A Reversal of Fortunes for Precious Metals
So far, 2016 is proving to be painful for those who were betting that some of last year's popular trends would continue. A group that outpaced the broader equity market in 2015, the “FANG”s–Facebook, Amazon, Netflix and Alphabet (Google)–has begun to falter, no longer immune to the selling pressures that have enveloped other shares. Meanwhile, some of the most unloved stocks of the past 12 months have found their footing, including beleaguered retailers such as Walmart, Macy's and Kohl's.
Another segment that was out of favor last year–gold, silver and precious metals mining stocks–also looks to be in the midst of a reversal of fortunes. While the S&P 500 index has dropped 6% since the end of December, the Market Vectors Gold Miners ETF (GDX) has jumped 5.8%. Over the same span, the SPDR Gold Shares (GLD) and iShares Silver Trust (SLV) ETFs have gained 4.2% and 0.8%, respectively, while the PowerShares DB Commodity Tracking ETF (DBC) has declined 4.2%. Last year, the mining, gold and silver ETFs fell 24.7%, 10.7% and 12.4%, respectively.
A supportive backdrop
There's little doubt that the backdrop for precious metals is supportive. For one thing, various developments are bolstering demand for safe haven assets. A number of foreign currencies have come under pressure, as noted in “U.S. Dollar: Last Currency Standing,” including most recently, the Chinese yuan, reflecting concerns about faltering growth and high levels of debt in the Chinese economy, as well as the pressures associated with rising capital outflows. In 2015, China's foreign reserves dropped by a record $512 billion. So far this year, its currency has lost nearly 1.5% versus the dollar.
Meanwhile, as detailed in “A Boiling Point… For Gold,” geopolitical conditions are deteriorating. In the Middle East, for instance, the recent decision by Saudi Arabia to execute 47 individuals for terrorist-related crimes, which spawned hostile rhetoric from Iran and a subsequent ransacking of the Saudi embassy in that country, has led the Saudis and other countries to cut diplomatic ties with Iran. Along with indications that the economy of OPEC's largest producer is being slammed by its efforts to flood markets with oil to drive low-cost U.S. competitors out of business, such developments raise the odds that conflict will break out in the already unstable region.
In Asia, North Korea's claim that it tested a hydrogen bomb have heightened tensions between that country and its neighbor to the south. Following a resumption of propaganda broadcasts by South Korean across the heavily fortified border between the two countries, North Korean said the act risked pushing the two sides “toward the brink of war.” Also unsettling conditions in the East was a report that China had landed its first plane on new island runways in a disputed region of the South China Seas, which sparked formal protests from Vietnam and the Philippines.
The fact that the dollar has recently flat-lined can also be seen as positive. I argued in “Is the Conventional Wisdom Wrong About Gold?” that a rising U.S. currency wasn't necessarily bad news for prices, because such a move would likely stem from a destabilizing unwinding of large structural dollar-short positions that would boost interest in other safe havens. That doesn't mean, of course, that a stable-to-lower dollar is negative for gold and silver, especially if, as reports indicate, it stems from efforts to reduce risk (i.e., by speculators who are closing out “carry trade” positions). A lower dollar makes precious metals prices more attractive to overseas buyers.
The set-up for a contrarian reversal
That said, what appears to be the catalyst for this year's move in mining stocks and precious metals is the same one that is helping to spawn reversals in equity and other markets: lop-sided sentiment. As the following two charts from Elliott Wave International suggest, pessimism in the gold market reached a dramatic extreme towards the end of last year. Historically, high levels of bullishness or bearishness regarding any security, sector or asset class have often been the set-up for a change in trend, sometimes suddenly and without warning.
The technical picture for precious metals also suggests that the path of least resistance is up. As the following chart shows, gold has fallen back to key support at the 2008 and 2009 highs, and appears to have traced out a positive momentum divergence, which has often been associated with trend reversals. Moreover, as illustrated by the second chart from the sales trading team at UBS, the yellow metal has made at least a medium-term bottom every 8 years or so since the 1970s, with the current time frame marking the latest cycle low.
Some might naturally view the recent outperformance in gold, silver and mining stocks as a temporary correction, in the same way that equity bulls might see the selloff in the FANGs as an opportunity to get back on board a trend that seemed unstoppable only weeks ago. More likely, the reversals seen so far this year are the lead-in to something bigger.