The strongest season of the year is here, just as consensus builds that metals have finally reached a real bottom. That creates opportunities in the short and long term.
In a repeat of last year, gold stocks are way oversold – and setting up for another seasonal rally.
In December 2013 gold stocks were beaten down. Over the next three months they staged a strong rally…before trading sideways and then losing all those gains and more, so that today they are even more oversold than they were a year ago.
Charts for the Gold Miners and Junior Gold Miners ETFs GDX and GDXJ illustrate my words.
First, 3.5-year charts for each show how much gold miners have been beaten down. The majors, as represented by the GDX, are down 73%.
The juniors, as represented by GDXJ, have lost 85% in this bear market.
That is one hell of a beating. A long rally is ahead and, while 2015 will include downs with the ups, the first step will be a seasonal rally in Q1.
As a preview of what could be to come: after tax loss selling in late 2013, GDX rallied 35% while GDXJ bounced 53% in two months.
I spoke to this seasonality in a recent article, when I outlined how the Venture Index reliably outperforms from mid-December to mid-March compared to the rest of the year. If you missed that article, it’s worth a read to convince yourself of the reliability of a Q1 rally.
That’s the seasonal side. In terms of fundamentals, the current bear market is now almost as bad as the worst bear of all, from 1996 to 2000:
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As the maker of this chart, Jordan Roy-Bryne of TheDailyGold.com, points out, the current bear matches the 1996-2000 bear on other fronts. Then the gold-dollar exchange rate declined 73%; at its recent low this time XAU had lost 73%. Then the Gold Bugs Index fell 83%; this time HUI has been down as much as 77%. In this bear the AMEX Gold Miners Index has lost 75%; GDM lost 77% in 1996-2000.
Followers are well familiar with the rest of my gold recovery rationale. Central banks are buying and repatriating gold as quickly as possible, savers in China and India are stockpiling before prices rise, production is down, physical supplies are low, currency questions are piling up, and geopolitical tensions are rising.
Signs suggest the bottom is in and in perfect time for a double whammy: a seasonal rally coincident with the start of a real recovery.
In Terms of that Real Recovery…
While it’s all well and good to point to charts and say ‘Patterns say it’s time for a recovery’, proof requires more than patterns.
Never fear: there is more.
When it comes to a mining and metals recovery, what really matters is China. That is where over a billion people are working to improve their standard of living. They are getting electricity and cars and appliances and paved roads and schools and hospitals and power plants and factories and all those things require metal.
So let’s look at China for a moment. This isn’t a fulsome look by any means, but it’s a glance intended to provide some reassurance that, regardless of oil prices or the US economy or even its own pace of economic growth, China needs more and more metal every year.
Growth versus Size
Let’s start with growth. When the dust settles 2014 will be derided as the year China’s economy grew at its slowest rate in 24 years. Journalists and pundits will be torn: should we cry over that or moan that 2015 will likely be even worse?
From those who choose the latter, expect many a headline predicting copper price weakness. China consumes 45% of the world’s copper, so a slowing Chinese economy will surely kill the copper price, right?
Wrong. We love to focus on rates of change, but what is missing in that connection and so commonly from discussions of Chinese growth are absolute numbers.
China’s economy managed double-digit growth in ten of the last 14 years, so an expected expansion of 7% next year seems small. But remember: the base gets bigger every year.
If China’s GDP does grow 7% next year, it will expand by roughly $700 billion (and that’s excluding Hong Kong). That is bigger than Switzerland’s entire economy. It is also the size of China’s entire economy in 1994, when Chinese growth peaked at more than 30%.
Annual growth compounds the size of China’s economy. Similarly, annual growth has greatly increased China’s basic metal needs.
Take copper. In 2004, a 9% increase in copper consumption increased demand by 280,000 tonnes. A 9% increase in 2013 boosted demand by almost 800,000 tonnes.
Size matters.
The Global Context
Arguably the most important global trend right now is the strengthening US dollar. The dollar gained 10.5% over 2014.
Another key trend is the decline of commodity prices as a whole and oil in particular. The Continuous Commodity Index is down 10.2% over 12 months.
These trends matter in North America and Europe and there are oodles of analyses over what oil and the dollar will do to these economies. Opinion is divided and I think it is too soon to know.
What can be contemplated with more certainty is what oil and the dollar will do to emerging economies.
In short: countries that rely on commodity exports will struggle, while those that rely on imports will benefit. Additionally, if the US Federal Reserve does raise interest rates money will once again start staying home, rather than being sent far afield, to grow.
How do those scenarios play out among the big emerging players?
Three of the five BRICS – Brazil, Russia, and South Africa – are very reliant on commodity exports. A fourth, India, benefits from lower commodity prices but has a big current account deficit and needs foreign funding to manage its exchange rate.
Thus these four emerging economies will struggle to thrive in a low price, strong dollar world.
The odd BRICS out is China. China is the biggest buyer of most commodities, so it has the most to gain when they are cheap. For example, in the first ten months of 2014 China imported 778 million tons of iron ore, 16.5% more than the previous year. However, because iron ore prices were down almost 20% the cost to China was actually 5.4% less.
Lower commodity prices also help keep inflation in check and the current account positive. And while a strong dollar hurts countries with dollar-denominated debts, China holds huge foreign currency reserves that are worth more today than they were a year ago.
China has problems on its hands too. Bad loans, empty cities, endless corruption, shadow banking, and pollution are some of the worst. But it is important to note the conditions that challenge other emerging economies actually make it easier for China to grow and thrive.
I Couldn’t Write An Entire Article and Not Talk About Gold
The journalist in me loves it when the mainstream media runs with a sensational rumor without a sufficient reality check.
There was a great example of this in the week before Christmas. Following a Yahoo lead, journos started writing that Russia was selling gold.
It was a great story: faced with a collapsing currency and runaway inflation, Vlad Putin had resorted to selling gold. Wow!
Of course, it was not true. Selling gold goes against everything Putin stands for. Russia has been buying gold aggressively for years and Putin has never shied away saying why: he wants to dethrone the US dollar as the world reserve currency and believes gold will play a key role in that shift.
Moreover, Russia’s debt load is a very manageable $350 billion, completely payable from its reserves, and this sure ain’t the first time the ruble has collapsed. There is no way Putin would get rattled by a little thing like a free-falling currency.
Shortly after these stories appeared, the Russian Central Bank revealed it bought no less than 18 tonnes of gold in November, bringing Russia’s official gold reserve count to 1,188 tonnes. That count has doubled in four years and is not about to reverse trend.
Turns out the whole Russia-selling-gold rumor stemmed from someone mixing up total reserves and gold reserves. Indeed: Russia still loves gold.
Gold is also selling like hotcakes in India. The country imported 150 tonnes of the yellow metal in November, a 571% increase in imports year-over-year. And the surge happened even though import restrictions were not eased until the beginning of December.
Finally, China continues to buy gold. Wholesale gold demand in China will likely best 2,000 tonnes before the year draws to a close, met by domestic production, recycling, and imports.
On the supply side, now that massive write downs, asset sales, project deferrals, production cutbacks, debt repayments, and management changes have addressed many of the massive mistakes miners made in the previous bull run, focus is shifting to the future…where consensus is solidifying that a gold supply crunch is pending.
Across the sector majors have been cutting back on exploration and development and reducing higher-cost mine output for several years. As a result, output is down and new sources of supply are few and far between.
Since it takes years to permit, fund, and build a new mine, the supply gap will likely last for several years…lifting gold all the while.
There are no guarantees in investing, but when it comes to gold we have massive demand (China, India, and Russia, plus other central banks), geopolitical anxiety, currency questions, and chart-based analyses all suggesting a lasting bottom has been formed and it’s onwards and upwards from here, in the short and long term.
Things look reasonable for nickel and zinc too, as well as uranium – but I’ll save that discussion for another day.
Happy New Year!
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