Gold Stocks’ Autumn Rally 3
Adam Hamilton August 3, 2018 3235 Words
The gold miners’ stocks have suffered a psychologically-grating year so far. They’ve remained trapped in their vexing low-consolidation trading range, disheartening and driving away the great majority of traders. But that should soon change as this deeply-out-of-favor sector enters its strong season, which begins with a powerful autumn rally starting late summers. This year’s has exceptional upside potential from such a low base.
Seasonality is the tendency for prices to exhibit recurring patterns at certain times during the calendar year. While seasonality doesn’t drive price action, it quantifies annually-repeating behavior driven by sentiment, technicals, and fundamentals. We humans are creatures of habit and herd, which naturally colors our trading decisions. The calendar year’s passage affects the timing and intensity of buying and selling.
Gold stocks exhibit strong seasonality because their price action mirrors that of their dominant primary driver, gold. Gold’s seasonality generally isn’t driven by supply fluctuations like grown commodities experience, as its mined supply remains fairly steady year-round. Instead gold’s major seasonality is demand-driven, with global investment demand varying dramatically depending on the time in the calendar year.
This gold seasonality is fueled by well-known income-cycle and cultural drivers of outsized gold demand from around the world. Starting in late summers, Asian farmers begin to reap their harvests. As they figure out how much surplus income was generated from all their hard work during the growing season, they wisely plow some of their savings into gold. Asian harvest is followed by India’s famous wedding season.
Indians believe getting married during their autumn festivals is auspicious, increasing the likelihood of long, successful, happy, and even lucky marriages. And Indian parents outfit their brides with beautiful and intricate 22-karat gold jewelry, which they buy in vast quantities. That’s not only for adornment on their wedding days, but these dowries secure brides’ financial independence within their husbands’ families.
After that comes the Western holiday season, where gold-jewelry demand surges for Christmas gifts for wives, girlfriends, daughters, and mothers. Following year-end, Western investors figure out how much surplus income they earned after getting bonuses and paying taxes. Some of this is invested into gold just like the Asian farmers do. Then big Chinese New Year gold buying flares up heading into February.
So during its bull-market years, gold has always tended to enjoy major autumn rallies driven by these sequential episodes of outsized demand. Naturally the gold stocks follow gold higher, amplifying its gains due to their profits leverage to the gold price. Today gold stocks are once again right at their most-bullish seasonal juncture, the transition between the usually-drifting summer doldrums and big autumn rallies.
Since it’s gold’s own demand-driven seasonality that fuels the gold stocks’ seasonality, that’s logically the best place to start to understand what’s likely coming. Price action is very different between bull and bear years, and gold is absolutely in a young bull market. After being crushed to a 6.1-year secular low in mid-December 2015 on the Fed’s first rate hike of this cycle, gold powered 29.9% higher over the next 6.7 months.
Crossing the +20% threshold in March 2016 confirmed a new bull market was underway. Gold corrected after that sharp initial upleg, but normal healthy selling was greatly exacerbated after Trump’s surprise election win. Investors fled gold to chase the taxphoria stock-market surge. Gold’s correction cascaded to monstrous proportions, hitting -17.3% in mid-December 2016. But that remained shy of a new bear’s -20%.
Gold’s last mighty bull market ran from April 2001 to August 2011, where it soared 638.2% higher! And while gold consolidated high in 2012, that was technically a bull year too since gold just slid 18.8% at worst from its bull-market peak. Gold didn’t enter formal bear-market territory at -20% until April 2013, thanks to the crazy stock-market levitation driven by extreme distortions from the Fed’s QE3 bond monetizations.
So the bull-market years for gold in modern history ran from 2001 to 2012, skipped the intervening bear-market years of 2013 to 2015, and resumed in 2016 to 2018. Thus these are the years most relevant to understanding gold’s typical seasonal performance throughout the calendar year. We’re interested in bull-market seasonality, because gold remains in its young bull today and bear-market action is quite dissimilar.
Prevailing gold prices varied radically throughout these modern bull-market years, running between $257 when gold’s last secular bull was born to $1894 when it peaked a decade later. All these years along with gold’s latest bull since 2016 have to first be rendered in like-percentage terms in order to make them perfectly comparable. Only then can they be averaged together to distill out gold’s bull-market seasonality.
That’s accomplished by individually indexing each calendar year’s gold price action to its final close of the preceding year, which is recast at 100. Then all gold price action of the following year is calculated off that common indexed baseline, normalizing all years regardless of price levels. So gold trading at an indexed level of 105 simply means it has rallied 5% from the prior year’s close, while 95 shows it’s down 5%.
This chart averages the individually-indexed full-year gold performances in those bull-market years from 2001 to 2012 and 2016 to 2017. 2018 isn’t included yet since it remains a work in progress. This bull-market-seasonality methodology reveals that late summers are when gold’s long parade of big seasonal rallies gets underway. And that starts with the major autumn rally which is born in gold’s summer doldrums.
During these modern bull-market years, gold has enjoyed a strong and pronounced seasonal uptrend. From that prior-year-final-close 100 baseline, it has powered 16.0% higher on average by year-ends! These are major gains by any standard, well worth investing for. While this chart is rendered in calendar-year terms since these increments are easiest for us to grasp, gold’s seasonal year actually starts in the summers.
Remember this whole concept of seasonality relies on blending many years together, smoothing away outliers to reveal the core underlying tendencies. Seasonally gold tends to bottom in mid-June, but then still largely drifts sideways in its summer doldrums until early July. This year’s low near $1216 came later in early August. And it was way worse than usual in price terms, which is a seriously-bullish harbinger.
On average gold’s summer-doldrums lows birthing its major autumn rallies see it still up 6.2% and 7.0% at worst year-to-date in mid-Junes and early Julies. But in early August 2018, gold slumped to a deep summer-doldrums low down a whopping 6.6% YTD! With gold diverging about 13% under its seasonal average this summer, its autumn rally has far-greater upside potential than usual. Gold needs to mean revert way higher!
Gold’s autumn rallies generally start grinding higher in Julies, which have seen modest average gains of 0.7% in these modern bull-market years per this dataset indexed from prior-year closes. They accelerate considerably in Augusts, which is when that Asian harvest buying kicks into full swing. Gold averaged big 2.2% gains in Augusts, which is its 4th best month seasonally! So traders need to be long gold by late Julies.
The upside momentum in gold’s strong autumn rallies only builds from there. From 2001 to 2012 and 2016 to 2017, Septembers enjoyed hefty additional average gains of 2.7%! That makes for gold’s 3rd best month of the year, only behind Januaries’ 3.1% and Novembers’ 2.9%. Gold’s major autumn rallies generally running from mid-Junes to late Septembers have enjoyed big 6.6% average gains in these bull years!
That’s a major upleg run by any standard in just 3.4 months. Overall US stock-market returns historically have averaged around 8% annually. So seeing gold surge nearly that much in just over a quarter the time is really impressive. And these big autumn rallies are only the first third of gold’s strong season. They are followed by much-larger winter rallies averaging huge 9.5% gains between late Octobers to late Februaries!
Then smaller spring rallies averaging 3.7% gains between mid-Marches to late Mays close out gold’s strong season before the summer doldrums return. Together gold’s autumn, winter, and spring rallies carve its strong seasonal uptrend rendered in this chart. Investors and speculators alike can certainly ride gold’s strong bull-market seasonality in physical bullion or the leading GLD SPDR Gold Shares gold ETF.
But the gold miners’ stocks well outperform gold’s underlying seasonal gains, amplifying gold’s trio of big seasonal rallies. The gold stocks enjoy powerful sentimental and fundamental boosts when gold rallies consistently. Higher gold prices shock traders out of their usual apathy for this small contrarian sector, restoring capital inflows. The resulting gold-stock gains start shifting sentiment back to bullish, fueling more buying.
That’s totally justified fundamentally, as gold-mining profits really leverage underlying gold gains. The higher gold prices flow directly through to bottom lines, as production costs are largely fixed when mines are being planned. Gold miners’ profits leverage to gold is very important to understand, illuminating why gold stocks are the best way to ride gold’s seasonal uptrend. The latest real-world data drives home this point.
The leading gold-stock investment vehicle is the GDX VanEck Vectors Gold Miners ETF. It includes the world’s biggest and best major gold miners. Every quarter I analyze the latest operational and financial results from GDX’s elite gold stocks. While this current Q2’18 earnings season is well underway, it won’t be finished until mid-August. So the latest full results available are still Q1’18’s, which proved quite strong.
The GDX gold miners reported average all-in sustaining costs of $884 per ounce, which is what it costs them to produce and replenish each ounce of gold. AISCs don’t change much regardless of prevailing gold prices, as mining still requires the same levels of infrastructure, equipment, and employees quarter after quarter. Between Q2’17 to Q1’18, the GDX gold miners’ AISCs averaged $867, $868, $858, and $884.
That makes for $869 AISCs over the past year. Gold-mining profits are the difference between prevailing gold prices and AISCs. At gold’s summer-doldrums low of $1222 this week, the gold miners were still earning fat $353 per-ounce profits. If gold’s 2018 autumn rally is merely average at 6.6%, it would climb back over $1302 by late September. If gold miners’ AISCs stay flat like usual, their profits would surge to $433.
That is big 22.7% earnings growth on a mere 6.6% gold rally, making for 3.4x upside leverage! This core fundamental relationship between gold-mining profits and gold prices is why gold stocks tend to amplify gold’s gains by 2x to 3x. That leverage grows much larger after gold stocks are wildly undervalued and deeply out of favor. In roughly the first half of 2016, GDX soared 151.2% on a 29.9% gold upleg for 5.1x upside!
So gold stocks’ own strong bull-market seasonality is fully justified fundamentally. This next chart applies this same seasonal methodology to the flagship HUI NYSE Arca Gold BUGS Index. We can’t use GDX for this study since its price history is insufficient, it was only born in May 2006. But since GDX and the HUI hold most major gold miners in common, they closely mirror each other. Gold stocks see big autumn rallies.
During these same modern gold-bull-market years of 2001 to 2012 and 2016 to 2017, the gold stocks as measured by the HUI enjoyed average gains of 10.5% between late Julies and late Septembers. Augusts and Septembers are actually gold stocks’ strongest 2-month span of the year, averaging respective big gains of 4.9% and 3.9%. Investors and speculators need to be fully deployed before Augusts, just like in gold.
The gold stocks’ 10.5% average autumn rally only leverages gold’s 6.6% one by 1.6x, behind that 2x to 3x expected. But that evens out over the winter and spring rallies, where the gold stocks rally another 15.5% and 12.8%. That works out to 1.6x and 3.5x upside leverage to gold. In full-calendar-year terms, the gold stocks’ bull-market seasonal gains averaging 28.9% amplify gold’s 16.0% by 1.8x. This falls short of that 2x to 3x.
Unfortunately gold stocks have underperformed gold for years, because investors have largely forgotten the latter. That’s dragged down gold stocks’ average upside leverage to gold. Investment gold demand wanes when stock markets are near record highs fueling extreme euphoria. Complacent investors forget markets are forever cyclical, feeling no need to prudently diversify their stock-heavy portfolios with gold.
Gold tends to rally when stock markets weaken, making it the ultimate portfolio diversifier. And in recent years these crazy bubble-valued euphoric stock markets have rarely seen much material weakness at all. That’s left gold way out of favor, making it hard for gold stocks to catch a significant bid. But they’ve still enjoyed strong autumn rallies even in such a hostile sentiment environment. Consider last year’s example.
In 2017’s summer doldrums, gold and thus the HUI bottomed in early July. Gold’s autumn rally was born from there as speculators’ collective gold-futures positions were too bearish, they’d hit selling exhaustion. So as they covered extreme short positions, gold surged 11.2% higher over the next 2.0 months into early September. The HUI rallied 22.7% higher over that same span, making for 2.0x gold-stock upside leverage.
This year’s autumn rally has much-greater potential. Before I get into that, this final chart slices up gold-stock seasonals into calendar months instead of years. Each is indexed to 100 at the previous month’s final close, and then all like calendar months’ indexes are averaged together across these same modern bull-market years of 2001 to 2012 and 2016 to 2017. Again Augusts and Septembers are the best 2-month span.
While the average 5.4% gains in Februaries and 5.0% gains in Mays beat the 4.9% in Augusts and the 3.9% in Septembers, they are much more isolated. Augusts and Septembers are the only back-to-back months where gold stocks have averaged strong rallies in modern bull-market years. Late summers offer the best seasonal buying opportunities of the year to aggressively deploy capital into beaten-down gold stocks.
And for a bunch of reasons, 2018’s coming autumn rally has far greater upside potential than usual. In pure seasonal terms alone, the gold stocks are way behind where they usually are. Typically by their final late-July summer-doldrums low, the HUI is still up 17.3% year-to-date. But this week when this year’s summer-doldrums low was hit, the HUI was actually down 14.5% YTD. That’s about 32% lower than normal!
This exceptionally-weak gold-stock performance this year is explainable by gold’s own. In early August when gold slumped to its summer-doldrums lows, it was again down 6.6% YTD. The HUI was just leveraging that 2.2x like usual. So when gold inevitably rebounds higher in its autumn rally, the abnormally-low gold stocks have real potential to see a huge mean-reversion-rebound rally. Their setup today is wildly-bullish.
Heading into their strong season, the gold stocks spent much of this summer mired in deep bearishness sentimentally, consolidating low technically, and trading at dirt-cheap prices fundamentally. So everything is stacked in their favor as gold turns around. And that’s inevitable after gold got hammered with heavy selling this summer. Both gold-futures speculators and normal investors sold to selling-exhaustion extremes.
I’ve discussed all these bullish factors in depth in recent essays. Traders hate gold stocks because their prices are so darned low. They’ve been basing in a low consolidation since early 2017, trading between $21 support to $25 resistance in GDX terms. While grueling psychologically, this has long since shaken out all the weak hands. Only the hardcore fundamentally-focused contrarian gold-stock investors remain.
At their recent summer-doldrums lows, the gold stocks were trading at prices first seen 15.0 years ago way back in August 2003 when gold was just in the $350s! It is fundamentally-absurd to see the same gold-stock price levels today with gold about 3.5x higher and gold-mining profitability radically greater in both absolute and percentage terms. These ludicrously-cheap gold-stock valuations won’t last forever.
They only exist because speculators and investors have totally forsaken this sector. But as gold powers higher in its coming strong season, they will start returning. Encouraged by surging gold-mining profits as discussed earlier, their capital inflows will bid the beaten-down gold miners’ stocks much higher. Gold itself has an exceptionally-bullish autumn-rally setup given speculators’ and investors’ excessive summer selling.
The hyper-leveraged gold-futures speculators who dominate short-term gold price action sold short at extreme levels in June and July. That resulted in record-high gold-futures shorts that have to be covered by buying offsetting longs! This same gold-futures short-covering dynamic is what propelled gold sharply higher in 2017’s autumn rally. Major gold uplegs are birthed by speculators buying to cover excessive shorts.
This summer’s extreme gold-futures shorting spooked investors into dumping in sympathy. This was really evident in the gold-bullion holdings of that leading GLD gold ETF, which fell sharply in recent months on heavy differential GLD-share selling. That waning gold investment forced GLD’s holdings down to major bull-market support levels. So investors too will have to buy back in as gold’s autumn rally powers higher.
With speculators and investors both nearing selling exhaustion this summer, gold is set up to see serious buying as this year’s strong season gets underway. The higher gold climbs, the more attention it will get from the financial media, speculators, and investors. As their sentiment turns bullish again, capital will flood back into the beaten-down gold stocks. Their surging profits on higher gold will justify that fundamentally.
While investors and speculators alike can certainly play gold stocks’ coming strong seasonal uplegs with the major ETFs like GDX and GDXJ, the best gains will be won in individual gold stocks with superior fundamentals. Their upside will far exceed the ETFs, which are over-diversified with underperforming stocks. A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.
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The bottom line is gold-stock seasonals argue this sector is right on the verge of a major autumn rally. Augusts and Septembers are the best couple-month span of the year for gold stocks seasonally in bull-market years. This is driven by a parallel autumn gold rally fueled by outsized Asian demand coming back online. Gold stocks naturally amplify gold’s gains since their profits leverage gold’s price moves.
And gold stocks’ upside potential in this year’s autumn rally is exceptional. They’ve way underperformed their seasonal averages in 2018, they’re super-low technically, and they’re trading at truly fundamentally-absurd prices. This beaten-down sector is overdue for a massive catch-up rally to mean revert far higher to reflect prevailing gold prices. It has a good chance of starting to unfold over this coming strong season.
Adam Hamilton, CPA August 3, 2018 Subscribe at www.zealllc.com/subscribe.htm