In the Outlook 2016 report that was out on Jan. 11/2016, I mentioned that the bear market for gold and gold stocks that lasted for around four years was over, and it was the start of a new bull market for gold and gold stocks. After that gut-wrenching bear market, it was a bold call, now that the trend has confirmed what I was seeing, I’m pretty happy it turned out well.
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Before considering where to from here, I wanted to talk about why I think this time it will be different when it comes to the next bullish trend for gold and the gold stocks. I was talking to a friend the other day, and I said that it is much like what happened with tech stocks over the past 20 years or so. We had the tech bubble of the late 1990s, followed by the tech wreck. It took many years for investors to recover from the wreck and then see another bull market in tech stocks.
During the tech bubble, practically any stock with dot-com in their name went up like it was actually worth the hype. The next bull market in tech stocks after the tech wreck was much different than the last tech bubble. Investors were much more discerning, they didn’t easily forget what happened when tech stocks went into free-fall. Tech stocks during the latest surge were based much more on reality, actual earnings, not just dot-com in their name.
From 2001 until 2011, we had the most spectacular bull market for gold and gold stocks ever, practically every stock with gold in its name went up. See the similarities with the tech bubble? Then the gold bull got knee-capped by Mr. Market. It took around 4 years for the bear market that ensued to end. Many, still don’t believe it has ended, even gold bulls are skeptical the bottom is in.
I want to point out the trend that has been developing since around the middle of October, 2015, but before that, I want to discuss some fundamentals of long-term supply and demand. I had been looking for gold to form a bottom for a long time. As you can see in the first chart, it just kept making lower lows and lower highs after reaching $1900.00, so what happened to give me confidence?
The reason that I kept looking for a bottom while watching it continue to go lower was because the long term supply and demand story that caused the bull market that brought gold from the lows of around $250.00 to the highs of 2011 hadn’t really changed.
The supply chain for gold has been weak for a long time, head grades at mines are in decline, there are not enough new discoveries to replace the current mines, discovery grades are down and exploration spending has been decimated. While demand globally is strong, driven by China and India, two countries that have trade restrictions on gold, if they ever took those off the price of gold would be much higher.
When gold hit those lows, it was during another period when the price of the USD was on a tear, much like the USD has been on over the past few years. The USD index last reached a peak when gold was trading at $300 and below. In the next chart, I would point out that after several years of the USD trading in a sideways multi-year trend, it went on an unprecedented run in the middle of 2014. It gained over 20%, against a basket of all the major currencies in the world, in less than one year. That kind of move has only happened a few times in history.
If it was moving based on explosive economic growth in the US, a government that was balancing budgets, and an economy creating jobs with healthy wage pressure which had consumers and corporation on a spending spree, I could understand it. Instead, after the Fed pumping all kinds of stimulus into the system and near zero interest rates, the economy was stumbling along. Hardly creating enough jobs to cut into the real softness in the labour market, workers haven’t received any raises, on average, since the 1980s.
The US government had also been running trillion dollar budget deficits and growing the national debt in a rapid fashion, recent estimates are that it will reach $19 trillion this year. Evidence that the labour market is weak can be found in the poor labour participation rate, the high level of under-employed, and it seems the only one that is fooled is the Fed.
The only reason that the USD made that move is due to the fear trade and the strong stock market. It got to be a very crowded trade to go long the USD and stocks.
In the chart above, a weekly chart of the S&P 500, it clearly enjoyed a powerful bullish trend, but it wasn’t fuelled on cheap stocks being valued higher due to strong earnings growth. In reality, for much of that trend stocks had stretched valuations trading at historically high levels, and the growth in earnings was very tame relative to those high valuations. So why were stocks doing so well? Again, the market was aggressively bullish because it looked like no matter what happened, the Fed would be there to support a strong stock market.
Then in the last meeting of the Federal Reserve in 2015, they decided to take away the punch bowl and changed course by raising interest rates. The only realistic argument to raise was for the Fed to try and save face with the market by bluffing that they aren’t painted into a corner.
They put on the brave face that the job numbers were actually strong, despite nearly zero wage pressure. The next daily chart shows the market doesn’t believe the Fed anymore.
Old Mr. Market wasn’t too kind to the Fed, rewarding their bluff attempt that it is time to raise rates, with the worst January in history. The January Effect has a very good record of predicting the year ahead, sure it isn’t perfect, but it is a pretty accurate indicator.
It is clear the market no longer believes the Fed will be there to bail it out no matter how stretched valuations are, or how soft earnings growth has been. To make matters worse for the perma-bulls on the stock market, it looks like earnings are headed for rougher waters.
In my Outlook 2016 report, I called for a 20-25% correction, which I based on the early signs in the first few trading days of the year. The follow-through with the worst January Effect reading ever, I’m more confident now than I was then.
The above chart is the daily chart for the USD index, I point out the right side of the chart, especially the month of February. The USD bulls seem to be in for a rougher time as well, after a sideways January, it has been punished of late. It seems like the crowded trade of jumping on the USD as a fear trade has played itself out as well. The USD index is on a collision course to test that resistance at the 94 level which it touched several times during the past 52 weeks. Now that the crowded trade looks to have cracks, I’m expecting to see the test of that 94 level over the next couple months.
Two of the most crowded trades have been to be long US stocks and the USD. I think the crowd is getting fearful and the rest of the year will continue to test their conviction. US stocks and USD are off to a poor start to the year, I think both have much more downside this year.
With gold, it has formed a cup, the next trend should be some sideways action to create the handle and then we will be off to the races for the remainder of the year. I don’t think we have reached the highs of the year and see that $1350-1400 is in the cards.
Next, are charts of the five companies selected in my Outlook 2016 report as my top gold stocks
The five top gold stock picks were selected for common characteristics. They all have exceptional projects, and as gold has been gaining strength they have as well. Early in this report, I talked about the similarities of the tech bubble and tech wreck, and the decade-long bull market that topped in 2011 followed by a gold bear market that lasted until December 2015.
After the tech wreck and multi-year bear market, we saw another bull market in stocks, but investors were more discerning. The same thing will happen in the new bull market for gold. In this new gold bull market, I won’t be covering as many stocks as I did during the last gold bull market as I expect investors will be more discerning. They won’t be as quick to jump on just any stock with gold in its name.
This plays right into my strategy and what has always set me apart from many of my peers. I have a good nose for undervalued stocks and spotting trends with a record of past performance that I would put up against any market commentator that follows the mining sector.
I’m always on the hunt for more gold stocks to bring to those that follow my reports. I have some companies on my radar screen, I’m especially looking for smaller gold stocks, this is where gold stocks are most missed priced. Stay tuned, I will have more soon.
All the best,
Allan Barry Laboucan
All stock charts courtesy of StockCharts.com