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Gold stock mean-reversion in progress

Commentaries & Views

Despite long-term interest rates continuing to move upwards, the precious metal’s sector has been steadily finding buyers since late September. Previously, rising bond yields acted as a factor for selling both gold and silver, paying no dividends or coupons. I believe the main reason for the recent dis-connect is investors viewing inflation differently since the end of September.

Never-ending supply chain problems, high energy prices, and accelerating wage growth has been amplifying pro-inflationary factors. This trend shows no sign of slowing down anytime soon and has investors questioning the world’s largest central bank’s “temporary” argument regarding inflation.

Last week, the U.S Bureau of Labor Statistics released the inflationary numbers for September, which showed U.S Consumer Price Inflation (CPI) accelerated by a whopping 5.4% from a year ago – its largest increase since July 2008.

Just like the 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 by Statistics Canada on Wednesday. This marks the fastest pace of growth since February 2003. Excluding gas, CPI rose 3.5% YoY, while monthly CPI has increased for the past nine consecutive months. Prices in every major sector saw 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 to many leading economists, the actual global inflation figures are likely much higher than being reported, because of the obvious understatement in housing and food costs buried in recent Consumer Price Index stats.

As the gold price continues to trade in a tight $80 trading range over the past six weeks, with an upward bias, a major mean-reversion catch-up rally is in the process of unfolding in the mining space due mostly to inflation fears.

The combination 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-water positions heading into Q4. Gold stocks began to be sold for tax-loss in mid-June, as nervousness regarding the expectation of future tightening of monetary policy increased.

Although tax-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 of out-performing ships in 2021, junior gold stocks became hated to the point of early tax-loss fueled capitulation. Many gold stock bag-holders who chased juniors making 5x to 10x moves higher, in the space of less than 5 months into August of 2020, began to capitulate positions at the start of H2/2021.

However, Fed tightening fears set up the perfect storm for contrarian money patiently waiting 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, the precious metals sector routinely pendulum swings from extreme greed, when speculators should be trimming profits; to extreme fear, when cashed-up contrarians should be buying at lower-risk/reward entry points before the next up-leg begins.

Gold mining stocks have a solid history of outperforming gold prices on the upside as well as to the downside. Gold Futures hit an all-time high of $2,089 on early August of 2020 and are down 15% from that level, trading at $1,781 per troy ounce as of Thursday. Shares of GDXJ are down 33% during the same period, closing Thursday at $44.

Looking at a 15-year monthly chart of the GDX, the VanEck Gold Miner ETF took 7-years to breakout of a huge 7-year accumulative base above $31. After the move in 2020 became extreme overbought above $45, a healthy 14-month consolidation of a 4.8-month surge higher came down to test this breakout level last month.

Into the end of Q3, GDX broke below $31 on a monthly basis, but that breakdown may have been a bear trap. Prices have since recaptured this critical support level, and has the potential for a significant bottom if the global miner ETF can maintain $31 at the end of October. A sustained breakout back above the 18-month moving average at $35.50 could signal the beginning of the next leg higher.

If the Fed gives us the "soft taper" as expected after the next FOMC meeting concludes on November 3rd, I expect a "buy the news" reaction from the gold complex based on the over-reactive pullback due to "taper-talk" that has 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 Fed starting to slow its colossal fourth QE money-printing campaign, while the gold price dropped 10%.

Over the past few weeks, while most investors remain more focused on rising equity markets and cryptocurrencies, cashed-up contrarians have already been bottom-fishing deeply oversold precious metals juniors. With both the mining sector and the silver price continuing to show relative strength to the price of gold over the past few weeks, one-by-one, quality junior gold and silver stocks have been breaking out of 14-month bullish falling wedge chart formations.

Although both GDX and GDXJ have become short-term overbought on a daily basis, I expect weakness to continue being bought quickly in quality juniors which became deeply oversold into Q4. With the mining complex beginning to mean-revert to the price of gold, this is a great time to begin scaling into quality precious metals juniors on weakness before the next up-leg is confirmed in this secular gold bull market. If you require assistance in doing so, and would like to receive my research, weekly newsletter, portfolio, watch list, and trade alerts, please click here for instant access.

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