The question about gold and gold stocks is rhetorical. Yes, gold stocks tend to follow gold bullion prices. Sometimes one will lag the other, but it is safe to assume that gold miners benefit from higher gold prices or suffer from lower prices. The more important question is whether gold (and gold stocks) will continue to rise beyond resistance or will fall again in early 2014. We believe that gold is likely to decline and drag gold miners down as well in the short term.
As gold’s price rose in the 2000s, gold miners benefited but then began to cannibalize each other as competition increased, leverage rates skyrocketed and management difficulties emerged. Because of these problems; since the decline in gold prices in 2011 gold miners have done very poorly. In fact, many of the so-called “gold juniors” or small-cap gold miners have completely disappeared.
You can get a sense of the scale of the decline among gold miners in the next chart of the Market Vectors Gold Juniors ETF (GDXJ) versus the SPDR Gold Trust ETF (GLD). GDXJ has lost nearly 80% since 2011, and likely has further to fall. The reasons gold rose in January are likely temporary and very different than the factors driving gold prices in the early 2000’s. The rally is extremely fragile and should collapse as traders get more confident about the market.
In the early 2000s, gold’s price was on the rise for three basic reasons. Unfortunately most of these factors have been reduced or completely evaporated since 2011.
- The largest gold sellers in the world (central banks) agreed in 1999 to only sell a limited amount of gold each year and soon nearly stopped selling altogether. When the largest source of supply dried up the price rose. This dynamic is starting to change, which has pulled the most important source of support out from under gold prices.
- Gold investments were much easier for investors to access. For example, the SPDR Gold Trust ETF (GLD) owns the ninth-largest gold position in the world. Unfortunately almost all of that accumulation was done before 2011.
- A version of quantitative easing was just ending in the early 2000s and another began in 2008. The Fed, European Central Bank (ECB), Bank of Japan (BoJ), and Peoples Bank of China (PBoC) have been pumping money into the system over the last few years, but those spigots are starting to slow. If traders become less concerned about QE related inflation then gold prices will decline further.
If the Fed really is pulling back on QE, the central banks are diversifying their portfolios, and growth among private investors and ETFs has slowed, what has been driving gold higher this January? The issue is a currency crisis in emerging markets. Traders are a little stressed that problems in Turkey, South Africa, and India will snowball and spread to other markets. This is a lot like the problems in Greece in 2010-2012 but on a smaller scale.
Gold is a store-of-value or hedge against currencies when they become unstable. In the next chart you can see the how the Turkish Lira (TRY) broke out in mid-December, which corresponds nicely to the rise in price of gold. As the lira fell in value, investors pushed into gold. A decline in North American stock indexes, helped the situation along as well.
This is a big week for gold and gold stocks. Central banks in Turkey and around the world are in crisis-mode in an attempt to stave off a full panic. They have been getting pretty good at this sort of thing over the last few years, so we are optimistic that the improvement in the lira’s value will continue. The Fed is also expected to reduce bond purchases by another $10 billion, which should reduce inflation fears. Finally, the S&P 500 has been relatively stable (despite a bad report from AAPL) at support, where traders are likely to look for new entries. All of these factors are bad for gold as a safe-haven investment.
If trader confidence continues to rise, we expect gold to fall back to its December lows. If the historical pattern holds, gold miners should follow and set a new lower, low. Gold juniors should suffer the most. We recommend traders take advantage of this situation by shorting the Market Vectors Gold Juniors ETF (GDXJ) at current market prices or buying puts with an initial target of $29 per share. If the selling is robust, support is in danger and our secondary projection is $23 per share.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.