Gold stocks’ summer bottom

Gold exhibits high seasonality, which seems counterintuitive.  Unlike grown commodities, the mined supply of gold is fairly constant year-round.  But supply is only half of the fundamental supply-demand equation that drives pricing.  Gold’s investment demand happens to be highly seasonal, and that’s what sets gold prices at the margin.  Investors favor gold buying far more during some parts of the year than others.

This gold-demand seasonality is well-known and heavily studied.  The seasonal gold year starts in late July as Asian farmers begin reaping their harvests.  They plow some of their surplus income into gold.  That’s followed by the famous Indian wedding season in autumn, with its heavy gold buying for brides’ dowries.  That culture believes festival-season weddings have greater odds of yielding long, successful marriages.

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 investment demand balloons after bonuses and tax calculations as investors figure out how much surplus income the prior year generated for investment.  Then Chinese New Year gold buying flares up after that heading into February.

These understandable cultural factors drive surges of outsized gold demand between late summer and early spring.  There’s one more seasonal gold-demand spike in spring, where the causality is murkier.  Spring’s increasing daylight and warmer temperatures breed optimism, which favorably affects investors’ sentiment.  That leads to gold buying too among northern-hemisphere investors, the vast majority of the world’s.

While these major income-cycle and cultural factors fuel higher gold investment demand throughout the year, they disappear during market summers.  June and July in particular are largely devoid of recurring seasonal gold buying.  The markets take a back seat to vacations, with traders leaving their computers to bask in the glorious sunlight.  So gold and its miners’ stocks, along with other markets, tend to drift listlessly.

A couple weeks ago I quantified this summer-doldrums phenomenon in depth for gold, silver, and their miners’ stocks.  Summer has always been the weakest time of the year seasonally for the precious-metals sector.  That naturally spawns widespread bearishness during market summers, which can really be challenging to weather psychologically.  But it creates the best seasonal buying opportunity of the year!

The highest-probability-for-success time to aggressively deploy capital in gold stocks seasonally occurs in their typical mid-summer lull in July.  That comes after the worst of the summer-doldrums downside in June, but before the Asian harvest buying gathers momentum in August.  In the heart of summer, gold stocks are often shunned and therefore relatively cheap.  That’s when contrarians seize the opportunity to buy low.

Quantifying gold’s seasonal tendencies during bull markets requires all relevant years’ price action to be recast in perfectly-comparable percentage terms.  That’s accomplished by individually indexing each calendar year’s gold price to its final close of the preceding year.  That’s set at 100 and then all the gold-price action of the following year is calculated off that common indexed baseline, normalizing all years.

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 methodology renders all bull-market-year gold performances in like terms.  That’s critical since gold’s price range has been so vast, from $257 in April 2001 to $1894 in August 2011.  That span encompassed gold’s last secular bull, which saw a colossal 638.2% gain over those 10.4 years!

So 2001 to 2011 were certainly bull years.  2012 was technically one too, despite gold suffering a major correction following that powerful bull run.  At worst that year, gold fell 18.8% from its 2011 peak.  That was not quite enough to enter formal bear territory at a 20% drop.  But 2013 to 2015 were definitely brutal bear years, which need to be excluded since gold behaves very differently in bull and bear markets.

In early 2013 the Fed’s wildly-unprecedented open-ended QE3 campaign ramped to full speed, radically distorting the markets.  Stock markets levitated on the Fed’s implied backstopping, slaughtering demand for alternative investments led by gold.  In Q2’13 alone, gold plummeted by 22.8% which proved its worst quarter in an astounding 93 years!  Gold’s bear continued until the Fed’s initial rate hike of this cycle in 2015.

The day after that first rate hike in 9.5 years in mid-December 2015, gold plunged to a major 6.1-year secular low.  Then it started rallying sharply out of that irrational rate-hike scare, formally crossing the +20% new-bull threshold in early March 2016.  Ever since, gold has remained in this young bull.  At worst last December after gold was crushed on the post-election Trumphoria stock-market surge, it had merely corrected 17.3%.

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 2017.  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.

This chart averages the individually-indexed full-year gold performances in those bull-market years from 2001 to 2012 and 2016.  2017 isn’t included in this analysis yet since it remains a work in progress.  This chart distills out gold’s bull-market seasonal tendencies in like percentage terms.  They reveal July is the best time seasonally to buy low.  It’s near the end of summer weakness, before the parade of big seasonal rallies.

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 16.2% higher on average by year-end!  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.

Seasonally gold tends to bottom in mid-June, at 6.0% above the prior year’s final close.  Remember this whole concept of seasonality relies on blending many years together, which smoothes away the outliers to reveal the core underlying tendency.  This year gold actually surged into early June, and then slumped into early July.  At its summer-to-date low of $1219 earlier this week, gold was up exactly 6.0% from 2016’s close!

Gold typically meanders in a summer trading range running +/-5% from May’s final close, as illustrated in my latest summer-doldrums essay.  That runs from $1205 to $1332 this year.  So despite gold’s rather-sharp selloff after its newest upleg peaked in early June, everything is perfectly normal so far based on the standards of past gold summers.  Sentiment is bearish like usual, but there’s no need to fear or flee this sector.

Smart contrarian speculators and investors take advantage of these lackluster gold summers to buy big ahead of gold’s coming major autumn, winter, and spring rallies.  While gold starts shaking off its summer malaise in July, the buying really accelerates in August and September.  That’s when the Asians are buying aggressively, first after harvest and later for the Indian wedding season.  This fuels a major autumn rally.

On average between mid-June to late September, gold has powered 6.9% higher in these modern bull-market years.  That’s nothing to sneeze at.  A similar rally this year off the early-July summer low would catapult gold back up to $1303.  And a decisive $1300 breakout would greatly improve sentiment, which would unleash all kinds of technical buying.  Now is the time to get deployed ahead of gold’s big autumn rally!

Gold then tends to suffer a sharp correction into late October, before its major winter seasonal rally gets underway.  That runs from late October to late February, fueled first by Western holiday jewelry buying, then by Western income-surplus new-year buying, and finally by Chinese New Year.  That happens to be gold’s best seasonal rally of the year by far, with gold powering 9.5% higher over that short span on average!

That October correction is so short and mild compared to gold’s bull-market seasonal rallies that it’s not worth worrying about in most years.  So gold’s autumn and winter seasonal rallies can really be grouped into a single monster one, which runs from right about now to late winter.  That’s why prudent contrarians have long loaded up on gold, silver, and their miners’ stocks deep in the heart of the summer doldrums.

After gold’s winter rally, there’s that last smaller spring one running from late March to late May.  While it has only averaged 3.8% gains in modern bull-market years, that’s still nice icing on the cake after riding the preceding big autumn and winter rallies.  All that gold rallying driven by outsized investment-demand spikes, nearly a year’s worth, starts from gold’s summer seasonal lull.  Investors fleeing leave gold on sale.

And as goes gold, so go gold stocks.  Gold stocks also exhibit strong seasonality, which is of course the direct result of gold’s own seasonality.  Since gold-mining costs are largely fixed when mines are being planned, fluctuations in gold’s price flow directly into amplified moves in gold-mining profits.  Higher gold prices drive much-higher earnings for the gold miners, which attract in more investors to bid up stock prices.

The ironclad historical relationship between the price of gold, gold-mining profitability, and therefore the gold-stock price levels is exceedingly important to understand.  If you need to get up to speed, I wrote an essay looking at gold-stock price levels relative to gold a few months ago.  Fundamentally gold stocks are leveraged plays on gold.  Thus they really outperform during gold’s strong seasonal rallies throughout the year.

This next chart applies this same bull-market-seasonality methodology used on gold directly to the gold stocks.  It looks at the average annual indexed performance in the flagship HUI NYSE Arca Gold BUGS Index in these same bull-market years of 2001 to 2012 and 2016.  Because of gold’s dominant influence over gold-mining earnings, gold-stock seasonality naturally mirrors and amplifies gold’s own seasonality.

Gold stocks enjoy strong seasonal rallies corresponding with gold’s own.  Yet unlike gold’s which vary considerably, gold stocks’ seasonal rallies have been much more consistent on average during these bull-market years.  Starting in autumn, they ran 11.2%, 15.4%, and 14.0% compared to gold’s 6.9%, 9.5%, and 3.8%.  The seasonal gains in gold stocks are more-evenly distributed over the calendar year than gold’s.

While 13 bull-market years are indexed and averaged in this chart, last year’s outsized gold-stock action still really influenced these seasonals.  As measured by the benchmark HUI, gold stocks blasted 182.2% higher in just 6.5 months between mid-January and early August 2016!  Later the post-election gold exodus on stock-market Trumphoria helped drive a massive 42.5% HUI drop by that brutal mid-December bottom.

So this entire gold-stock-bull seasonal chart shifted higher by about 5 indexed points compared to last year’s version before 2016!  The gold stocks tend to bottom with gold seasonally, in mid-June.  But that’s followed by a secondary low only slightly higher in late July.  So on average, later this month is the best time of the year seasonally to throw heavily long gold stocks.  They are battered down in the summer doldrums.

But remember these seasonals are based on bull-year average performances, they are mere tendencies not hard templates.  So I’m not willing to roll the dice and wait until late July to deploy.  Gold tends to rally modestly in July, up 0.8% on average in these bull-market years.  And then its August gains accelerate to 2.1% on average.  So gold stocks sometime rally in July with gold, making the June low a better time to buy.

A superior buy-low strategy than waiting for the seasonal-tendency average lows to come to pass is to seize the opportunity on any significant gold-stock weakness in June or July.  That’s certainly the case this week, where the gold stocks slumped back to the same major support zone between 180 to 185 per the HUI from where they bounced in both early March and early May.  That ought to prove this summer’s low.

While gold stocks are mired in universal bearishness in the summer doldrums, that’s the time to buy low ahead of their powerful autumn, winter, and spring rallies.  It’s never easy fighting the herd to deploy into an out-of-favor sector, but that’s the only time stock prices are on sale.  The opportunity to ride a parade of major 11.2%, 15.4%, and 14.0% seasonal rallies between now and next spring is unparalleled in all the markets.

Big gains aren’t unusual for this super-volatile sector that has long richly rewarded smart contrarians.  In all of last year, the HUI still rocketed 64.0% higher trouncing every other sector despite all that brutal fourth-quarter selling.  In gold stocks’ last secular bull between November 2000 and September 2011, the HUI skyrocketed 1664% higher over 10.8 years.  That works out to huge 30%+ compound annual gains!

And since the gold stocks have way underperformed in the first half of 2017, odds heavily favor them mean reverting to far outperform in the second half.  On average in these modern bull-market years, the HUI was up 17.3% year-to-date at its mid-June seasonal low.  As of this week’s summer-to-date low, the HUI had actually slumped 0.4% since the end of last year!  That’s why gold-stock sentiment is so hyper-bearish.

The major gold stocks of the HUI and also that leading GDX VanEck Vectors Gold Miners ETF generally see gains amplifying gold’s upside by 2x to 3x.  Gold was once again up 6.0% year-to-date as of this week’s summer low.  Thus in a normal year the HUI would’ve been up 12% to 18% in the first half, right in line with its bull-market-year seasonal averages.  The tendency to mean revert is exceedingly strong in this sector.

Following periods when gold stocks really lag gold, they tend to see massive buying that catapults them back up to restore their normal fundamental relationship with the dominant driver of their profits.  So the coming gold-stock upside in their autumn, winter, and spring seasonal rallies is likely to prove far larger than usual after such a weak first half of 2017.  That makes this summer’s buying case exceptionally compelling.

Some of gold stocks’ biggest seasonal months of the year are right around the corner.  This final chart breaks down gold-stock-bull seasonality as exhibited by the HUI into calendar months.  Each is indexed to 100 as of the previous month’s final close, and then individual calendar months’ indexes are averaged across gold-stock-bull calendar years.  These monthly seasonals flesh out the seasonal rallies’ internals.

During these modern bull-market years from 2001 to 2012 and 2016, August and September were gold stocks’ fourth- and third-best months of the year seasonally!  August averaged HUI gains of 4.7%, while September’s were even slightly better at 4.8%.  While February and May are bigger, gold stocks have no other two-month span like August-September that averages such massive back-to-back gains for this sector.

That’s another reason why it’s so important to buy low in the summer doldrums when you least want to, when it feels miserable.  Most speculators and investors aren’t contrarians, they haven’t painstakingly forged the hard discipline necessary to actually buy low.  Instead they wait until after a sector has already rallied, and then chase the momentum.  That’s not only far riskier, but yields much-lower long-term gains.

After gold stocks have already started powering higher in their coming big autumn rally, the easy gains have already been won.  While there are outliers, the average of 13 years of bull-market gold-stock price action decisively proves that the summer doldrums are indeed the highest-probability-for-success buying opportunity of the entire year!  Contrarians strong enough to fight the herd can back up the truck for great bargains.

I’ve studied and written about gold and gold-stock seasonality for many years now.  And without a doubt the most-important thing to realize is seasonals are mere tendencies.  While these averages over years are driven by underlying sentiment, technicals, and fundamentals, the seasonals can easily be overpowered in any year by these same driving forces.  Seasonals are like tailwinds or headwinds, not primary engines.

So seasonal rallies are strongest when gold stocks have sentimental, technical, and fundamental reasons to power higher.  That’s certainly the case this year.  Bearishness in this sector is extreme after that terrible first-half performance, implying the sentiment pendulum is overdue to once again swing back to bullish.  And after lagging gold so dramatically, gold-stock prices are likely to mean revert far higher to regain normalcy.

nd relative to gold which drives their profits and thus ultimately stock prices, the gold miners’ stocks are exceedingly undervalued today.  They have rarely been cheaper fundamentally.  This will quickly become apparent when the gold miners report their Q2’17 results starting in late July.  The average gold price climbed 3.1% to $1258 in Q2 from Q1, which should really boost this sector’s profits from already-strong Q1.

While investors and speculators alike can certainly play gold stocks’ coming autumn rally with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals.  Their upside will trounce 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 Q1, this has resulted in 928 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 +22.0%!

The key to this success is staying informed and being contrarian.  That means buying low when others are scared, like during gold stocks’ summer doldrums.  An easy way to keep abreast is through our acclaimed weekly and monthly newsletters.  They draw on our 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 $10 per issue, you can learn to think, trade, and thrive like contrarians.  Subscribe today, and get deployed in great gold stocks before the parade of big seasonal rallies begins!

The bottom line is gold, and therefore its miners’ stocks, usually drift listlessly during market summers.  As investors shift their focus from markets to vacations, capital flows wane.  June and July in particular are simply devoid of the big recurring gold demand surges seen during much of the rest of the year, leaving them weak.  While trying psychologically, that creates the year’s best seasonal buying opportunities.

These weak summer seasonals have existed for many decades at least, they should be expected.  The summer doldrums need to be embraced, not feared.  Traders fleeing drive gold-stock prices to some of their cheapest levels of the year relative to gold.  So smart contrarians willing to fight the herd to deploy when it’s unpopular are subsequently richly rewarded when gold stocks’ seasonal rallies march much higher.

Adam Hamilton, CPA