- Gold has gained over +20% in three months.
- The narrative beyond gold's recent rally is about as convincing as that during the 2016 gold rally.
- Don't overstay your welcome in gold or the miners this time around.
Gold: Fear Trade Or Something More?
If there was an "asset class of the summer", it would have to be the gold complex. The price of physical gold has jumped +20% since May.
The weekly chart of gold looks attractive for chartists. A three-year basing pattern then clean break above 2016 and 2018 highs. Technicals alone, as we discuss below, won't bring the gold price back to 2011 highs, however.
As asked in our sub-title, is gold surging on fear of recession? Or trade war uncertainties. Or perhaps gold just goes through cycles, like any asset, and it so happens that gold price rises every few years.
The first question our readers have been asking is, "is gold reacting to the yield curve inversion". As shown below, in the four prior instances of a 10-2 yield curve inversion (all followed by U.S. recessions), gold has had major moves in three cases. During the shallow 1991 recession, gold traded sideways, then down. So, our response would be that the gold price does react to impending recessions. Although we note that the yield curve all but inverted in December 2018 (when everyone knew the economy was entering recession) and gold prices were falling. Either the gold market knew December 2018 was not the real recession warning or there is something else this time that sparked the gold rally in the past three months.
Is that "something else" sparking the gold price inflation in the economy? Not likely CPI and PCE inflation measures remain below the 2% inflation target. Even the University of Michigan Inflation Expectations are tame.
Gold, priced in dollars, also tends to rise when the greenback weakens. So, the recent dollar strength belies a strong gold rally.
In sum, we are lacking fundamental reasons to explain a continuation of the gold rally to 2011 highs. Unless, of course, the gold market is right, unlike in 2016, and the economy and financial markets are heading for disaster. The more likely scenario is, as soon as the trade wars are over and recession fears pass, money will come out of bonds and gold and go back into productive assets.
Gold Miners Are Finding Friends Among Mainstream Investors
Turning to the Gold Miners (GDX), these stocks have been an even better 2019 investment than physical gold. Probably a lot of short-covering in this chart.
However, the weekly chart of the gold miners is bumping up against 2016 highs, which should bring back bad memories for gold investors. We don't like it when talking heads on CNBC are recommending a 5% weight in gold miners for the Average Joe's retirement portfolio.
The peak-to-trough rally for the GDX in 2016 was +140%. For readers hoping for a repeat performance for GDX in 2019, we point out that the 2016 rally came from a low base. That said, the GDX probably will extend gains, at least testing the $32 level.
Moreover, looking at the biggest GDX holdings, valuation will soon become a headwind.
Newmont Goldcorp (NEM) (10.8% of GDX), like all the gold miners, are enjoying strong positive EPS revisions. Nevertheless, for the moment, earnings are not being revised up as fast as the stock price is rising. Of course, the market may be right and EPS for next year needs to be revised much higher. But with a P/E using the most up-to-date forward earnings at 25.3x, Newmont's stock price will probably come off current levels if the gold price just "plateaus" at $1,500. We like Newmont for growth, but we have a Sell based on our value criteria.
Barrick Gold Corp. (GOLD) (10.3% of GDX) is even more pricey at 37.2x forward earnings. Our valuation score (Enterprise Value/EBITDA) for Barrick is ranked 210 out of the 287 Materials companies we track. Not reassuring for a long-term hold.
Newcrest Mining (OTCPK:NCMGF) (6.8% of GDX) is the cheapest of the big gold miners on a P/E basis, but other valuation metrics leave us dubious. We have a sell on Newcrest as a value stock also.
We are not negative on gold miners here. But we are very prudent after the lightning-fast 2016 run-up in the GDX, in similar conditions. We are not against owning growth stocks with poor relative valuation scores in our methodology. However, this means greater attention must be paid to EPS and Revenue Revisions. If the analyst consensus no longer sees earnings accelerating, we'd get out of the miners… even if the price meltdown is underway.
One solution open to resource investors is to continue playing the gold miners during this rally, but proactively take profits into price strength. Money taken out of gold miners can be used to accumulate Energy stocks at bargain prices. We recommend targeting high-dividend paying Energy companies with strong balance sheets, as discussed in last week's Commentary, "Want Yield? Fuel Up On Energy".
This article was written by
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