Gold trades a familiar path

Gold trades a familiar path

In the past month, gold has traded in an extremely narrow range between US$1,185 per ounce and US$1,215 per ounce, a mere 2.5% range from high to low. It has been one of the quietest and least volatile periods in gold trading since December 2015.

Currently, gold is trading around US$1,200 per ounce, exactly in the middle of the high-low range of the past month.

A gold investor who fell asleep a month ago and woke up today would not have missed a thing.
What’s extraordinary about this low-volatility stretch is that we are not living in a low-volatility world.

Argentina and Turkey face the prospect of financial collapse. Venezuela is approaching the level of a failed state.

Iran will become the target of severe economic sanctions in a matter of weeks. China and the US are in an escalating trade war, the worst since the 1930s. Brexit negotiations are falling apart.

Upcoming US elections may tip the House of Representatives to the Democrats and lead straight to impeachment proceedings against President Trump.

If ever there was a world where gold should be the beneficiary of safe-haven demand, this is it. Yet, nothing is happening.

We’ve seen this before

Of course, the gold price is facing strong headwinds at the same time.

The Fed continues to raise nominal interest rates and is also raising real rates because the pace of inflation remains subdued. US growth is strong, at least in the short-run, and stocks are reaching new all-time highs on major indices.

The US dollar goes from strength-to-strength on this combination of good news and higher rates. With the strong dollar, US stocks, and US Treasury bonds all competing for investor US dollars, it’s not surprising that gold appears unattractive to the global hot money crowd.

Geopolitical turmoil is putting a floor under gold prices, and higher rates and stock prices are imposing a cap.

These offsetting trends are probably the best explanation for why gold is moving sideways instead of decisively up or down. The bigger question, then, becomes how long this price equilibrium can last.

If the equilibrium breaks, which way is the gold price headed?

One important clue comes from the last time that gold traded sideways in such a narrow range.

That stretch was in December 2015, at exactly the same time the Fed executed the ‘lift-off’ by raising interest rates for the first time in nine years.

Following the lift-off, gold staged a massive rally from US$1,050 per ounce to US$1,365 per ounce in early July 2016, during the aftermath of the Brexit vote in the UK.

That December 2015 low marked the end of the bear market that began in September 2011 and the beginning of a new bull market that persists to this day.

If low volatility is a precursor to a major rally, then gold investors have a lot to look forward to in the months ahead.

Mergers could ignite a gold stock rally

A second clue has to do with the disparity between the performance of gold bullion versus gold mining stocks. Traditionally, gold and gold mining stocks are correlated with higher volatility on the part of gold miners.

When gold rallies, gold stocks go up even more because of their operating leverage.

When gold falls, gold stocks fall even more for the same reason. In the past year, this correlation has broken down. Gold has moved sideways, but gold miners have underperformed. A wide gap opened between the performance of the two related investments.

Suddenly, the gold miners are catching up.

The chart below shows 5% gains in the S&P Metals and Mining ETF versus the broader S&P 500.

This upward gap was particularly pronounced on 18 September, when the miners rallied 2% in one day versus a slight decline in the S&P 500.

This kind of performance will quickly close the gap between gold miners and gold.

It illustrates that gold was the price to watch all along, and a reconciliation would come in the form of higher prices for mining stocks instead of lower prices for bullion.

S&P Metals & Mining Index v. S&P500

Source: YCharts

This good news on mining stocks continued on September 23 when Barrick Gold and Randgold Resources announced they were in talks about a potential US $25 billion merger that would result in the largest gold producer in the world.

Generally, large mergers in a particular industry lead to a wave of mergers by smaller companies in the same sector as they strive to achieve the economies of scale needed to remain competitive.

A series of mergers in the gold mining sector would boost gold mining company stock prices as surely as a rally in the price of gold itself.

Despite the price doldrums of the past month, gold and gold mining stocks could be poised for a significant rally as political uncertainty grows, the Fed considers a pause in rate hikes in December, and a merger trend in gold mining companies plays out.

Investors may soon look back on today’s US$1,200 per ounce price as the last good entry point.

All the best,

Jim Rickards Signature

Jim Rickards,
For The Daily Reckoning Australia