Gold stocks have defied the odds to blast higher in the early summer doldrums. Investors have flocked back in recent weeks, their heavy buying driving record June-to-date gains. If this newfound momentum continues, gold stocks have the potential to achieve a record summer. With their exceptionally-bullish technicals this is certainly possible, but remains a tall order unless gold's rare summer rally resumes.
As gold stocks are still the most hated, ignored, and undervalued sector in all the stock markets, the vast majority of traders have no idea they are soaring. But earlier this week, the benchmark HUI gold-stock index and flagship (NYSEARCA:GDX) gold-stock ETF were up an amazing 16.5% and 16.8% month-to-date! These are utterly massive gains, demolishing the S&P 500's 2.0%. Gold stocks should be the belle of the ball.
The main reason the gold miners have rocketed higher is the massive gold short-covering rally that Fed chair Janet Yellen unleashed last week. At her quarterly post-FOMC-meeting press conference, she downplayed the growing inflationary trends by calling that data "noisy". Gold-futures traders were quick to interpret this as the Yellen Fed being more tolerant of higher inflation for longer than previously expected.
While the primary US gold-futures trading session was already closed for the day before Yellen's press conference started, American futures speculators reacted in force the next morning. They aggressively bought to cover some of their outsized gold shorts, catapulting gold up 3.4% for its best daily rally seen in 9 months. Investors flooded back into gold stocks on that, driving a really big 5.2% up day in the HUI.
But that Yellen-scoffs-at-inflation surge certainly isn't the whole story. 3/7ths of the HUI's June gains had already happened as of the day before that FOMC meeting and Yellen's subsequent press conference. And 4/7ths were on the books by the end of that press-conference day, the afternoon before gold's massive short-covering spike erupted. So while Yellen certainly helped gold stocks, there's more to their rally.
While gold stocks have always been an exceptionally-volatile sector, seeing such gains in June is truly unprecedented. Gold-stock price levels are overwhelmingly driven by the price of gold, which ultimately determines their profits. And gold prices are actually highly seasonal throughout the calendar year. While mined supply is constant, investment demand fluctuates considerably around key cultural events.
Gold's strong demand-driven seasonality explains the vexing precious-metals summer doldrums. The market-summer period of June, July, and August is simply devoid of regular recurring investment-demand spikes. The leading example of such surges is the autumn Indian wedding season, when vast amounts of gold are purchased. Their absence in summer makes this gold's weakest season of the year.
This is painfully obvious for long-time gold-stock investors and speculators. Gold stocks can and have surged in major uplegs anytime between September and May when global gold investment demand is strong. But during the summer doldrums, gold stocks usually just drift sideways at best. So hoping for big summer rallies in gold stocks certainly slams into the wall of precedent, a hardcore contrarian bet.
This next chart illustrates gold stocks' summer-doldrums drift. It takes every market summer in gold stocks, as represented by the HUI, since gold's secular bull was born way back in 2001. And then each individual year's summer HUI action is indexed to 100 as of that year's final trading day in May. This is essential to make each gold-stock summer perfectly comparable percentage-wise despite very different HUI levels.
The HUI summers between 2001 and 2013 are represented by yellow lines. Though they are a spilled-spaghetti mess, it is their central tendency we are interested in. That is distilled down in the red average of the indexed HUI summers over that secular span. And then the superimposed blue line shows this year's HUI indexed to 100 as of May 30th. June 2014 has seen a record secular-bull gold-stock advance!
In general, gold stocks just drift sideways through the summer doldrums of June, July, and August as the center-mass of their yellow indexed lines reveals. The vast majority of the time, the gold stocks meander between 10% above to 15% below their levels on May's final trading day. And this drift has a downside tendency, as evidenced by more breakouts below its lower support than upper resistance.
Interestingly last June, when gold was experiencing its worst quarterly plunge in 93 years thanks to epic record GLD gold-ETF selling, gold stocks suffered their worst June of this secular bull by far. At worst in late June 2013, the HUI had plummeted 24.6% month-to-date! Ouch. While that was truly anomalous on all kinds of different levels, gold stocks do tend to drift lower in June and July before bottoming.
This is readily evident in the red line averaging all the yellow ones. Gold-stock seasonals generally deteriorate throughout the summer until they finally bottom in late July. That's the highest-odds-for-success time to buy gold stocks ahead of their several episodes of major seasonal strength between September and May. So that makes this month's strong gold-stock rally look even more extreme and atypical.
As a sector gold stocks have never been up 16%+ in June before. The only comparable attempt came way back in 2001 right after gold's secular bull was born in despair. The HUI enjoyed a quick early-summer gain to +14.8%, but that quickly faded throughout that summer. By the time the end of August rolled around that year, the HUI was merely up 5.2% which is right in line with the subsequent average.
There were a couple more summer-doldrums upside breakouts in 2003 and 2005, but only the former could maintain its momentum. 2003 saw the HUI end August 36.9% higher than it had been at the end of May, a stupendous summer rally. But that was utterly unique, nothing else even comes close. The second-best summer performance happened in 2005, and that was merely a 10.9% 3-month gain.
This market precedent really drives home just how extraordinary the gold stocks' massive June 2014 rally has been. If they merely drift sideways from here until the end of August, it will easily be the second-best gold-stock summer of this secular bull! But obviously the seasonal odds are weighted heavily against such outstanding summer performance. 13 years is certainly a lot of history to fight.
I suspect the primary factor driving gold stocks' incredible June 2014 was their atrociously miserable May 2014. Last month the HUI plunged 8.6%, which is extremely atypical since May is the second-strongest month of the year on average for gold stocks. As of 2011, the last time I updated the full gold-stock-seasonals analysis, the average HUI gains in May between 2001 and 2011 were an amazing 7.9%.
This year gold happened to suffer a sharp and anomalous late-May selloff on record levels of gold-futures short selling by American speculators. But since that was a pure sentiment trade totally lacking any fundamental basis, it quickly reversed as gold began rallying the moment that extreme selling pressure started to abate. Markets' strong mean-reversion tendencies alone can explain June's big HUI surge.
Last month's gold-driven gold-stock plunge was only exceeded by May 2006's, which happened after an epic 42.4% year-to-date surge as of mid-May. That was the last time the gold-stock sector achieved some semblance of popular enthusiasm. Provocatively this year nearly saw comparable out-of-the-gates gains, with the HUI up 30.6% year-to-date by mid-March 2014. But obviously that promising rally stalled out.
And if the gold stocks' exceptionally-weak May 2014 is indeed the main reason June 2014 has been so awesome, just an oversold bounce, then the odds of this rally's momentum building throughout summer are low. And before gold stocks' and gold's Yellen surge erupted last week, the HUI was merely up 7.0% month-to-date which is well within that normal early-summer center-mass trend. That's not encouraging.
A normal mean reversion boosted by an exogenous Fed event can easily explain the gold stocks' whole record June so far. Couple this with this sector's strong tendency to drift sideways to lower in summer until late July or so, and the smart bet would sure seem to be against gold stocks rallying farther before then at the earliest. Unfortunately I suspect that's what we'll see, although there is a chance for a rare summer rally.
As always it hinges on gold, which will have to power higher contrary to its normal summer trend. The one event that could drive a rare summer investment-demand spike for gold is the lofty US stock markets rolling over. And they certainly should given how epically overextended, overvalued, and toppy they've become during the Fed's artificial levitation of the past 18 months. Gold ought to surge in a decisive stock selloff.
And if gold is bid higher, the gold-stock technicals are very bullish and perfectly situated to support serious buying. This final chart looks at the GDX gold-stock ETF over that last year-and-a-half where the general stock markets melted up. Despite facing the fierce headwinds of contrarian investments like gold and gold stocks falling out of favor while stock markets surged, gold stocks have formed a very strong base.
Gold stocks are hated today largely because of their catastrophic drop in the first half of last year. They suffered a free fall during gold s panic-like plunge of April 2013, and were hammered again last June when gold fell on the threat of the Fed slowing its QE3 bond-monetization campaign. The result was a dreadful 52.1% GDX plunge over the first 5.8 months of 2013! This naturally spawned epic gold-stock bearishness.
But over the past year, gold stocks have stabilized despite the universal calls for them to spiral lower forever. GDX has traded in a year-long consolidation basing zone between $20 and $30. This is actually incredibly bullish performance considering all the factors arrayed against this sector. Everyone hated gold stocks and gold, and the consensus view on gold stocks a year ago was that they were utterly doomed.
No one wanted to touch this pariah sector with a ten-foot pole, and gold remained under heavy selling pressure. Even after GDX's bottom last June, American stock traders continued to dump GLD shares at staggering differential rates while American futures speculators continued to pare their long bets. If there was ever a year for gold stocks to plunge, their critics are certainly right that this past year was it.
Yet they didn't, gold-stock prices stabilized in the face of mind-boggling pressure to drop. Only one thing can drive bottoming consolidations, and that is new buyers snatching up all the shares the sellers are jettisoning. Over the past year, brave contrarian investors have fought the crowd to prudently buy low all the gold-stock shares being cast away. This strong basing is the perfect technical foundation to launch a major new upleg.
Gold and gold-stock bearishness peaked in December, when GDX slumped to new lows. But despite the extreme anti-gold sentiment then, they were only marginally lower than late June's so it was essentially a successful low retest. And then starting this year, gold stocks have enjoyed gradual and sustained buying. This is a big contrast to their sharp short-covering rallies last July and August, much healthier.
While gold stocks carved an interim high in mid-March before drifting lower into late May, they are still in an uptrend as the support line above shows. And this month's record June surge has catapulted GDX back up to another 200dma breakout and left it on the verge of another Golden Cross. These are some of the strongest buy signals ever seen, when 50-day moving averages cross back above the 200-day ones.
Now there was a gold-stock Golden Cross in March too, that looked very promising. I wrote a whole essay on it and Golden Crosses in general then. But as sometimes happens at major turning points in markets, there can be indecision that leads to a series of Golden Crosses and Death Crosses (50dma falling under 200dma) before the turn is finally decisively carved. Obviously that's happened this year as well.
Any gold rally at all, which again is highly likely as the lofty stock markets inevitably start selling off soon here, is going to push the HUI higher and trigger this next Golden Cross. That powerful buy signal, one of if not the strongest in all of technical analysis, will attract in a lot of new investment capital. And the fact that gold stocks have been in an uptrend after consolidating near lows for a year will certainly help.
Professional institutional investors like hedge funds are actually starting to get interested in gold stocks again. It's hard to believe, I know, but they are looking for sectors that are still undervalued in these stock markets full of very-expensive valuations. And gold stocks remain deeply undervalued in absolute terms and more importantly relative to gold, which drives their profits and hence ultimately their stock prices.
These elite traders always look to their peers for ideas. So as they see gold stocks start to show up on the quarterly SEC holdings reports of hedge funds, more money managers are going to want to commit capital as well. This process will feed on itself, with higher gold-stock prices and improving technicals attracting in a wider group of contrarian investors. And it may very well start this summer, despite the weak seasonals.
All this gold-stock strength we've seen so far in 2014 in defiance of the extraordinarily bearish sentiment plaguing the precious metals means now is the time to do your homework. There are literally many hundreds of gold stocks out there, but the great majority will never achieve any success. So whether you want to add positions now or wait until the traditional late-July seasonal low, you have to do some research.
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The upside potential in gold stocks is vast. Last week I explained why gold stocks in general ought to at least quadruple in the coming years due to their undervaluation relative to gold. And that is in the headline gold-stock measures like the HUI and GDX dominated by slow-moving major gold stocks. The much-smaller junior gold producers' stocks will see gains amplifying and dwarfing those of the large miners!
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The bottom line is gold stocks have enjoyed a secular-bull-record June. While their recent gains can be explained by a mean-reversion bounce after a terrible May accelerated by a Fed chair dismissing any inflation concerns, they still add to increasingly-bullish gold-stock technicals. All gold stocks need to surge is for gold to continue rallying, which is highly likely once the overextended stock markets inevitably roll over.
So now is the time to do your homework, to take advantage of the summer doldrums and learn about the stock markets' only hyper-undervalued sector. Whether gold stocks continue rallying from here or wait a month until their traditional seasonal lows, they are heading much higher. As always the greatest gains by far will be won by contrarian investors willing to fight the bearish herd to buy out-of-favor gold stocks low.
Adam Hamilton, CPA
June 27, 2014
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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I own extensive gold-stock and silver-stock positions which have been recommended to our newsletter subscribers.