A Fundamental Basis For A Gold Stock Turnaround

Includes: AEM, GDX, GLD, KGC, KL
by: Clif Droke

Earnings and revenue expectations rise for leading gold producers.

Many mining stocks can be considered as oversold and undervalued.

I expect XAU index will eventually rebound to last summer's high.

One of the biggest obstacles facing gold in the last year was the weak outlook for many of the companies which produce gold. Revenue and earnings estimates for some of the top gold miners were subdued in 2018, and this kept the PHLX Gold/Silver Index (XAU) in a position of relative weakness versus physical gold for most of the past year. With earnings and revenue estimates for several important mining companies on the upswing in recent quarters, however, there is now a fundamental basis for the gold stocks to finally realize their potential and “catch up” to the gold price. We’ll discuss this improvement in today’s report.

The gold price rose to its highest level since April last week as the yellow metal had a blow-out performance. With last week’s impressive performance, gold has established its biggest win streak since an 11-day rally ended Jan. 5, 2018. Gold has seen a more than 3% year-to-date advance and was 2.4% higher in the latest week.

Fear was palpable among investors last week as concerns about an escalating tariff war between the U.S. and some of its biggest trading partners reached a fever pitch. Safe-haven inflows into gold were clearly in evidence as gold briefly eclipsed U.S. Treasury bonds as the favored repository for flight-to-safety cash. This can be seen in the following graph which compares the 1-month performance of the iShares 10-20 Year Treasury Bond ETF (TLH) with the SPDR Gold Shares (GLD), the world’s largest gold-backed ETF.

iShares 10-20 Year Treasury Bond ETF vs. SPDR Gold Shares

Source: BigCharts

Gold futures have risen for eight consecutive trading sessions, a remarkable upside run and a further indication of the metal’s safety demand. Along with the obvious increase in fear, the market has also been buoyed by expectations that the Federal Reserve will cut interest rates at some point in the coming month. This expectation was strengthened by the release of the latest U.S. employment report. The latest report showed that non-farm payrolls for May increased by just 75,000, which was considerably below the consensus expectation of around 180,000. The outlook for lower rates is potentially good news for gold investors since lower rates reduce competition for the non-yielding metal.

Let’s now turn our attention from gold to the gold mining stocks. I’ve argued in recent reports that the major gold mining and exploration stocks would likely benefit the most from the latest surge of interest in the precious metals. One reason for this expectation is the fact that the gold mining stocks have been, by and large, major laggards compared to bullion prices in the last few months. But not only have the gold stocks underperformed the physical metal, some of them can be described as “oversold” and undervalued after the April-May decline.

A few examples of this will suffice to emphasize this point. Consider for instance the trend in the estimated revenues for top producer Agnico Eagle Mines Ltd. (AEM), a component of the PHLX Gold/Silver Index. After trending lower for the first several quarters of last year, analyst expectations for Agnico’s revenue outlook have shown a remarkable about-face in the last few months. The consensus expectation is for Agnico’s revenues to drastically increase in this quarter and in Q3. This provides a clear fundamental basis for the recent rally in AEM shares and is a reason for expecting further stock price gains in the months ahead.

Source: Reuters

Another XAU component company, Kinross Gold Corp. (KGC), shares a similar outlook. Revenue and earnings estimates for Kinross have bounced back dramatically from last year’s reduced outlook. As you can see here, the revenue outlook for Kinross is trending solidly higher. It suggests that Kinross shares have been overlooked based on the subdued stock price performance of 2019 to date. It also provides a fundamental basis for higher prices for KGC in the coming months.

Source: Reuters

One of the top-performing North American gold mining stocks of 2019 is Kirkland Lake Gold Ltd. (KL). Kirkland Lake’s share price performance is based in part on the company’s strong cash flow and financial condition. This is reflected in the company’s earnings-per-share estimates for the current quarter and the next one.

Source: Reuters

Beyond the increased revenue and earnings outlook for many individual mining companies, there’s also a continued technical basis for the latest XAU rally. Shown below is my favorite measure of the incremental demand for gold stocks. It’s a 4-week rate of change (momentum) indicator of the new highs and lows of the 50 most actively traded U.S.-listed gold stocks. The latest 4-week rate of change in the highs-lows tells me that the gold stocks still have some near-term rally potential despite being temporarily “overbought” on an immediate-term basis. As I’ve emphasized lately, as long as this indicator is rising, participants are justified in remaining long the gold stocks which are in a relative strength position versus the XAU index.

Source: NYSE

In summary, unlike some of the brief rallies we saw among the actively traded gold shares last year, there’s definitely more of a fundamental basis behind the latest XAU index rally. The improved revenue and earnings outlook for several top gold producers paves the way for investors to recognize many of the bargains to be found in this sector. This in turn should keep investor interest in the gold miners elevated in the coming months. It should also allow the XAU index to eventually recover to its previous high level from last summer.

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. The latest weekly close under the 50-day moving average in the U.S. dollar index should help support the intermediate-term outlook for gold prices.

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.