Gold Mining Stocks Breakout Convincingly

The breakout in gold mining stocks in April is impressive on the technical measures

Paul Wong | May 7, 2020 | SmallCapPower: Gold equities broke out of a multi-year resistance level on massive buying flows. Using the NYSE Arca Gold Miners Index (GDM) as a reference, the 860 index resistance level was taken out convincingly. As shown in Figure 2, there is very little meaningful resistance until 1,200 (+25%). In March, gold equities, like bullion, experienced a forced liquidation event. Selling in GDX forced the ETF to trade at a significant discount to its underlying net asset value (NAV). Like many other ETFs, the selling volumes in GDX outpaced the liquidity in the underlying securities. Off the lows, the price action as measured by volume, breadth and money flow far exceeds the bullish thrust of the 2019 summer rally. This breakout, without question, is impressive on the technical measures.

(The following is an excerpt from an article originally published on on May 5, 2020)

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Figure 2. Gold Mining Equities Track Gold Higher
The NYSE Arca Gold Miners Index (GDM) has broken out of a broad base pattern; our short-term target is 1,200.

The absolute price action is impressive, but when measured relative to the S&P 500 Index (Figure 3), the chart pattern looks even more impressive. Typically, new market leadership is more evident when measured against the broad market index. As shown in Figure 3, the NYSE Arca Gold Miners Index (GDM) relative to the S&P 500 Index has put in a very bullish bottom base pattern. There is a double bottom pattern set up with the right bottom shaping a head and shoulder breakout pattern. This bullish pattern within a bullish pattern is a very positive sign.

Figure 3. Gold Mining Equities vs. S&P 500 Show Convincing Breakout
GDM is putting a remarkable long-term basing chart pattern and breaking out in the medium term.

Increasing Revenue with Deflationary Input Costs

The gold mining industry, like many other industries, is experiencing disruptions due to pandemic shutdowns. But unlike other industries, gold producers are experiencing a steep increase in the selling price of its product. Gold bullion is up +11% year to date and up over +31% year-over-year (through April 30, 2020). From a cost perspective, energy and labor are typically the two highest cost components for miners. The dramatic fall in crude oil is a rare function of both a supply shock (the Organization of the Petroleum Exporting Countries [OPEC] price war) and a demand shock (pandemic shutdowns) co-occurring. The enormity of both events will have lasting price consequences well beyond a few quarters. Labor, the other component, has been devastated by the pandemic. A tremendous labor crisis is occurring globally. In the U.S. alone, jobless claims have now exceeded 30 million, a crushing toll. Both of these conditions are deflationary shockwaves that will ripple out to all corners of the economy. There is virtually no major cost component (reagents, consumables, equipment) that will not see lower costs. Though near-term gold company earnings may be volatile due to COVID-19 disruptions, the potential increase in long-term profit margins may be unlike anything seen in recent history, and most comparable to the 1930s when gold company revenues soared and costs plummeted.

As QE (quantitative easing) Infinity continues to expand and ZIRP (zero interest rate policy) takes hold in a likely recession (or depression), growth equities will become highly sought after. Gold mining equities will have one of, if not the highest growth in earnings of any industry. Because of the nature of its revenue product (gold bullion), and its input costs (deflation), gold equities will likely develop into a convexity trade. Relative to the broad market, gold mining equities have a more direct path to higher prices. In the absence of earnings and post liquidity lift, general market equities require QE to increase stock prices by suppressing the risk-free rate and credit spreads, thereby reducing the discount rate used to calculate the present value of cash flows. Currently, cash flows are near impossible to forecast. The broad market equity risk is if earnings do not recover for more than a year due to COVID-19 and/or if a risk event pushes up credit spreads (i.e., credit defaults). Both risks are quite high compared to the risk for gold mining equities.

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