. "Now is the time we need to be patient, steely-eyed central bankers, and not be head-faked by temporary data surprises."
In the meantime, the Fed has pledged to continue buying $120 billion per month of U.S. Treasuries and mortgage-backed securities. Its balance sheet is currently at $7.8 trillion and the size could increase to $10 trillion by the end of 2021. Given the continuance of outsized liquidity, the upside potential for gold prices in the long-term remains.
The bottom line is the Fed is all in to support the economy by focusing on employment and ignoring inflation, while we are in truly unchartered territory given the un-proven economic policies being experimented with by "steely-eyed central bankers." That is long-term positive for the precious metals complex and detrimental for the U.S. dollar.
At 1.7%, the yield on 10-year Treasuries is now about 2.5% higher than the yield on 10-year Treasury inflation-protected securities (TIPS), compared with a gap of just under 2.0% at the end of last year. With inflation now rising much faster than interest rates, real rates have now fallen to a level that is about as bullish for gold prices as anything we have seen in recent years.
Amid very positive macro fundamentals, the gold price is knocking on the door of its downtrend line from the all-time high at $2089 reached in August of 2020. Once we see a weekly close above $1850, which lies at the top of this descending channel, a technical breakout may take place from a 9-month bullish falling wedge.
Although many global miners and royalty firms have likely formed significant bottoms with the gold price over since the end of March, the higher risk/reward junior space continues to present the best value to patient contrarian resource stock speculators.
While underground gold reserves held by major mining firms continue to be low and falling, new reserves are becoming increasingly harder to find as resources are used up, and exploration is costly. Major mining companies have a few ways to remedy their shortages. They must either discover new underground resources through exploration, or acquire them via the takeover of junior development companies.
It is now cheaper for companies to buy developing or developed projects on Bay Street via acquisition, rather than to develop projects themselves given shortages of capable development teams and timeline pressures while the gold price consolidates its gains from 2020.
Recently cashed-up and well-funded Junior developer/explorers are in the process of de-risking the world's next mines. Quality juniors control deposits that the major and mid-tier miners need to replace reserves and to continue producing at their current levels. History shows that juniors de-risking a large deposit, likely to be of interest to a major mining company or financing partner, offer the best leverage to rising metals prices.
The VanEck Vectors Junior Gold Miners ETF fund GDXJ holds a portfolio of mostly mid-tier and junior mining shares of the companies involved in gold exploration and production. Being a reliable barometer for the junior resource complex, this nearly $6 billion fund is closely followed by junior speculators and momentum traders.
The index broke out of a 7-year base above $45 in mid-2020 on its way to an 180% gain in just 4.8 months, then tested this breakout level on the subsequent 33% correction by late March of this year as interest dried up in the gold complex.
During the 8-month consolidation process into the March low, each successive lower low stopped out more investors down to where there were no bears left and only buyers. And since that low, volume on up days has been mostly higher than the volume on down days which is a sign of accumulation.
Once we see a weekly close above $1850 in gold futures, I expect the juniors may begin leading the miners higher. After testing its 7-year breakout line of support at $45, the technical upside target in the GDXJ is $90. With the knowledge of gold being in a bull market, patient speculators have been given ample time to carefully construct a concentrated portfolio of exceptional junior gold stocks before the next up-leg begins.
However, time may be running out to accumulate a basket of junior developers controlling large projects being de-risked into the finance stage at these "fire sale" prices. With the gold price having likely bottomed in March, after a 20% correction from its all-time high of $2089, global producers will begin to focus more on replacing depleting reserves.
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