GLD: Capitulation Time?
Summary
- Given what's occurring in the gold stocks, it seems only a matter of time before GLD breaks down.
- When it's all said and done, the 2011-? bear in gold stocks might be the worst on record, one that will most likely never be beaten.
- For the first time, I see the finality of this bear market in GLD.
- The reason I'm bullish on GLD for the long-term is continued strong money supply growth, flat to declining gold production, increasing interest payments on US debt, and low valuations.
- Most gold companies will be able to survive a lower price environment.
GLD has risen to the 115 level, as it rocketed higher after the Fed meeting this past Wednesday. So just more of the same indecisiveness; however, the gold stocks aren't really following GLD's move to the upside. From the beginning of this bear market, it's the gold stocks that have been leading the way lower. GLD's strength might just be temporary due to a knee jerk reaction to the Fed statement. In the past, these initial moves turn out to be incorrect in terms of which way GLD is ultimately going to go.Since that time, GLD has weakened considerably and actually temporarily moved below the 110 level today (Wednesday), which is major support that held in November 2014 and March 2015. If this is the final sell-off of this bear market, then that 90-100 target that I have been talking about since last year comes into play - and fast too. The weekly MACD also shows another negative crossover, which could portend new lows are ahead.
(Source: Schwab)
Given what's occurring in the gold stocks, it seems only a matter of time before GLD breaks hard to the downside. The NYSE ARCA Gold Bugs Index ($HUI) is comprised of 16 gold companies and it includes the biggest names in the sector. The index has been incredibly weak as of late, and when you see the gold producers selling off like this, usually GLD isn't too far behind.
This looks like capitulation, which I have been waiting many months for. So without question, if GLD breaks aggressively lower, this will be the final sell-off for this bear market. I wasn't sure if it was going to happen but now the likelihood grows everyday the more gold stocks collapse.
This would be a most welcome turn of events as this bear market is very long in the tooth.
When it's all said and done, the 2011-? bear in gold stocks might be the worst on record, one that will most likely never be beaten. The HUI hit an all-time high of 630 in late Summer of 2011, which means it has declined 78% from that point to today's levels. If GLD enters that final leg lower, you could get some major panic selling in the shares of these precious metal companies. It's not out of the question for the Gold Bugs Index to be cut in half if GLD hits 90 (or about $950 for gold). That would put the HUI at 70 and change, which is an 89% sell-off from peak to trough.
We have to go back to the Great Depression to see that kind of carnage in a U.S. stock index, as the Dow declined from 381 in 1929, all the way to 41 by 1932. An 89% sell-off as well. But it only took a few months for the Dow to double off of the lows, and a year later it had tripled from the bottom. I expect a similar rebound in terms of percentage and swiftness should the HUI move substantially lower over the coming weeks/months.
(click to enlarge)
(Source: StockCharts.com)
No market index is going to lose 80%-90% of its value and just remain at those levels for years. These size percentage losses only occur in major oversold events where investors misprice assets to the extreme. At bubble tops, peak prices last for just a few days/weeks, the same goes for bear market bottoms. The lows in the Nasdaq during 2002 (after the tech/internet bubble burst) only lasted a few days. 2-3 months later the index was up 50%, a year later the Nasdaq was up 100% from the lows.
If we go back and look at the previous bear market in the HUI (which ended in late 2000), the bottom was very short-lived. History will repeat here as well. These gold stocks are already at deep deep discounts to their fair values. The further they move to the downside from current levels, the tighter the rubber band is pulled, and the faster and harder it will snap back.
I'm Still On The Sidelines
With GLD and the gold producers acting very weak over the last few months, I have been in mostly cash. For the first time though, I see the finality of this bear market. During previous lows that have occurred over the last few years, it was questionable. While gold and precious metal share prices were cheap, they weren't at extremes levels that would mark a final bottom. This would be more definitive now, as gold anywhere under $1,000 is simply unsustainable.
I still believe that GLD is in its bottoming stage while the stock market is in its topping stage. I don't see a market crash occurring in the next few months, rather I expect this chopping action to continue. Marginally higher highs could be hit in the major US indices, or we could just see a series of lower highs. Next year though (and maybe towards the end of this year) will not be pretty for the market.
Many investors look for reasons why GLD has been performing so poorly since 2011-2012. This has nothing to do with the strength of the USD, as so many people believe. It's simply the result of the huge bull market in stocks that has occurred. But the stock market is not attractive at the moment as valuations are extremely stretched. And with the Fed about to embark on raising rates probably sooner rather than later, it's time to be booking profits.
Why Am I A Long-term Gold Bull?
I'm currently bearish on GLD's short-term outlook, long-term though I'm pounding the table. I know for a lot of investors it's hard to see this sector ever returning to its former glory of 2011. But this is going to be the best performing asset class over the next several years. Gold will continually move higher in price as long as we have a non-gold backed fiat currency system.
You have M2 surpassing the $12 trillion level in the last few weeks. With the money supply constantly expanding at a very brisk pace, it's only a matter of time before the gold price catches up.
(Source: Federal Reserve)
You also have the major gold producers showing a flat to declining production profile over the next several years. This is in stark contrast to what the landscape looked like in 2011, when many gold projects were being developed and growth in output for most gold companies was very strong.
Some might worry about the Fed raising rates, which investors believe would put further downward pressure on the price of gold. But we are in a negative interest rate environment, and the Fed Funds rate would have to hit 2% for that to change. I doubt the Fed gets past 1.0-1.5% before this economy starts to buckle. That figure could move higher if inflation and GDP growth pick up in the short-term.
But it's not just the economy that will feel the pressure of rising rates, it's the U.S. Government's debt position that will be impacted the most. The Government is a huge beneficiary of this low interest rate environment, as it means lower interests. The second rates increase, so will interest payments. If rates "normalize" to the 4% level, interest will skyrocket.
From the Congressional Budget Office's updated projections for 2015-2025:
Interest Payments. CBO expects the government's interest payments to rise sharply during the coming decade, largely as a result of two conditions. The first is the anticipated increase in interest rates as the economy strengthens. Between 2015 and 2025, CBO projects, the average interest rate on 3-month Treasury bills will rise from 0.1 percent to 3.4 percent and the average rate on 10-year Treasury notes will rise from 2.6 percent to 4.6 percent. Second, debt held by the public is projected to increase significantly under current law....Together, the rising interest rates and federal debt are projected to more than triple net interest costs-from $229 billion in 2015 to $808 billion in 2025.So as confirmed by the CBO, should rates normalize, the interest that the U.S. will be paying on the debt will go from $229 billion to $808 billion over the next decade (this doesn't include interest credited to Social Security and other government trust funds). The faster the Fed raises rates, the faster these payments balloon. The simple fact is the U.S. will be running $1+ trillion deficits again in the not too distant future.
Of course GDP is projected to increase as well over the next decade, so a $1 trillion deficit won't be the same in terms of "percent of GDP" as it was say 5 years ago. But that's also a reflection of the amount of inflation/growth in the system, so gold will respond positively to this.
The U.S. is still dealing with a ever increasing debt obligation that simply can't be repaid. This stealth inflation that has been in place since the 2008 financial crisis will remain. Gold will have its turn as it must adjust for higher levels of money supply growth.
The biggest reason though to be a long-term gold bull is simply because of the extremely compelling valuations in the sector. Sure, they will get even cheaper if GLD takes one last plunge. It wouldn't be out of the realm of possibility to have many producers/developers/explorers selling at or below cash values soon, as their businesses will be worth nothing to investors. This is exactly what occurred in tech/internet stocks in 2002, the general stock market in 2008, and housing in 2009-2010.
At a certain price point, an asset becomes as close to a "sure thing" as it will ever be.
What's The Timing Of This?
Should GLD break down decisively, I'm expecting this bottom/capitulation process to last 2-4 months for GLD and the gold stocks. That would mean investors should be looking to be buy sometime in the September-November timeframe. The window to acquire GLD and precious metal shares at or near the absolute lows will be small and will not hold for many days. Timing though isn't extremely important providing investors are purchasing somewhere near the bottom. Once the bottom is reached, I expect a V-shaped recovery with GLD moving back swiftly to the 115 level.
Will There Be A Mass Wave Of Bankruptcies In The Gold Stocks?
Given a possible low of $950 for gold, and the debt loads for many of these companies in the sector, investors might assume that we will see a wave of bankruptcies come this Fall. But that is unlikely for a few reasons.
1. While net debt levels are high for some gold producers, much of this debt is long-term in nature. Barrick Gold (NYSE:ABX) for instance, the most indebted company in the sector, has plenty of cash on hand to cover its debt obligations (including interest) for the next several years.
The majority of companies will be able to survive a trip down below $1,000. Most of the weak ones have already perished (Allied Nevada for example), the rest have adapted to this low gold price environment and can withstand more downside. Unfortunately their stock prices will suffer.
2. As I mentioned earlier in this article, as well as in previous articles on the sector, gold under $1,000 isn't sustainable. The simple reason is cash costs will never be able to get down to that level across the industry without a serious supply disruption. And we haven't had a big enough increase in total gold output worldwide over the last 15 years that would warrant/necessitate a decrease in production.
Gold producers have done a tremendous job with reducing their costs structures since the precious metal started to decline in 2011, but to ask them for more is too much. Everything that could be done (to reduce All-in Sustaining costs), has been done. The only other avenue would be to take offline some of this lower margin supply. I just don't see that happening though because of the disruption this would cause to the industry.
In Summary
This feels like the start of capitulation in GLD, and in typical fashion it's the gold stocks leading the way lower. Should GLD break down hard (and we don't have some last gasp stick save event), I'm expecting the ETF to bottom out around the 90-100 region (probably closer to 90).
The gold stocks have much further downside than GLD, and we could see the HUI fall as much as 90% from the 2011 peak when it's all said and done.
There is much to be bullish about when looking at the long-term for GLD. Production growth is flat to declining, M2 is still rising at a very strong pace, net interest for the U.S. will skyrocket which will cause the deficit to hit $1 trillion again, and valuations in the gold sector are extremely compelling already.
If "this is it" then I expect the bottoming process to last for 2-4 months. We won't see a mass wave of bankruptcies in the sector either during that time. Net debt levels are high for some gold producers, but much of this debt is long-term in nature. I also don't expect gold to remain under $1,000 for long, so it won't be an issue for most companies.
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