Gold stocks’ autumn rally

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 isn’t driven by supply fluctuations like grown commodities experience, as its mined supply remains pretty steady all year.  Instead gold’s major seasonality is demand-driven, with global investment demand varying dramatically depending on the time within 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 now in late summer, 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 secures 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 massive 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 the best place to start to understand what’s likely coming.  Price action is very different between bull years and bear years, and gold is absolutely in a new bull market.  Between the 6.1-year secular low it suffered in mid-December and early July, gold powered 29.9% higher easily exceeding that +20% new-bull threshold.

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 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 near-miraculous stock-market levitation driven by extreme distortions from the Fed’s bond monetizations.

So the modern bull-year seasonality relevant to this new bull year in 2016 ran from 2001 to 2012, before the Fed-induced bear-market years between 2013 to 2015.  This first chart distills down gold’s bull-year seasonal tendencies, by averaging gold prices indexed within each calendar year.  This methodology is essential because it renders price percentage moves perfectly comparable despite differing prevailing gold prices.

Gold’s close on the final day of each preceding year is recast at a level of 100, with all the following year’s daily gold closes indexed off that.  An indexed level of 110 simply means gold was up 10% year-to-date at that point.  Each calendar year’s individually-indexed gold prices are then averaged together to arrive at this gold-bull seasonality.  Gold has always had a strong tendency to enjoy major autumn rallies.

During its last bull-market years from 2001 to 2012, gold’s major autumn rally started on average in late July.  While gold seasonals technically bottomed in mid-June, that was just part of gold drifting listlessly sideways in the summer doldrums between late May and late July.  Gold’s major autumn rally averaging hefty 7.5% gains between mid-June and early October didn’t actually break out to the upside until early August.

And that’s exactly where we are today!  Gold is on the verge of once again seeing outsized demand from those key seasonal income-cycle and cultural drivers that ignite in this late-summer period and then run well into autumn.  Note above how August and September together saw gold’s strongest seasonal gains on average during its last secular bull.  These next couple months are among gold’s top-performing calendar ones.

Gold averaged gains of 2.5% in Augusts and 3.3% in Septembers between 2001 to 2012, making those its 4th- and 2nd-best calendar months respectively.  While Novembers take the title with 4.0% average gains, no other couple-month span outperforms August and September!  Gold is just entering its strongest stretch of the year in seasonal terms, which is a very bullish near-term omen for it and gold-stock prices.

While that’s definitely exciting, this year does face some unique risk factors that could dampen gold’s usual seasonal strength.  A merely average 7.5% rally from gold’s $1286 levels in mid-June would take it to $1382 by early October.  But obviously gold already almost got there!  2016 saw gold blast higher during the summer doldrums in a rare counter-seasonal breakout.  This proved a record summer rally for this metal.

Between the end of May and early July, gold rocketed 12.3% higher!  That is radically better than bull-years’ seasonal average summer-to-date performance of -1.1% by that point.  This incredible surge was driven by a combination of massive buying by both investors and gold-futures speculators.  The former is great and not a problem at all, as investors are strong hands looking to own gold outright for the longer term.

But unfortunately futures speculators’ frenzied buying was the dominant force fueling gold’s radically-unprecedented summer rally.  Speculators grew exceedingly bullish, ramping their upside bets on gold to towering record levels.  But these hyper-leveraged gold-futures contracts are exceedingly risky, since relatively-small adverse moves in gold prices can result in total losses of the capital speculators risked.

Gold’s record summer rally this year may have borrowed from its strong autumn gains, effectively pulling some of that autumn buying forward into summer.  That hinges on whether investors resume buying gold aggressively or not.  And the record gold-futures longs accumulated by speculators leave gold with a near-record futures selling overhang heading into autumn.  This remains a serious near-term risk for gold.

If some news or market event spooks the uber-bullish speculators, they will be forced to exit their wildly-excessive long positions en masse.  This heavy gold-futures selling will drive down gold fast, forcing a snowballing number of speculators to liquidate or face catastrophic losses due to futures’ extreme leverage.  So until speculators’ collective gold-futures positions normalize, a cascading gold selloff is possible any time.

I suspect gold’s strong autumn seasonals will ultimately prevail, as Asian farmers and Indian parents are not going to postpone their usual large gold buying due to extreme gold-futures positions in American markets.  Nevertheless given the wildly-anomalous summer setup leading into this year’s autumn gold rally, odds are it is going to prove far more volatile than normal.  Caution is in order this year, not complacency.

Gold’s strong autumn seasonals are why gold stocks enjoy strong autumn seasonals of their own.  Gold stocks amplify gold’s price action because gold-mining profitability leverages it.  This next chart uses the same bull-market seasonal methodology applied to the flagship HUI gold-stock index.  The gold stocks are now entering their best couple-month span of the year seasonally, a very bullish portent for this sector.

As of this week, the gold stocks as measured by the HUI have already skyrocketed 181.7% higher since their 13.5-year secular low in mid-January!  That very week I pointed out the fundamental absurdity of those gold-stock prices given prevailing gold levels, and aggressively bought and recommended many new gold stocks in our newsletters.  Once gold-stock bulls get underway, they grow to immense proportions.

Between November 2000 and September 2011, this leading HUI gold-stock index soared an astounding 1664.4% higher!  That epic secular bull covered the vast majority of gold’s bull-market years between 2001 to 2012, so we can use those for gold-stock seasonals as well.  And on average during that span of mighty bull years, the gold stocks bottomed seasonally in late July.  And then massive autumn rallies erupted.

On average between late July and late September in those last modern bull years, the HUI rocketed 15.0% higher!  A similar rally today from this index’s late-July low would boost the HUI to 286, and like gold we are already there in early August.  Just like gold, gold stocks enjoyed a super-anomalous record summer rally this year.  So they too may have seen much autumn buying pulled forward into summer.

If gold gets hit by cascading gold-futures selling as speculators are forced to rapidly unwind their still-near-record longs, gold stocks are going to fall in sympathy and amplify gold’s losses.  Considering the HUI’s staggering gains, not far from a triple in just a half-year, a healthy bull-market correction wouldn’t be surprising at all.  The setup leading into this year’s autumn rally is radically different than in normal years.

But while that portends much-greater coming volatility than usual just like in gold, it shouldn’t negate gold stocks’ entire autumn rally.  If gold climbs on balance in the coming months as it ought to with all that outsized Asian gold demand coming online again, the gold stocks will follow it higher.  Gold stocks have some aces up their sleeves as well, which could lead to investment demand really accelerating.

No other sector in all the markets is even remotely close to challenging gold stocks’ commanding performance supremacy this year.  Professional investors including hedge-fund managers are really taking notice.  They are having a tough time performing this year in these frustratingly-fake central-bank-levitated markets.  They need to find some winners soon to salvage their years, and the momentum is in gold stocks.

Gold and gold-stock excitement is mounting after their record summers, and gold’s strong autumn seasonality is well-known.  So there’s a good chance much more investment capital than usual will flood into both gold and its miners’ stocks this autumn.  And these inflows will accelerate dramatically when the lofty stock markets inevitably roll over, as gold is the ultimate portfolio diversifier since it moves counter to stocks.

Thus gold’s near-record futures selling overhang and its downside threat to gold-stock prices may very well be mitigated or even negated by exceptional investment demand this autumn.  It’s been years since investors got excited about gold and gold stocks, and that’s just starting to build as evidenced by all the bullish comments on the precious metals in the mainstream financial media.  This autumn could prove remarkable.

Just like in their primary driver gold, gold stocks’ best couple-month span of the year seasonally comes in August and September.  This next chart breaks down gold-stock bull-year seasonality per the HUI into more-granular monthly form.  Each calendar month between 2001 to 2012 is individually indexed to 100 as of the previous month’s final close, and then all like calendar months’ indexes are averaged together.

Gold stocks enjoyed big average gains in Augusts and Septembers in the bull-market years between 2001 and 2012 of 6.7% and 4.8%.  These coming couple months happen to be gold stocks’ 2nd- and 4th-best months of the year!  Those are the same relative rankings as gold’s monthly bull-year seasonality, but reversed.  No other time of the year has a higher probability of witnessing major gains in the gold stocks.

With such massive seasonal tailwinds starting to blow, it’s hard not to be heavily long gold stocks this time of the year regardless of how far and fast they got here.  With gold stocks’ epic performances this year winning growing popularity even among mainstream investors and speculators, there’s no better time for a new rush of capital to flood into them than late summer and early autumn.  That’s really bullish.

But it’s important to remember that seasonals are mere tendencies, not sure things.  Just like in weather, long-term averages can mask considerable extremes.  This year has already seen gold stocks buck their seasonality in record ways.  April is a relatively-weak month seasonally, with the HUI averaging modest 0.5% losses in bull years.  Yet this past April the gold stocks greatly defied seasonality with a huge 31.0% rally!

April’s weakness is followed by May, which weighs in as gold stocks’ strongest month of the year seasonally.  Its average 6.9% HUI gain between 2001 to 2012 edged out August’s 6.7%.  This May the HUI plunged 13.8% as gold stocks mean reverted to give back some of April’s incredible gains!  So it’s important to realize that gold stocks certainly haven’t behaved in line with seasonal norms in recent months.

This July saw the HUI surge another 11.2% higher, vastly greater than the bull-year average of a 1.9% loss.  While that’s nothing like the extreme gold-stock rally seen in April, it still pressures this year’s August to diverge down from normal years’ average performance.  Seasonality is important to consider, but it doesn’t actually drive anything.  It just quantifies what’s caused by sentiment, technicals, and fundamentals.

While gold stocks face greater downside risk than normal in the coming weeks thanks to that extreme near-record futures selling overhang looming over gold, their sentiment, technicals, and fundamentals are still arguing for an exceptional autumn rally.  Mainstream investors and speculators are getting more excited, but they aren’t yet euphoric and remain woefully under-deployed in this small contrarian sector.

Technically the gold stocks look super-bullish, with incredible strength even in the summer when there shouldn’t be much if any.  And fundamentally the gold stocks remain very low relative to gold, their primary driver.  This is easiest expressed through the HUI/Gold Ratio, which I last wrote about a month ago.  Between 2009 to 2012, the last normal years before the Fed-spawned gold bear, the HGR averaged 0.346x.

Even this week as the gold stocks climbed to a new bull record of 283.7 on the HUI, the HGR was still only running 0.206x.  Thus merely to regain post-stock-panic normal-year average levels relative to today’s prevailing gold prices in the $1350s, the HUI still has to rally another 68% higher from here!  That implies a HUI trading near 470, so there are great gains still to be won in gold stocks even at these gold levels.

As always investors and speculators can play the likely coming autumn rally with the leading GDX gold-stock ETF, which closely mirrors the HUI’s performance.  But a carefully-handpicked portfolio of the elite gold miners with the best fundamentals will see gains trouncing those of the benchmarks.  Uncovering these winners takes incredible amounts of time, work, and expertise, but the resulting gains are well worth it.

At Zeal we’ve literally done tens of thousands of hours of research on individual gold stocks, so we will always prefer portfolios of this sector’s very best miners and explorers.  We build these portfolios in real-time as market trends allow and buying opportunities arise in our acclaimed weekly and monthly newsletters.  Since 2001 we’ve recommended and realized 833 stock trades in real-time for our subscribers.

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The bottom line is gold-stock seasonals argue this sector is right on the verge of a major autumn rally.  August and September 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.

While this year’s autumn-rally setup isn’t as clean as usual, gold stocks still have great potential to surge in the coming months.  Futures speculators drove a record summer gold rally, leaving gold with a near-record selling overhang that could cascade anytime.  But mainstream excitement is growing for the red-hot gold stocks, so much bigger capital inflows are likely coming.  And there’s no better time of the year to buy.

Adam Hamilton, CPA