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The gold stock seven year bottoming cycle

Commentaries & Views

There were fortunes made by contrarian speculators that began to accumulate a basket of high-risk/reward quality precious metals junior stocks, just as significantly undervalued and oversold mining space situations appeared in 2001, 2008, and 2015. This seven-year pattern of bombed-out juniors creating significant bottoms is likely in the process of taking place here again in 2022.

In 2001, the secular bull market in gold began with the “Brown Bottom,” combined with events surrounding 9-11 and the dotcom stock market crash. Gordon Brown, who was then the UK Chancellor of the Exchequer, sold approximately half of the UK’s gold reserves in a series of auctions at what eventually became a major bottoming of the gold price below $300.

This ill-timed decision kick-started a strong gold move to briefly trade at the psychologically significant $1000 per ounce region by early 2008. During the 2005-2007 miner bull-run leading up to this temporary peak in gold, the huge gains harvested from my junior miner portfolio provided me enough capital quit a dead-end job and travel the globe for the next five years.

By the time the Global Financial Crisis (GFC) had induced a global margin call to force investors to liquidate gold holdings with huge gains, the price of bullion cratered below $700 in three months to create another major low in the mining space into October 2008.  

Once the Federal Reserve re-capitalized the U.S. banking system shortly thereafter, the gold price peaked at $1925 three years later. This historic rise in the safe-haven metal made fortunes for contrarian speculators accumulating gold stocks into late 2008. But the four-year bear market that followed was as brutal as the decade-long bull which proceeded it was euphoric, sending generalist investors running from the resource sector en masse.

Seven years after the October 2008 bottom in the mining space, a peak-to-trough opportunity was being presented to cashed up contrarians once again. After the sector had been bludgeoned by an 85% decline from the highs in 2011 into the end of 2015, a situation similar to the 2001 “Brown Bottom” was again being formed.

At the time, precious metals stock investors were fearful of gold losing the psychologically critical $1000 level as the Fed was gearing up to raise interest rates for the first time since the GFC took the Fed Funds rate to zero.

Meanwhile, the bombed-out and undervalued miners were in the process of creating an accumulative six-month base as investors geared up for the inevitable hiking of interest rates. But one month after the Fed finally pulled the rate-hike trigger, shorts began to take their massive gains which triggered the GDXJ to zoom nearly 300% in just 6 months once the gold price bottomed at $1045.

Fast forward to the present, with the mining space presenting a similar set up to the significant 2015 low. This time, it is the $1675 level which has most every analyst and gold sector pundit expecting this critical support line to be broken, ushering in a gold bear market.

Yet, the gold price has held long-term support at $1675 with each of its five tests of this critical level over the past two years being met with strong buying. This resilience in the safe-haven metal has taken place directly in the face of one of strongest U.S. dollar rallies experienced in decades, which is a sign of long-term strength.

However, precious metals stock speculators have already priced in a stop-run below $1675 in gold, believing a near-term selloff below this long-term support line is a foregone conclusion. After correcting 53% from its all-time high in just four months, Newmont Mining Corp. (NEM) has continued to trade like a junior penny stock. This sharp plunge of the world’s largest gold miner has kept generalist investors scared out of the sector, as the Newmont share price tested its 2016 peak last week at exactly $40.27.

With my expectation of most generalist capital remaining on the sidelines until deeply oversold NEM climbs back above $52, the stock hammered intraday after testing its 2016 high tic recovery at $40.27 last Thursday, continuing its tepid climb this week.

The gold price was trading over $300 lower at $1375 when NEM peaked at $40.27 in July 2016, while the stock paid a much lower dividend than the currently very attractive 5.4%. The global gold miner constitutes nearly 13% of the GDX, which is also trading at a level when the gold price was over $300 lower than its current price.

Additionally, sentiment levels for both gold and silver are at rock bottom. One of the better sentiment tools available is the Daily Sentiment Index (DSI), having historically been one of the best barometers for a major low being reached in the sector when we see a reading below 10. Late last week, both the silver and gold DSI fell below 10 simultaneously, which is extremely rare.

The latest Commitments of Traders (CoT) report shows retail speculators holding net short positions in gold, and even more so in silver. The Gold Futures Commercial CoT also shows short positions similar to May 2018, just before a $900+ up move in the gold price.

Should evidence emerge that inflation concerns are fading from CPI data released next week, causing the extremely overbought dollar to pull back and reduce fears that higher interest rates will curb growth, then the gold and silver futures markets may quickly experience a bout of heavy short-covering.

Another technical point to consider is the GDX/SPX ratio having fallen to the level marking significant mining sector bottoms in late 2015, September 2018, and March 2020. After each of these major lows were completed, strong multi-month up-legs took place in the mining complex.

Since the secular bull market in gold began at the turn of the century, every major up-leg in the mining space started during, or just after, a -20% decline in the stock market. The S&P 500 has already declined 20% earlier this year, and the Nasdaq is faring even worse, plummeting over 29% into mid-June.

Moreover, the historically weak performance in the stock market for the month of September, along with August’s declines and expectations of even higher rates from the Federal Reserve and other central banks, raises concern over a potential test of major support at the 3200 level in the S&P 500 as we head into crash season. The Federal Reserve’s beige book, released on Wednesday and typically published two weeks before each meeting of the policy-setting FOMC, pointed out weaker U.S. economic growth.

Meanwhile, the world’s largest central bank continues to raise interest rates after two consecutive quarters of negative U.S. GDP signaled the economy being in recession just ahead of its previous FOMC meeting in late July.

Furthermore, the yield curve on treasuries remains inverted and continues to get worse. The 10-year/2-year spread is now more negative than it was ahead of the dotcom crash and the GFC. Since 1953, there have been 11 inversions (10-year yield minus 2-year yield) and 10 recessions. The only non-recession was in 1966. This inversely presents huge bullish tailwinds for the entire precious metals complex – as they are viewed as one of the most reliable hedges against economic risk, stagflation and recession.

With the bear side of the gold boat becoming more overcrowded by the day, there are more than a few lurking gold bullish catalysts on the horizon to consider with the stock market heading into crash season.

The Chinese lockdowns will eventually lift, inflation data will likely flatten while the Fed continues to destroy demand, and deeply depressed gold may begin to price in the rate hike cycle ending as the economy goes deeper into recession.

Geopolitical headlines will also likely resurface in China, Russia, and the Middle East this fall. Although I am not hoping for this to be the reason for higher gold prices, an escalation of tensions or a full-scale military operation in Taiwan would provide a substantial boost to the gold price.

We also cannot rule out an expansion of the ongoing war in Ukraine, or an indictment of former President Donald Trump after the recent FBI raid of his Mar-a-Lago home being potential bullish gold catalysts.

It can also be argued that hawkish central banks and expectations of weaker global economic growth that are likely to crimp consumer and commercial demand for metals, has now been factored into gold and silver prices ala late 2015. With gold sentiment at rock bottom, a “sell the rumor, buy the fact” scenario may develop in deeply oversold gold and silver markets in the near term, regarding the bearish central bank element for the metals.

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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.