It was a stunning Sunday selloff that got my attention…
Within minutes, I sent an email to my team at Katusa Research to standby on alert.
Gold bullion cratered in overnight trading on Sunday, falling over $60 per ounce in a matter of minutes, breaching $1,700 per ounce.
Some are blaming it on thin overnight trading due to the Asian holiday, while others are justifying it with recent economic data.
Regardless, watching gold and gold stocks fall while the rest of the market roars higher is an uncomfortable feeling for gold bugs…
Many of you have seen this song and dance before. Trudged through trenches and held on through bleak times.
A large number of investors are new to the sector…
And it’s the first time you’ve got that white towel firmly in your grips.
This investor was drawn in by last summer’s rapid gold price ascent and the incredible gains gold stocks returned in that rally.
That Was Then. This Is Now…
While it can change in the blink of an eye, out of all the major asset classes, as many bitcoin enthusiasts will remind you, gold is the worst year-to-date performer.
Weak: What is Causing the Gold Price Decline?
One major seller in thin holiday trading aside…
The real driver of gold prices right now is the state of the U.S. economy and the outlook for growth and inflation.
Strong U.S. employment data released Friday played a pivotal role in the recent price action for gold.
The labour statistics point to improving conditions, which indicate a stronger and healthier economy.
In theory, a stronger economy should require less financial heroism — meaning less stimulus and money printing from the government and central bank.
For the record, I don’t think the Fed intends on changing its key accommodative policy stance anytime soon.
However, as an economy strengthens, it incentivizes investors to buy growth over protection.
Eventually a stronger economy could provide a catalyst for real interest rates to move closer to 0%, rather than down 1.15% today.
If you’re in the camp that one should earn a positive rate of return after inflation on bond investments or at least break even, then you’d be hard pressed to think gold is undervalued at these prices.
It’s Not What You Might Want to Hear…
But the numbers speak for themselves.
The chart below shows every weekly gold price relative to U.S. bond yields adjusted for inflation (Real Yields) since 2006.
By this metric, even if you wanted to break even on your debt investments and earn a 0% rate of return after inflation, gold is overvalued by over $200 per ounce.
How Well Does This Gold Price vs. Real Yields Model Work?
For the mathletes, an R2 of 0.86 indicates strong explanatory power between gold and real yields. Below is a chart which shows actual weekly gold prices since 2008 and the predicted price from the model.
I received a lot of hate from the Twitter crowd a few weeks ago when I said we may not like the current price action in gold, but we must respect it. As it looked like it would go lower from our analysis.
That was exactly what happened.
The gold market is a multi-trillion dollar a year industry. One seller for a few billion dollars on a Sunday is not going to make or break the sector in the long term.
But, the fact that one seller can significantly influence the price is a sign of short-term weakness.
Again, respect the price action and use the information the price action provides to make investment decisions.
Comparing Gold’s Biggest Corrections
While the recent price action doesn’t look promising, these drops don’t even make the top 20 worst monthly declines for gold.
Below is a table which shows the largest monthly declines for gold, and the subsequent returns three and 12 months later.
Back in June, gold retreated 7.7% for the month when it fell from $1906 to $1770 per ounce.
It was the worst performing month since November 2016.
Given the current price action, buying the dip in June likely won’t prove to be a winning strategy over the short run. Meanwhile, if August continues its trajectory, it’s shaping up to be just as bad as June or worse.
That’s definitely not a stat gold bugs will want to brag about. But the scabs, cuts and open wounds are starting to pour some blood into the streets.
Buy the Dip in Silver?
Silver prices have struggled as well, down 11% on the year and so far 9% for the month.
Again, similar to gold, silver’s worst months trounce the current price action.
In the next table, you’ll see the top 20 month over month declines, and the “buy the dip” model results for three- and 12-month returns.
In the short run…
Like Birds of a Feather: August and Gold
From Nixon closing the gold window on Aug. 15, 1971 to the Fed injecting billions to plug the sub-prime crisis on Aug. 9, 2007; decisions by the U.S. Fed in the month of August have had profound effects on gold.
A town with a population of 10,500 holds the keys to gold’s future success or failure…
In late August the annual Federal Reserve Jackson Hole symposium will take place.
It is often the place of major policy discussions and unquestionably the hot topic will be how to keep the economy running without sending it into an inflationary crisis.
With the coronavirus recession behind us, it’s hard to see nominal policy rates getting more accommodative rather than less.
A simple indicator I like to use is to see how many precious metal stocks above a $100 million market cap with over $5 million in cash are at 52-week lows versus how many are at 52-week highs — and the ones in neither category.
You can see that there the percentage of companies within 10% of their 52-week lows is rocketing higher.
And that’s where alligators start to come out of hibernation…
I’m happy if gold goes down because it means I get to increase my positions in my favorite gold stocks at half NAV. That’s smart investing.
To give yourself the most upside with least risk, you have to be a contrarian. Sell when others are manic buying.
And buy when others are heading for the exits and throwing in the towel.
I took cash off the table late in the summer and fall last year. I took a lot of flack for it because “gold was going to the moon”.
The hate doesn’t bother me and neither does the confirmation bias. Cash is king and my subscribers and I are cashed up now and can buy when others who are overleveraged are forced to sell.
Subscribers and I recently began nibbling on my favorite gold stocks again…
Slowly and methodically, we’re building positions over weeks and months. And that is the key in this marathon to building wealth.
It’s all detailed in my premium research service — Katusa’s Resource Opportunities.
In fact, there are three gold positions at my buy target price right now. How long they’ll stay at these price levels is anyone’s guess.
But I’m buying using my tranche strategy — and you can learn it too.
Going all in and buying your entire position on the first dip is a recipe for disaster and financial ruin.
It may not be as exciting as going all in, but it sure allows you to sleep better at night.