GLD: Is The Final Decline On The Way?

| About: SPDR Gold (GLD)

Summary

The inverse correlation between the major U.S. indices and GLD/gold continues.

This decline in the shares of the gold and silver producers is because of technical breakdowns that have nothing to do with what's occurring in the major U.S. indices.

The long-term fundamentals for GLD look exceptional, in fact, they are getting better and better every day.

I continue to believe that sometime in the next several weeks to several months, will be a prime opportunity to accumulate precious metal stocks in a very aggressive way.

The SPDR Gold Trust ETF (NYSEARCA:GLD) has caught a bid over the last few weeks, as the sell-off in the U.S. stock market - as well as global markets - has resulted in investors trading in their shares of imploding companies for the physical metal. However, the move higher in GLD has been tepid at best, as the gold sector is still in the bottoming process, and strong downside pressure remains.

The inverse correlation between the major U.S. indices and GLD/gold continues, as YTD, GLD has seen a slight gain while the S&P 500 has declined by a hefty 8.26%. For a time-frame of only 3 weeks, that's one of the more brutal sell-offs in general equities that we have seen in recent years. I'm not surprised though that GLD couldn't tack on greater gains, as the gold sector is still very much unloved. But gold has provided a respite from the carnage in the global markets.

GLD Chart

GLD data by YCharts

What's interesting though is the divergence now occurring between GLD and the major gold indexes such as the XAU and HUI. We have had these large divergences before, and I have pointed out a few of them over the last year. Sometimes it's GLD that is the correct predictor of future price action, sometimes it's the gold stocks. Usually one of them tips their hands to show where the ultimate direction will be, and in this case it appears that the precious metal shares are pointing the way. The only reason GLD hasn't succumbed as well is because of the sell-off that we have had in the general stock market. Once the fear subsides then we should see GLD's true colors.

GLD Chart

GLD data by YCharts

One could argue that the HUI and XAU are just getting caught up in the decline in equities, and they will rebound should the stock market do so as well. But gold stocks haven't moved in unison with the Dow or S&P for many years. Rather, this decline in the shares of the gold and silver producers is because of technical breakdowns that have nothing to do with what's occurring in the major U.S. indices. The XAU and HUI simply appear to be entering their final washout phase, and it just so happened that it coincided with the tail end of recent free-fall in major U.S. indices. Just take a look at what the gold indexes were doing in the first week of 2016 while the S&P plunged. I don't believe this is the precious metal producers just being fashionably late to the party, this is an entirely different party.

^HUI Chart

^HUI data by YCharts

For the last 5-6 months, these two gold stock indexes have been testing their major support levels relentlessly, and each time they did so they were able to bounce. About a week and a half ago they were in a similar situation again. At that time I said:

The XAU has been in this position on many occasions over the last 6 months, and has managed to pull itself up. But I don't think it survives this time. I haven't made that call yet, but the action in the gold stock sector is much different than what has occurred during previous lows in the XAU. We weren't seeing near this amount of capital destruction during the previous lows. I'm taking this as a warning sign.

The XAU did in fact break that key support a few days later, and has since experienced a waterfall sell-off. The HUI has been a little more stubborn - as a result of the heavy weighting of South African stocks helping to keep it elevated - but it too finally broke down.

(Source: StockCharts.com)

I believe that gold shares are leading the way here, and GLD will soon follow. We just need to see the stock market stabilize in order for GLD to roll over. If that occurs, this will be the final decline of the bear market in gold. The prices of the gold stock indexes are signaling this endpoint because they are getting close to that 90% peak to trough decline territory. The XAU and HUI would need to climb back above their breakdown points for me to re-evaluate this call. That's not an insurmountable objective, but I would say the odds of that happening are low given the ferocity of this decline. Never say never though, especially in the highly volatile gold stock sector.

Short-term, the gold companies are oversold, and we could see some sort of modest rebound over the next week or so before this washout phase resumes.

Triple Digits in Gold Still Looks Highly Probable

With GLD rebounding to the 105 level (which equates to $1,100 gold), the thinking might be that a price under $1,000 an ounce seems further and further out of reach. But the recent breakdown in the gold stocks is telling us that it's still very much on the table. However, I don't expect gold will fall too much below that key psychological support level, and it will be a relatively short stint in the triple digits.

The decline in oil and other commodities might make some worry that a similar fate is in store for gold, and that the metal will fall far below $1,000 an ounce. After all, oil is at prices that haven't been seen since the early 2000's. But I warned last year that oil has problems and it's going to continue to have problems. Some of those issues (like oversupply) will begin to dissipate now that the price has come down, but there are still some issues to deal with from a long-term structural point of view. My argument remains that oil still isn't the best way to play any inflationary environment that will soon arise. Although I will admit that the price is getting to levels where a solid bottom could take place.

The same argument goes for other commodities like copper, which has seen a brutal sell-off as well over the last 6-9 months. If you look at the price action of GLD since that time though, and compare it to what copper, oil, and other commodities have been through, you will see that it has held up very well during that time. I don't believe it is just waiting and will soon play catch-up. The reason that the price level in the $900's should hold is because of supply/demand fundamentals that are being influenced by dire financial positions.

Money Supply And Debt - Two Keys To Higher Long-term Gold Prices

The long-term fundamentals for GLD look exceptional, in fact, they are getting better and better every day. The increasing money supply in the U.S., as well as higher and higher deficits, are the catalysts that are needed for a major bull market in gold.

Deficits equal rising debt. And that picture just got a whole lot worse, at least according to the latest report out of the Congressional Budget Office. The CBO just released the "Summary of The Budget and Economic Outlook: 2016 to 2026" a few days ago. The full report will be released next week. I thought I would share a few key pieces of information contained in this report. But how about a statement from it first, as this pretty much says it all:

Over the 2016-2025 period (which was the 10-year projection period that CBO used last year), CBO now projects a cumulative deficit that is $1.5 trillion larger than the $7.0 trillion that the agency projected in August 2015. The $1.5 trillion increase is the net result of projected revenues that are lower by $1.2 trillion and projected outlays that are higher by $323 billion.

In a way, this is both shocking and not shocking all at the same time. $1.5 trillion is almost 10% of the total debt outstanding at the moment.

Below is a look at the adjustments to the projected annual deficits that have been made by the CBO. The first thing you will notice is the 2016 deficit will be $544 billion, $130 billion higher than the one that the agency projected in August 2015, and $105 billion more than the deficit recorded last year. Part of this increase (or $43 billion) is the result of a shift in the timing of some payments that the would ordinarily have made by the U.S. Government in fiscal year 2017. But because October 1, 2016 falls on a weekend, and that is the first day of fiscal year 2017, the payments will instead be made in FY2016. But unfortunately, this doesn't make the 2017 deficit look any better, as it is now projected to come in at $561 billion, versus the $416 billion estimate back in August. These updated estimates mean that the U.S. will be back to $1 trillion deficits by 2022, much sooner than expected. And the way this is going that date might be moved up even more.

Click to enlarge

(Source: CBO)

Half of this $1.5 trillion increase - or $749 billion - is largely the result of legislation enacted over the last 4 months. The retroactive extension of tax provisions by the Consolidated Appropriations Act, 2016, is the the main culprit, as it will reduce corporate and individual income taxes. Because of the new laws, revenues are now expected to decrease by $425 billion and outlays are expected to increase by $324 billion during 2016-2025.

The other half of the $1.5 trillion increase is because of revisions to the CBO's economic forecast over the next decade (which were lowered), as well as "technical estimating changes" that the CBO has made since August (which boosted their projections of federal outlays for Medicaid as well as projections that spending will increase substantially for veterans' disability compensation).

As for the implications of all of this, here are some facts:

  • The current deficit projections by the CBO would increase public debt to 76 percent of GDP by the end of 2016. That's 2 percentage points higher than 2015 levels, and the highest it has been since the years immediately following World War II. And for the first time since 2009, the deficit that is posted this year is expected to increase in relation to the size of the economy.
  • Unless the U.S. Government changes current laws that are impacting our revenue and outlays, by 2026, the federal deficit will be considerably larger than its average over the past 50 years.
  • Net interest payments are expected to increase in 2016 by $32 billion over 2015 levels. By 2017, interest payments will move higher by $50-$75 billion every year. This is the result of rising interest rates and increasing federal debt.
  • In 2019, the deficit will start to rise more sharply, and is expected to hit $1.4 trillion in 2026, or 4.9 percent of GDP. A total of $9.4 trillion of debt will be racked up over the next 10 years. By that time, the debt held by the public will be 86 percent of GDP, more than twice the average over the past five decades.
  • If we remain on this course past 2026, this will all start to accelerate very fast and push debt up even more sharply. The CBO is projecting that unless current laws are changed, in three decades, the debt held by the public will equal 155 percent of GDP. That's pretty much where Greece was at when it imploded. I also believe the U.S. will hit that level much sooner than expected.

Luckily for the U.S., we answer to nobody, unlike Greece and other members of the Eurozone. We hold the keys to the printing presses and have our own fiat monetary system. We will never go bankrupt because we will just keep ramping up the money supply. And that continues to rise unabated.

It seems like the bazooka's were brought out 2 weeks ago when the market was going into a black hole, as M2 increased over $130 billion from January 4 to January 11. It was fairly stagnate for a month or two, but nothing like a good spike lower in the net worth of U.S. investors to get the ball rolling on the money supply front. It will be interesting to see what the latest data shows, given that volatility seems to has picked up even more over the last 5-10 trading days.

(Source: Federal Reserve)

M2 increased by 6% last year, not an obscene amount, but just enough to keep all of this going. The continual rise in the money supply, and a probable acceleration of the percent change in annual rates down the road, are exactly what will cause gold to reach prices which right now seem unobtainable.

(Source: Federal Reserve)

The declining gold price is also resulting in the yellow metal's supply/demand fundamentals looking much brighter as well over the short, medium, and long-term. I don't see how one could be a gold bear for much longer.

The Gold Sector Remains On Track

At the beginning of this year, I put a time table on the ending of this bear market in GLD and the sector. I hadn't really focused heavily on that before as price objective was the key, not time. But the way this was all looking on the charts, mostly when talking about the HUI, this had a definite finality coming.

The HUI had to choose a path in a very short amount of time: up and it broke a major multi-year downtrend, down and it would finally see one last drop. It seems to have picked a direction, but we still need more confirmation. That would come by way of GLD reversing course and the decline in the HUI picking up speed and firmly moving below 100. The XAU is the weakest by far, and could be leading the way.

Unfortunately, a quick trip to 90 for GLD ($900's gold) might be just what this sector needs before it puts in a final low. There is no rhyme or reason to have GLD decline to those levels, other than simply to washout as many gold bulls as possible. That goes for the gold stocks as well.

I continue to believe that sometime in the next several weeks to several months, there will be a prime opportunity to accumulate precious metal stocks in a very aggressive way. I'm not sure we are there yet, but we are very very close.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.