Gold nearing bull breakout

With capital inflows following performance, investments that aren’t high and rallying naturally see waning popularity.  That’s the story of gold over the past couple years or so.  Gold’s last new bull-market high came way back in early July 2016, when it hit $1365.  That was 21.3 months ago, which may as well be an eternity in terms of sentiment.  In most traders’ minds, gold has effectively been dead and buried ever since.

While contrarian investors always follow gold, most mainstream investors don’t.  They only get interested when gold is powering up to major new highs.  This psychology holds true everywhere in the markets, it’s certainly not unique to gold.  A handful of mega-cap tech stocks have soared since Trump’s election win in November 2016, but other mega-cap tech stocks have lagged far behind.  Traders always pursue performance.

This first chart looks at gold’s technical price action over the past couple years or so.  A mighty new bull market erupted out of deep despair, blasting higher with steep gains.  But the gold-investment-driving force behind it soon reversed, so this young bull stalled out.  Gold hasn’t been able to best those initial bull highs ever since.  So with no new highs to spark excitement, gold has slipped off investors’ radars.

Gold prices are heavily influenced by gold-futures speculators.  The extreme leverage inherent in futures trading enables these traders to punch way above their weight in bullying the gold price around.  There is nothing these guys fear more than Fed rate hikes, even though history proves that’s absolutely irrational.  So heading into the Fed’s first hike of this cycle in December 2015, gold slumped to ugly 6.1-year secular lows.

But such extreme bearishness made no sense, as gold has thrived in past Fed-rate-hike cycles.  So once that initial rate hike came and gold didn’t plunge, speculators rushed to buy back in to gold futures after that $1051 low.  They were soon joined by investors with their huge pools of capital.  They were spooked by the first stock-market corrections in 3.6 years, which boost gold demand to diversify stock-heavy portfolios.

Thus gold soared 29.9% higher in just 6.7 months in essentially the first half of 2016, easily crossing that classic +20% new-bull-market threshold.  Gold’s $1365 bull peak in early July 2016 was closely tied to stock-market fortunes, coming the very day before the flagship US S&P 500 stock index achieved its first new record close in 13.7 months.  With stock markets off to the races again, gold investment demand waned.

Gold had been very overbought after such a blistering rally, and speculators had record long positions in gold futures which is a contrarian indicator.  But gold still consolidated high in the summer of 2016 until it was hit by two anomalous events.  First gold-futures stops were run as gold fell below $1300, driving a sharp drop to its 200-day moving average.  Gold recovered quickly from that until Trump’s surprise win.

Very few traders expected Trump to stage a colossal underdog upset and win the presidential election in early November 2016.  It was an extreme contrarian position, seen as madness.  Interestingly as I wrote the very weekend before that voting, a powerful stock-market indicator predicted Trump would indeed win!  That soon came to pass, shocking speculators and investors into greatly reevaluating their outlooks.

With Republicans soon to control the presidency and both chambers of Congress, traders’ euphoria flared to eye-searing brilliance.  They were captivated by hopes for big tax cuts soon, and rushed to buy stocks with reckless abandon.  As the stock markets surged first on Trumphoria and later taxphoria, gold fell deeply out of favor.  Investors abandoned it since they felt no need to prudently diversify their soaring portfolios.

Thus a normal healthy gold correction after a strong upleg cascaded into a 17.3% plunge over 5.3 months ending in December 2016.  Such sharp losses naturally devastated gold psychology among traders.  The bull market was still alive and well technically, as gold didn’t cross that -20% new-bear trigger.  But gold was still left for dead as the levitating stock markets sucked in most capital.  Traders had largely moved on.

But gold still looked really bullish in mid-December 2016, as I explained within days of that correction low.  Investors were radically underinvested in gold after fleeing in the election’s wake.  And the truly incredible psychology unleashed by the Republican sweep wasn’t sustainable or repeatable.  It’s pretty rare where nearly everyone gets presidential and congressional elections so wrong!  So gold was overdue for some buying.

Ever since that post-election anomaly it has indeed powered higher on balance in the solid uptrend you can see in this chart above.  Gold has been relentlessly carving a series of higher lows and higher highs, which made for a 20.4% upleg over the next 13.3 months.  That’s actually big enough to qualify as a new bull market, but again gold never entered a bear.  Such strong price action should’ve improved sentiment.

But it really didn’t.  The extreme taxphoria last year made 2017 one of the most-extraordinary years on record for the US stock markets.  The S&P 500 ceaselessly levitated to a massive 19.4% gain in the first year of the Trump Administration, accompanied by record-low volatility.  With big US stocks powering higher so dramatically and painlessly, who needed gold?  It tends to rally when stock markets are selling off.

While contrarians were rightfully impressed with gold’s strong bull-market uptrend since those anomalous post-election lows, mainstream investors didn’t know or care.  Everything was rainbows and unicorns for them, despite dangerous bubble valuations in the stock markets.  While gold’s 13.2% rally in 2017 would command attention normally, the 35% to 57% gains in the FANG stocks overshadowed it and stole the limelight.

There’s no doubt over a year of gold seeing higher lows and higher highs is very-bullish price action.  All students of the markets would recognize this viewing gold charts.  But climbing support and resistance lines are lost on the financial media and mainstream investors.  Investments only start garnering talk and mindshare when major new highs are hit.  Popular psychology is totally dependent on that one technical aspect.

Futures speculators view the horizontal $1350 line as key technical resistance.  Gold has tried and failed to break out above it from several to nearly a dozen times since the summer of 2016 depending on how you slice such attempts.  These guys need to see a decisive $1350 breakout to really motivate them to buy again.  I define decisive as 1%+ beyond an old technical extreme, or about $1364 in gold’s case today.

That’s just a stone’s throw away, very close.  Last week gold closed near $1352, and this week it was still up at $1349.  All gold needs to see is a couple modest up days of 0.6% to push it back over $1365 for the first time in 21.3 months!  That would work wonders for sentiment, rapidly turning it to bullish which would fuel much gold-futures buying.  And the speculators currently have lots of room to buy gold futures.

As of the latest Commitments of Traders report before this essay was published, total spec gold-futures longs are only running 25% up into their past year’s trading range.  That means 3/4ths of these traders’ likely capital firepower remains available to buy back in.  Believe me, if they think gold is going to break out above $1350 resistance they will flood in with a vengeance.  These elite traders follow charts by necessity.

Every gold-futures contract controls 100 troy ounces of gold, worth $134,900 this week.  Yet these only require traders to keep $3,100 of cash per contract in their accounts.  That works out to absurdly-extreme 43.5x maximum leverage!  The legal limit in the stock markets has been 2x for decades.  Traders running at that crazy limit would lose 100% of their capital risked if gold merely moves 2.3% against their futures bets.

At 20x leverage that risk is still suffocating, with a 5% adverse move necessary to wipe out capital risked.  So when gold looks to be breaking out above $1350, these traders will rush to buy to cover shorts and add new longs.  They are well aware gold has formed a giant ascending-triangle chart pattern over the past couple years or so.  That’s defined as rising lower support compressing a price into horizontal upper resistance.

When ascending triangles resolve, it’s usually with a sharp-to-explosive upside breakout.  Once that long-vexing overhead resistance fails, traders rush back in catapulting the price higher.  When gold breaks out of such a massive ascending triangle, technically-oriented traders are going to get the heck out of the way if they are short and rush to ride the breakout on the long side.  Futures speculators live and breathe technicals.

Their coming buying will fuel a far-more-important breakout.  To the financial media and investors, new bull highs are the only thing that will draw their interest.  Before July 2016’s $1365 bull-to-date peak, the last time gold closed over $1365 was way back in March 2014.  So a $1365+ close right now would be a major new 4.1-year high.  You better believe that will catch investors’ attention, getting gold back on radars!

A 1% decisive breakout above $1365 requires $1379 on close.  That sounds lofty since it’s been so long since gold challenged $1400, but it is merely 2.2% above this week’s levels!  When investors start getting excited about gold again, it takes months or even years to reestablish meaningful portfolio positions.  The vastly-larger pools of capital they control overpower and dwarf whatever the futures speculators are doing.

As I explored a couple months ago, investors are radically underinvested in gold today.  They will have to shift capital into gold for a long time to come to reverse this major anomaly.  New gold bull-market highs all alone will prove a powerful motivator for them.  But that will likely be amplified greatly by the ongoing stock-market correction.  Stock selloffs ignite big investment demand for counter-moving gold to diversify portfolios.

If either speculators buy gold futures or investors buy gold and its major ETFs led by GLD SPDR Gold Shares in any significant quantities, gold will absolutely see these major breakouts.  And there’s actually a good probability of that coming to pass in the next month or so.  Gold tends to enjoy a major seasonal rally from late March to late May.  That ought to be plenty big to drive gold decisively over $1350 and $1365.

This should really excite contrarian speculators and investors.  While the gains in gold will be nice, they will be trounced by the accompanying surge in the gold miners’ stocks.  This sector’s leading benchmark is the GDX VanEck Vectors Gold Miners ETF.  Its technical price action over this same gold-bull span is shown in this second chart.  While gold is nearing new bull highs, the gold stocks are lagging far behind.

With little interest in gold since Trump’s election victory, the gold miners’ stocks have been abandoned and left for dead.  They’ve been drifting sideways in a vexing consolidation between $21 to $25 in GDX terms since late 2016.  That’s despite their very-strong fundamentals.  In their latest-reported quarter of Q4’17, these leading gold miners reported collective all-in sustaining costs averaging just $858 per ounce!

That’s far below prevailing gold prices, showing this industry is earning fat operating profits.  In Q4’17 gold averaged about $1276 per ounce.  In the latest Q1’18 which the gold miners will soon report on, that surged 4.1% quarter-on-quarter to a $1329 average.  That implies profits of $471 per ounce, which is up 12.7% QoQ from Q4’17’s results!  The gold miners are thriving which stock prices haven’t recognized yet.

In Q1’18 GDX’s average price of $22.57 was actually 0.8% lower than Q4’17’s $22.76!  This highlights how deeply out of favor the gold miners are.  But that psychology will reverse dramatically on that coming major gold breakout.  Once gold starts hitting new highs again, traders will flock back to gold stocks since their mining profits leverage and amplify gold’s gains.  That will drive a parallel big breakout in major gold stocks.

This week GDX was languishing near $23, dead-center in its 15.6-month-old consolidation between $21 support and $25 resistance.  It would have to surge to $25.25 for a decisive breakout that would attract in a deluge of new capital.  That’s 9.9% higher from this week’s levels, which actually isn’t much at all for this small volatile sector.  Once gold stocks start rallying, they tend to move fast making for huge gains.

Since gold’s bull market began in mid-December 2015, GDX has actually seen 55 trading days with 3%+ gains!  That’s nearly 1 out of every 10 trading days over that entire 2.3-year span.  The gold stocks are truly less than a week of decent rallying away from a decisive breakout of their own.  And once they start moving, traders will rush to buy back in to ride their explosive upside.  When gold is in favor, this sector soars.

In roughly the same span of this gold bull’s first upleg in the first half of 2016, GDX skyrocketed 151.2% higher in 6.4 months on the parallel 29.9% gold upleg.  That made for awesome wealth-multiplying 5.1x upside leverage to gold!  While gold stocks are abandoned and forgotten when gold isn’t on traders’ radars, once they get interested again the gold stocks stage massive catch-up rallies.  The next one is nearing.

The major gold miners’ early-2016 upleg wasn’t extreme at all considering the fundamentally-absurd prices gold stocks were trading at back then.  GDX actually slumped to an all-time low, while the major gold stocks as measured by their HUI index were at a 13.5-year low.  They were trading at levels last seen in July 2002 when gold was near $305.  So they needed to soar to mean revert out of that crazy anomaly.

Another massive mean reversion higher is certainly needed today.  Gold first hit this week’s $1350 levels in mid-October 2010.  Since this metal was carving new all-time highs, investors were eager to buy in for the ride.  Back then GDX was trading over $57, or 150% higher than today’s levels with these same prevailing gold prices!  GDX’s bull-to-date peak in early August 2016 was $31.32, or just 36% higher from here.

So there’s a high chance the gold-stock upleg driven by the coming gold breakout will easily catapult the gold stocks to new bull highs too.  During the last secular bull in gold stocks between November 2000 to September 2011, the HUI skyrocketed 1664% higher.  There were 11 major uplegs during that span that averaged 81% gains over 7.9 months each!  So seeing gold stocks rally 40% or 50% from here is nothing.

The gold stocks are truly a coiled spring today, ready to explode higher soon and trounce everything else.  They are deeply out of favor, incredibly undervalued, and one of the only sectors that can rally sharply when general stock markets sell off.  If you want to multiply your wealth this year by fighting the crowd to buy low then sell high, this small and forgotten contrarian sector is the place to be.  Nothing else rivals it.

While investors and speculators alike can certainly play gold stocks’ coming powerful upleg with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals.  Their upside will far exceed the ETFs, which are burdened by over-diversification and underperforming gold stocks.  A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.

At Zeal we’ve literally spent tens of thousands of hours researching individual gold stocks and markets, so we can better decide what to trade and when.  As of the end of Q4, this has resulted in 983 stock trades recommended in real-time to our newsletter subscribers since 2001.  Fighting the crowd to buy low and sell high is very profitable, as all these trades averaged stellar annualized realized gains of +20.2%!

The key to this success is staying informed and being contrarian.  That means buying low before others figure it out, before undervalued gold stocks soar much higher.  An easy way to keep abreast is through our acclaimed weekly and monthly newsletters.  They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks.  For only $12 per issue, you can learn to think, trade, and thrive like contrarians.  Subscribe today, and get deployed in the great gold and silver stocks in our full trading books!

The bottom line is gold is nearing a major bull breakout above $1365.  That will turn psychology bullish and bring traders back in droves.  Gold is rallying ever closer to new bull-market highs as evidenced by its massive multi-year ascending-triangle chart pattern now nearing a bullish climax.  Today gold is only a couple percent below that decisive breakout, which will finally blast it back onto the radars of investors.

That’s likely coming soon, with gold in the midst of its major spring seasonal rally.  Speculators have lots of room to add gold-futures longs, while investors remain radically underinvested.  And once gold comes back into favor, the abandoned gold miners’ stocks are going to soar.  Their prices are far below where they ought to be based on their fundamentals and prevailing gold levels.  Their upside from here is enormous.

Adam Hamilton, CPA

April 20, 2018

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