The gold miners are signaling that further declines in the price of gold are coming. Here is where the miners show the gold price could be headed…
Gold has had a rough several months. The precious metal is down some $170 from its peak in April near $1,370, closing today just below $1,200 on the New York COMEX futures market. As we indicated in our last article, gold has failed to maintain the structure that would be indicative of a bull market in progress. That said, no market moves in a straight line, and a reversal will be in store at some point. What are some price projections as gold heads lower over the coming months where we may look to see support emerge?
There are a number of ways to estimate price targets for gold. Established support and resistance zones, Fibonacci retracements, and trend channels are just a few. However, for this article let us focus on a powerful way to gauge the potential for future gold prices – and that is: what the mining complex is expecting.
Miners Gold Price Expectations
Gold mining profits are leveraged to the underlying metal price. When the price of gold rises by 1%, gold miner profits typically rise by 2% – 3%, as the underlying costs to mine the metal remain relatively fixed. The same leverage works to the downside of course. The bottom line is that investors in the gold mining sector should have a solid idea of what the price of gold itself is going to do, as the price is a critical determinant of operational success.
That said, let us examine the figures that the gold miners are now pricing in for their own product. This can be a valuable form of analysis to use any time one is preparing to make a sizeable gold purchase.
Below we show the GDX large-cap gold miners fund on top, with the price of gold immediately below it. The GDX contains an average of approximately 50 different mining operations. Let us examine the relative valuations of the two since late-2015:
Note how the GDX closed today just above 18. In green, we have highlighted the last time that the GDX traded near this level, which was in December 2016.
Following the green arrow down, note where gold traded the last time that the GDX was at this same 18 level: approximately $1,125 per ounce.
It is clear from this comparison that the gold miners are still pricing in at least another $75 downside in the price of gold. Thus, gold investors should be on alert for further weakness over the months to come before any potential for a sustained reversal higher.
Miners Wrong At Extremes
No method of analysis will be correct 100% of the time, and it is always worth considering times in which the gold miners were incorrect in their pricing expectations for gold.
The main idea here is that the miners tend to get their projections wrong at extremes, whether that is lower or higher.
Below, note how during January 2016, the GDX miners made a final lower low below the 13 level (green highlight). Meanwhile, gold had already risen to above $1,100 from its recent low and did not look back after that point. The miners simply got it wrong by making this lower low, as extreme negative sentiment fed on itself after years of declines and the miners succumbed to capitulation selling.
Let us now look at the opposite scenario: note how in August 2016, after the nearly 200% rise in the miners and 30% rise in the price of gold, the GDX made a new higher peak above the 31 level. This final surge did not correspond with a higher peak in gold, and what more, it in fact marked a false breakout from which the sector has since not recovered. In essence, what we saw here was the inverse of the above false breakdown. At extremes, positive sentiment can feed on itself leading to irrational buying at exactly the wrong point.
The main point here is that the miners tend to get things wrong at extremes – both higher and lower.
Takeaway On Gold Price Forecast
Let us return to the first chart of this article: as we can observe, neither the miners nor the price of gold are presently at extreme valuations. Both are well within the recent ranges of the past 36 months. Thus, as the miners are already pricing in at least $1,125 per ounce gold, we are hesitant consider this a false signal.
Precious metals investors should either take defensive action, or wait to initiate new purchases until a more clear bottoming pattern is observed. Further declines are likely over the months ahead.