After a rare late summer capitulation, and after a short-circuited autumn rally, it’s looking extremely bullish for a winter rally. Here are the details…
The gold miners’ stocks suffered a rough late summer this year. A rare forced capitulation walloped them to deep new lows, short-circuiting their usual autumn rally. That’s left this sector anomalously low as the subsequent winter rally gets underway, gold stocks’ strongest seasonal surge of the year. Starting from beaten-down levels after skipping the prior seasonal rally gives gold stocks exceptionally-bullish upside potential.
Seasonality is the tendency for prices to exhibit recurring patterns at certain times during the calendar year. While seasonality doesn’t drive price action, it quantifies annually-repeating behavior driven by sentiment, technicals, and fundamentals. We humans are creatures of habit and herd, which naturally colors our trading decisions. The calendar year’s passage affects the timing and intensity of buying and selling.
Gold stocks exhibit strong seasonality because their price action mirrors that of their dominant primary driver, gold. Gold’s seasonality generally isn’t driven by supply fluctuations like grown commodities experience, as its mined supply remains fairly steady year-round. Instead gold’s major seasonality is demand-driven, with global investment demand varying dramatically depending on the time in the calendar year.
This gold seasonality is fueled by well-known income-cycle and cultural drivers of outsized gold demand from around the world. And the biggest seasonal surge of all is just now getting underway heading into winter. As the Indian-wedding-season gold-jewelry buying that normally fuels this metal’s big autumn rally winds down, the Western holiday season ramps up. The holiday spirit puts everyone in the mood to spend money.
Men splurge on vast amounts of gold jewelry for Christmas gifts for their wives, girlfriends, daughters, and mothers. The holidays are also a big engagement season, with Christmas Eve and New Year’s Eve being two of the biggest proposal nights of the year. Between a third to a half of the entire annual sales of jewelry stores come in November and December! And jewelry historically dominates overall gold demand.
According to the World Gold Council’s latest data, between 2013 to 2017 jewelry accounted for fully 60%, 58%, 56%, 47%, and 53% of total annual global gold demand. That averages out to 55%, which is far bigger than investment demand. During those same past 5 years, that weighed in at just 18%, 20%, 22%, 37%, and 30% to average 26% of the world total. Jewelry demand is over twice as large as investment demand!
That frenzied Western jewelry buying heading into winter shifts to pure investment demand after year-end. That’s when Western investors figure out how much surplus income they earned during the prior year after bonuses and taxes. Some of this is plowed into gold in January, driving it higher. Finally the big winter gold rally climaxes in late February on major Chinese New Year gold buying flaring up in Asia.
So during its bull-market years, gold has always tended to enjoy major winter rallies driven by these sequential episodes of outsized demand. Naturally the gold stocks follow gold higher, amplifying its gains due to their great profits leverage to the gold price. Today gold stocks are now once again heading into their strongest seasonal rally of the year driven by this annually-recurring robust winter gold demand.
Since it’s gold’s own demand-driven seasonality that fuels the gold stocks’ seasonality, that’s logically the best place to start to understand what’s likely coming. Price action is very different between bull and bear years, and gold remains in a young bull market. After being crushed to a 6.1-year secular low in mid-December 2015 on the Fed’s first rate hike of this cycle, gold powered 29.9% higher over the next 6.7 months.
Crossing the +20% threshold in March 2016 confirmed a new bull market was underway. Gold corrected after that sharp initial upleg, but normal healthy selling was greatly exacerbated after Trump’s surprise election win. Investors fled gold to chase the taxphoria stock-market surge. Gold’s correction cascaded to mammoth proportions, hitting -17.3% in mid-December 2016. But that remained shy of a new bear’s -20%.
Gold’s last mighty bull market ran from April 2001 to August 2011, where it soared 638.2% higher! And while gold consolidated high in 2012, that was technically a bull year too since gold just slid 18.8% at worst from its bull-market peak. Gold didn’t enter formal bear-market territory at -20% until April 2013, thanks to the crazy stock-market levitation driven by extreme distortions from the Fed’s QE3 bond monetizations.
So the bull-market years for gold in modern history ran from 2001 to 2012, skipped the intervening bear-market years of 2013 to 2015, and resumed in 2016 to 2018. Thus these are the years most relevant to understanding gold’s typical seasonal performance throughout the calendar year. We’re interested in bull-market seasonality, because gold remains in its stalled bull today and bear-market action is quite dissimilar.
Prevailing gold prices varied radically throughout these modern bull-market years, running between $257 when gold’s last secular bull was born to $1894 when it peaked a decade later. All these years along with gold’s latest bull since 2016 have to first be rendered in like-percentage terms in order to make them perfectly comparable. Only then can they be averaged together to distill out gold’s bull-market seasonality.
That’s accomplished by individually indexing each calendar year’s gold price action to its final close of the preceding year, which is recast at 100. Then all gold price action of the following year is calculated off that common indexed baseline, normalizing all years regardless of price levels. So gold trading at an indexed level of 105 simply means it has rallied 5% from the prior year’s close, while 95 shows it’s down 5%.
This chart averages the individually-indexed full-year gold performances in those bull-market years from 2001 to 2012 and 2016 to 2017. 2018 isn’t included yet since it remains a work in progress. This bull-market-seasonality methodology reveals that gold’s strongest seasonal rally by far is its winter one which tends to start in late October. That portends big gains in coming months from still-beaten-down gold stocks.
During these modern bull-market years, gold has enjoyed a pronounced and strong seasonal uptrend. This whole concept of seasonality relies on blending many years together, smoothing away outliers to reveal underlying core tendencies. On average by year-ends, gold has powered 16.0% higher from the prior-year-final-close 100 baseline! And the majority of these major gains accrue during gold’s winter rally.
On average gold’s winter rally starts powering higher in late October, right after the seasonal correction following gold’s autumn rally. This major winter-rally bottoming has technically averaged out to arrive on that month’s 16th trading day, which was October 22nd this year. But in 2018 gold bottomed early after getting blasted lower by a wild frenzy of extreme all-time record gold-futures short selling by speculators.
Initially ignited by a sharp rally in the US dollar, that incredible leveraged shorting soon took on a life of its own and snowballed. So gold’s usual autumn rally was obliterated this year, it didn’t even exist! Instead of climbing the typical 6.6% between mid-June to late September, gold was hammered a serious 9.1% lower in that autumn-rally span. Both gold-futures speculators and gold-ETF investors dumped it aggressively.
Seasonality defines mere tendencies over long spans, not primary drivers. So seasonal tailwinds can sometimes be drowned out or bucked entirely when sentiment, technicals, or fundamentals get sufficiently bearish. That just happened to an extreme degree this year, as negating an entire seasonal rally is fairly rare. But the bright side of this is seasonals often exhibit strong mean-reversion patterns after price extremes.
So much-smaller-than-normal seasonal rallies like 2018’s missing-in-action autumn one generally lead to larger-than-normal subsequent ones. Gold powers higher faster to make up for lost ground! Thus this year’s young winter rally enjoys good odds for growing exceptionally large. On average in these modern bull-market years, gold’s winter rally ran 9.5%. That already dwarfs the spring and autumn rallies’ 3.7% and 6.6%.
Gold’s winter rally is so powerful because November, January, and February see some of its best average monthly gains. This month clocks in at 2.9%, making it gold’s 2nd-best calendar month. That peters out in December which averages just 0.7% upside. But January more than makes up for it with really big 3.1% average gains, which is gold’s best month of the year seasonally. February ranks 5th with 2.1%.
So gold’s 4.2-month winter-rally span enjoys its best average seasonal performance of the entire year. This is the time witnessing peak seasonal tailwinds. So if gold is already heading higher for sentimental, technical, or fundamental reasons, this strong seasonality will amplify its gains. And that is certainly the case this year. Both gold futures and gold ETFs suffered serious late-summer selling that needs to be unwound.
Gold’s autumn rally vanished this year because extreme record gold-futures shorting way overpowered it. Between mid-June and late-August which is the majority of that normal autumn-rally span, speculators added an astounding record 156.4k gold-futures short contracts! Since shorting gold futures effectively requires borrowing them first, these excessive shorts must soon be closed by buying offsetting long contracts.
Speculators’ collective gold-futures positions are reported weekly in the famous Commitments of Traders reports. The latest-available CoT data before this essay was published is current to October 23rd. At that point speculators still had another 93.6k contracts of short-covering buying necessary to bleed off their huge bearish bets back down to mid-June levels. That’s the equivalent of 291.2 metric tons of marginal demand!
All that remaining covering buying out of those epic record shorts will almost certainly occur in this year’s winter rally. That’s on top of normal strong seasonal demand. And that extreme speculator gold-futures shorting blasting gold sharply lower really tainted investor psychology too. So they started fleeing in sympathy and dumping gold-ETF shares. That was readily evident in the leading GLD SPDR Gold Shares’ holdings.
Between mid-June and early October they collapsed 11.9% or 98.6t! As of this week, investors still had to buy enough GLD shares to push its holdings another 74.7t higher in order to mean revert back up to those early-summer pre-gold-selloff levels. So speculators and investors alike have far more gold buying than usual to do in this year’s winter rally. That odd outsized autumn-rally selling all needs to be reversed.
Normally gold’s winter rally starts with gold up an average of 10.9% year-to-date in late October. But this year’s extreme selling anomaly had hammered gold down 9.9% YTD at its mid-August lows. While it did recover some to -6.7% YTD by late October, that still left a massive negative seasonal divergence around 18%. All that lost ground needs to be regained, giving this year’s winter rally far-larger-than-usual upside potential.
And the bigger gold’s winter rally, the better the gold miners’ stocks will perform over this same coming seasonally-strong timeframe. The gold stocks enjoy powerful sentimental and fundamental boosts when gold rallies consistently. Higher gold prices start shifting psychology back to bullish in this small contrarian sector, restoring capital inflows. And the resulting gold-stock price gains are also justified fundamentally.
Gold-mining profits really leverage underlying gold gains. The higher gold prices flow directly through to bottom lines, as production costs are largely fixed when mines are being planned. Gold miners’ profits leverage to gold is really important to understand, illuminating why gold stocks are the best way to ride gold’s major seasonal rallies. Recent real-world data illustrates the fundamental impact of higher gold prices.
The leading gold-stock investment vehicle is the GDX VanEck Vectors Gold Miners ETF. It includes the world’s biggest and best major gold miners. Every quarter I analyze the latest operational and financial results from GDX’s elite gold stocks. While this current Q3’18 earnings season is well underway, it won’t be finished until mid-November. So the latest full results available are still Q2’18’s, which proved quite strong.
The GDX gold miners reported average all-in sustaining costs of just $856 per ounce, which is what it costs them to produce and replenish each ounce of gold. AISCs don’t change much regardless of prevailing gold prices, as mining still requires the same levels of infrastructure, equipment, and employees quarter after quarter. Between Q3’17 to Q2’18, the GDX gold miners’ AISCs averaged $868, $858, $884, and $856.
That makes for a past-year average of $867. Gold-mining profits are the difference between prevailing gold prices and AISCs. At gold’s $1174 low in mid-August driven by that record gold-futures shorting, the major gold miners would’ve earned $307 per ounce. Assuming gold’s winter rally is merely average at +9.5%, that would carry gold back to $1286. Gold-mining profits would surge 36.5% higher to $419 per ounce!
This example shows gold-mining earnings leveraging a garden-variety gold winter rally by 3.8x. This core fundamental relationship between gold-mining profits and gold levels is why gold-stock prices tend to amplify gold’s gains by 2x to 3x. That leverage grows larger after gold stocks are wildly undervalued and deeply out of favor. In roughly the first half of 2016, GDX soared 151.2% on a 29.9% gold upleg for 5.1x upside!
So gold stocks’ own strong bull-market seasonality is fully justified fundamentally. This next chart applies this same seasonal methodology to the flagship HUI NYSE Arca Gold BUGS Index. We can’t use GDX for this study since its price history is insufficient, it was only born in May 2006. But since GDX and the HUI hold many major gold miners in common, they closely mirror each other. Gold stocks see big winter rallies.
During these same modern gold-bull-market years of 2001 to 2012 and 2016 to 2017, the gold stocks as measured by the HUI enjoyed average gains of 15.5% between late October to late February. That also makes the gold stocks’ winter rally their largest seasonal one of the year, besting both the spring rally’s 12.8% gain and autumn rally’s 10.5% upside. But gold stocks’ average winter-rally leverage to gold is lacking.
Their 15.5% seasonal rally on 9.5% gold gains makes for relatively-weak leverage of only 1.6x. That’s well behind the 2x to 3x expected based on historical precedent. Even in full-calendar-year terms, the 28.9% average gold-stock gains per the HUI only amplify gold’s 16.0% by 1.8x. This is the result of gold stocks dramatically underperforming gold in recent years, which dragged down and skewed their average gains.
That was mostly the result of euphoric record stock markets retarding gold investment demand. Gold is the ultimate portfolio diversifier since it tends to rally when stock markets weaken. So as stock markets appeared to do nothing but rally indefinitely for years on extreme central-bank easing and later massive US corporate-tax cuts, investors felt little need to own counter-moving gold and the stocks of its miners.
That’s starting to change though. When the US stock markets plunged 5.3% out of the blue in two trading days in mid-October, frightened investors suddenly remembered gold and bid it 2.8% higher. The gold stocks blasted up 9.1% on that, making for excellent 3.2x upside leverage! Because gold miners’ profits are fully dependent on prevailing gold prices, they can defy major stock-market selloffs to power higher with gold.
So if the stock markets are rolling over into their long-overdue next bear market driven by the record Fed tightening under full-speed QT, gold and gold stocks will return to favor in a major way. That ought to at least restore gold stocks’ normal leverage to gold, if not boost it well above historical precedent for quite some time in a mean-reversion overshoot. This could very well begin in coming months in this year’s winter rally.
Also after gold stocks’ autumn rally was short-circuited by that record gold-futures shorting, their winter-rally upside potential is much greater than usual. Between late July and late September, the gold miners’ stocks as measured by the HUI typically climb 10.5%. But this 2018 period was an unmitigated disaster. Gold stocks plummeted 26.4% between mid-June and early September when a brutal forced capitulation climaxed!
Normally when gold stocks’ winter rally is getting underway in late October, the HUI is already up 20.3% YTD on average. But this year on October’s 19th trading day which is the average winter-rally bottoming, the HUI was still down a colossal 25.4% YTD. So gold stocks are entering their strongest seasonal period of the year at a gigantic 46% negative divergence! That’s a mountain of lost ground they still need to make up.
And you could argue that gold stocks’ winter rally isn’t really righteous until they’ve first mean reverted back up to normal year-to-date levels. So this small contrarian sector’s upside potential in the coming 4 months or so is truly exceptional. Gold being driven much higher by speculators’ enormous gold-futures buying and investors returning will act like rocket fuel catapulting a major gold-stock upleg much higher.
This last chart slices gold-stock seasonality into months instead of years, which offers a more-granular perspective. Each calendar month in these same modern bull-market years is individually indexed to 100 as of the previous month’s final close, then all like months’ indexes are averaged together. Gold stocks’ winter-rally period encompassing November to February enjoys some of this sector’s strongest months of the year.
Between 2001 to 2012 and 2016 to 2017, the HUI averaged hefty 4.2% gains in November. That ranks as their 4th-best month of the year. Then like and because of gold, there is a winter-rally lull in December which retreats to 2.4% average gains. But gold stocks tend to power higher early in new years, with a return to strong 3.9% average gains in January. The winter rally is finally capped by February’s beast-mode surge.
February’s massive 5.4% average gold-stock gains per the HUI across all these bull-market years win out as their best month of the calendar year! This unbroken winter-rally streak is what makes this period between late October and late February the best time of the year to be heavily long gold stocks. There is no other seasonal span with such unparalleled consistency of big gold-stock gains, it is remarkably strong!
And this year’s winter-rally setup is way more bullish than most. Both gold and gold stocks got bashed far below where they ought to be this time of year. These enormous negative-divergence anomalies need to be unwound with majorly-outsized winter rallies. And with both gold-futures speculators and gold-ETF investors needing to do massive buying to normalize their wildly-bearish positions, fuel abounds to drive them.
The gold miners may have a sentimental and fundamental ace up their sleeve as well. According to WGC data, global gold production surges dramatically quarter-on-quarter from Q2s to Q3s. The past 5 years have seen gold mined in Q3s surge 9.0%, 9.1%, 7.4%, 7.1%, and 4.8% QoQ! This 7.5% average growth is huge. I suspect it is timed to maximize stock gains into year-ends, when most bonuses are calculated.
While gold miners’ quarterly tonnage throughput doesn’t change much, mine managers decide what kinds of ore grades to feed into mills. They seem to prefer to process lower-grade ores in years’ first halves, then move on to higher-grade mixes in second halves. The gold miners’ Q3 earnings season will wrap up over the next couple weeks, and this typical higher production should lead to proportionally-lower AISCs.
Average per-ounce costs naturally fall when there are more ounces mined to spread the big fixed costs across. And there’s nothing that warms gold-stock investors’ contrarian hearts more than growing production and its accompanying lower costs. So gold-stock sentiment could improve considerably soon independent of gold’s recovery upleg as collective Q3 results look better fundamentally fueling nice buying.
The greatest gains in this coming winter rally won’t be won in the popular ETFs like GDX and GDXJ, as they are far-overdiversified and burdened with way too many underperforming gold miners. So it’s much more prudent to deploy capital in the best individual gold miners with superior fundamentals. Their gains will handily trounce the ETFs, further amplifying the already-huge upside potential of this sector as a whole.
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The bottom line is gold stocks are just entering their seasonally-strongest period of the year. Their big winter rally is fueled by gold’s own, which is driven first by outsized demand from holiday jewelry buying and later new-year investment buying. So both the metal and its miners’ stocks have strong tendencies to rally between late October and late February in bull-market years. It’s the best calendar span to own gold stocks!
And this year’s coming winter rally looks exceptionally bullish with far more upside potential than normal. Gold and the gold stocks both skipped their usual autumn rallies on record gold-futures shorting and the sympathetic investor flight. So they have huge lost ground to make up as traders normalize excessively-bearish positions with big mean-reversion buying. That should soon catapult the gold stocks sharply higher.
Adam Hamilton, CPA