Gold Stocks Benefiting From 'Fear Momentum'

Includes: GDX, GLD
by: Clif Droke

Investors' growing fears have created a momentum wave for gold.

Hedge funds are showing increasing interest in the yellow metal.

Gold stocks are still the biggest beneficiaries of gold safety demand.

In the market, there are basically two types of momentum which most investors are cognizant of. The first is when asset prices are propelled higher on a sustained basis based on widespread bullish sentiment. The other is type is fundamental in nature, e.g. the momentum of earnings growth or of a surging economy.

Yet when it comes to the gold market, there is yet a third type of momentum to consider, namely the momentum of fear. For when investors are deeply concerned about the economic or financial market outlook, they often turn to gold as a safety hedge. If investors’ fears are intense enough, it can generate significant price increases for gold over a short time period. This fear-based momentum appears to be the driving force behind gold’s latest rally, and in this report, I’ll make the case that gold – and the gold mining shares – should continue to benefit from “fear momentum” in the near term.

With Washington threatening to increase trade tariffs on imports from China and Mexico, gold has arguably been the biggest safe-haven draw of late. Even as interest in corporate bonds, and even U.S. Treasuries, has flagged in recent days, gold has picked up the slack as retail investors increasingly push money out of the stock market and into the yellow metal. This time, though, gold doesn’t have much competition from other precious and industrial metals. Safe-haven demand appears to be primarily relegated between gold and the stocks of the leading gold mining and exploration firms.

Also boosting gold prices is the recent pullback in the U.S. dollar. The dollar’s sharp decline in the last few days has definitely helped gold by allowing its currency component to strengthen. The U.S. dollar index (DXY) below has fallen under its 15-day moving average after confirming a break of its immediate-term (1-4 week) upward trend on June 3. More importantly, it has also violated its technically and psychologically significant 50-day moving average, which ultimately determines the strength of the dollar’s intermediate-term (3-6 month) trend. A weekly close under the 50-day MA for the dollar on June 7 would pave the way for an even bigger rally in the gold price in the coming weeks in my estimation.

U.S. Dollar Index

Source: BigCharts

However, it’s important not to lose sight of the fact that gold’s currency component isn’t the primary driver of this gold rally. Instead, it is clearly gold’s fear component which is responsible for most of its recent gains. There was a similar instance of the dollar being strong while gold commenced a fear-fueled rally in late 2018 and early 2019. We could be witnessing a repeat of this atypical relationship between a relatively strong dollar and a strengthening gold price. The key factor in gold’s continued strength is the perpetuation of fear and uncertainty among investors, especially as it pertains to the global economic outlook. As long as investors remain apprehensive about the stability of the world economy, gold should be able to continue attracting inflows from safety-conscious participants.

It’s not just individual investors who are flocking to gold, however. Even respected hedge fund managers are buying the yellow metal right now. In a market characterized by depressed commodity prices and a weak short-term stock market outlook, money managers are looking to put cash to work. And, right now, gold is one of the top performers in an otherwise volatile financial market. Gold analyst Lawrie Williams points out that after seeing significant outflows in April and May, the SPDR Gold Trust (GLD) – the world’s largest gold ETF – has seen a major reversal in interest so far this month. In a recent article, he referenced Ray Dalio of the $150 billion Bridgewater hedge fund as recently increasing his fund’s exposure to gold due to global trade war concerns.

If Dalio, who manages one of the world’s biggest hedge funds, is long gold, then it’s safe to assume that many other fund managers are also pushing into gold right now. The combined weight of big-money inflows into gold and the gold mining stocks is creating a powerful momentum wave, based mainly on fear, which may prove to be self-sustaining well into the summer months. As I argued in a recent report, a major pullback in the stock market almost always sparks interest in gold. Moreover, the fear which led investors to dump stocks tends to persist long after stock prices have established a bottom.

I’ve also argued in recent reports that gold stocks present the best opportunity to leverage this fear-based upside momentum. Shown here is the PHLX Gold/Silver Index (XAU), the benchmark for the leading U.S.-listed gold and silver mining shares. As you can see, the XAU has decisively broken out above its 15-day and 50-day moving averages for the first time since early April and has produced its biggest 5-day rally since January. Rallies of this magnitude compressed in such a short time suggest the presence of more than just retail investor demand. It suggests institutional demand which can be very powerful and allow the gold stocks to remain buoyant for several weeks.

PHLX Gold/Silver Index

Source: BigCharts

Another important factor behind the latest gold stock rally beyond “fear momentum” is the positive increase since late May of gold stock internal momentum. I define internal momentum as the rate of change in the new highs and new lows of the 50 most actively traded U.S. and Canadian gold mining shares. I use a 4-week rate of change indicator to identify shifts in the short-term internal momentum picture for the gold stocks, and the updated chart of this indicator is shown below. As I’m emphasized in the last few reports, this indicator is now on the upswing and in support of higher gold stock prices. My rate of change projections suggest that internal momentum will continue to rise for the mining shares in the immediate term, and this in turn should particularly benefit the stocks which have shown the greatest amount of relative price strength versus the XAU index.

Source: NYSE

In summary, I expect that gold mining shares and physical bullion prices will continue to benefit from the growing wave of investor fear in the coming weeks. While the intensity of the market’s fears over the trade war will undoubtedly wax and wane, the overriding fears have been exceedingly persistent and aren’t likely to be relieved anytime soon. For that reason, gold will remain a leading choice among those looking for a safe place to store cash until worries have subsided. Gold mining stocks should also benefit from safe-haven inflows due to the superior leverage they offer in the face of rising gold prices.

On a strategic note, I’m currently long the VanEck Vectors Gold Miners ETF (GDX) using a level slightly under the $20.42 level (the May 29 closing price) as the initial stop-loss on an intraday basis. Investors can also maintain longer-term investment positions in physical gold. I don’t recommend increasing long positions in the yellow metal, however, until the U.S. dollar index closes under its 50-day moving average on a weekly basis.

Disclosure: I am/we are long GDX. 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.