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Bombed out junior miners creating an accumulative bottom

Commentaries & Views

With a blistering short-covering rally in the gold complex taking place heading into this week, the positive impact of less-hawkish Federal Reserve comments faded while investors waited for more signs on the data front. Gold prices rose 2.57% last week as markets firmed up the $1700 support level, while bullion ended above formerly significant resistance at $1780 on a monthly closing basis.

After reaching the key $1800 level into Tuesday’s Comex session, a round of profit taking sent the gold price down towards support at $1760 by mid-week. But the move lower did not last very long as another major central bank influenced the buying of Gold Futures to close above $1800 on Thursday with more recession fears.

The Bank of England (BoE) followed its counterparts in the United States and euro zone with a hefty hike in interest rates to quell inflation. As widely expected, the BoE increased rates by 50 basis points to 1.75%, its sixth increase since December but the biggest since 1995.

What made this rate decision bullish gold is the BoE's quarterly Monetary Policy Report (MPR), which included an expected protracted recession. The MPR stated the UK economy would begin to shrink in the final quarter of 2022 and contract throughout next year, making it the longest recession since after the global financial crisis, the central bank said.

Last week, the gold price took off into the weekend after a less hawkish Fed, followed by another negative GDP report meant the U.S. was technically in recession after Q1 GDP came in at -1.6%. Commonly, a recession is understood as two consecutive quarters of GDP contraction. While it is refreshing to see the BoE admit to the UK economy going into recession, both the White House and Federal Reserve continue to deny the U.S. economy already being in, or even heading into, recession.

After a better-than-expected U.S. jobs report came in on Friday morning, the gold price volatility continues within a $40 range as $1760 support has held and bullion weakness is being bought. The Bureau of Labor Statistics said 528,000 jobs were created in July. The data significantly beat expectations, as economists were forecasting job gains of around 250,000.

Although jobs data continues to remain strong, markets are now focusing more on the threat of a recession than Fed rate hikes, which has weakened the U.S. dollar and capped bond yields. At the same time, even with the economy weakening, it is highly unlikely the Fed will be able to bring inflation entirely under control. One of the most challenging obstacles for gold has been a strong economy in the face of the Fed's aggressive rate hikes.

Recent Fed policy moves making U.S. dollar denominated debt more expensive to carry has investor fears of stagflation being rekindled for the first time since the 1970s, which is expected to keep gold well bid. And if inflation expectations keep rising and growth expectations keep falling, this is the very definition of a stagflationary environment.

Despite what the Fed and its government continue to deny during an election year, the U.S. economy is likely heading towards an "official" recession. And as long as Wall Street believes the Fed will deliver a slower pace of tightening, gold should continue seeing safe-haven flows. Now that the economy is slowing with Fed forced demand destruction, the outlook for gold and its miners has become positive.

As the gold complex sentiment reached rock-bottom levels last month, precious metals ETFs are in the process of creating accumulative rounded bottoms after three months of relentless capitulation selling. And the moves higher over the past few weeks in this beaten down and left for dead sector have been led by the higher-risk junior space.

After creating an inverse head & shoulders bottoming pattern on its daily chart during the entire month of July, the GDXJ broke out above its neckline at $32 last Friday. Many junior stocks started to bottom well ahead of the major precious metals’ equity indices.

Meanwhile, GDX pricing remains a bit behind GDXJ, as the global miner ETF has yet to break out of its own head & shoulders bottoming pattern. A strong close above its neckline at $27 is required to complete the pattern.

I expect most generalist investors to remain on the sidelines until Newmont Mining Corp (NEM) ceases trading like a penny junior stock and reclaims its former long-term support level at $51. The world’s largest gold miner lost nearly half of its value in just over three months after hitting an all-time high over $85 in mid-April. An extreme oversold Newmont stock, which is 13% of GDX, has been attempting to bottom at $44 this week.

As the GDXJ is in the process of forming its month-long rounded bottom, many higher-risk juniors have already moved up double-digits after capitulation selling left them deeply undervalued in relation the price of gold. The last time GDXJ traded at these levels, the gold price was trading below $1400.

Buying a basket of quality juniors during a capitulation event to hold until the next peak in the mining cycle is the best strategy for 7-10x gains in select gold stocks. Before this tiny sector comes back into favor, it is best to accumulate full positions in select juniors ahead of the coming herd of momentum traders.

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