Do gold mining stocks, as represented by the Barrons Gold Mining Index (BGMI) or the XAU or the HUI, lead gold bullion at significant turning points? According to many analysts the answer is a resounding “yes”. However, according to the historical record the answer is “sometimes, but not consistently”. I’ll go with the historical record.

There are plenty of examples of gold mining stocks leading the bullion price at a turning point from down to up or up to down, but there are at least as many examples of gold mining stocks lagging the bullion at a turning point. The most blatant example of the latter occurred in 1980. It is well known that gold bullion reached a long-term price top in January-1980, but it is less well known that gold mining stocks, as represented on the following weekly chart by the BGMI, experienced a huge rally after the major high in the gold price and didn’t reach a long-term peak of their own until September-1980.

Another example of gold bullion leading the gold-mining sector at a meaningful turning point occurred during the mid-1980s. First, gold bullion reached a multi-year bottom in February-1985, but it wasn’t until July-1986 that the XAU reached a similar bottom. Second, the XAU commenced an intermediate-term rally in late-July of 1986, but as noted on the following daily chart the associated bottom in the gold price occurred about 6 weeks earlier.

Here are examples of the same lead-lag relationship from the more recent past:

1) Gold bottomed on a long-term basis in early-December of 2015, but the equivalent low for the HUI didn’t occur until mid-January of 2016. Gold then reached an intermediate-term top in July-2016, but the associated top for the HUI wasn’t put in place until about a month later. In other words, the gold-mining sector lagged the bullion market at both the start and the end of the 2016 intermediate-term rally.

2) Gold made an intermediate-term bottom in August-2018, whereas the HUI waited until September-2018 to make an intermediate-term bottom of its own. Then, in May of 2019 the HUI made a sequence of lower correction lows while gold bullion remained above the low it made at the beginning of the month.

In my experience, rather than labour under the unreliable assumption that gold stocks lead the bullion at turning points, any divergence or non-confirmation between gold stocks and gold bullion should be viewed as potentially bullish after prices have become stretched to the downside and potentially bearish after prices have become stretched to the upside. For example, after prices have been trending downward for several months, a new multi-month low in the gold price that isn’t quickly confirmed by the HUI or a new multi-month low in the HUI that isn’t quickly confirmed by the gold price should be viewed as a bullish sign. By the same token, after prices have been trending upward for several months, a new multi-month high in the gold price that isn’t quickly confirmed by the HUI or a new multi-month high in the HUI that isn’t quickly confirmed by the gold price should be viewed as a bearish sign.

To put it more simply, non-confirmations between the gold price and the related mining indices matter, but it doesn’t matter whether the non-confirmations involve relative strength or relative weakness in the mining sector.

[This post is an excerpt from a recent TSI commentary]

Over the past four months the Fed has added about $400B to its balance sheet. To put this into perspective, since early September the Fed has expanded its balance sheet at an annualised rate of around 30%. According to the Fed, the purpose of this dramatic monetary expansion was to address a temporary liquidity issue in the “repo” market. The question is: If the Fed is dealing with only a temporary shortage of liquidity in the market for short-term money, why did it introduce a program in mid-October to supplement the temporary injections of “repo” money with $60B/month of permanent money?

The answer is that the Fed is dealing with something more than a temporary shortage of liquidity in the market for short-term money. The fact that the Fed sees the need to remove $60B/month of Treasury supply from the market in addition to the Treasury supply that is being removed on a temporary basis via “repo” operations implies that the overall demand for Treasury debt is falling short of Treasury supply at the Fed’s targeted interest rates. Looking from a different angle, it is clear that at current interest rates the global financial system wants more dollars and less Treasury debt. The Fed is accommodating this desire by increasing the supply of dollars to the market and reducing the supply of government debt that must be absorbed by the market.

The key phrase in the above paragraph is “at current interest rates”. If the supply of and the demand for money and credit were permitted to balance naturally then interest rates would now be much higher. However, the Fed doesn’t want supply and demand to strike a natural balance; the Fed has decided that it wants the price of credit at a certain level and that it will use its power to create and destroy money to override natural market forces. In this regard the current situation is unusual only in degree, because the Fed has been attempting to override market forces for more than 100 years.

The US Federal government is not about to slow the pace at which it emits new debt. On the contrary, the rate of growth in government debt supply looks set to rise. Therefore, one of two things will have to happen if interest rates are to stay near current low levels: The Fed will have to keep absorbing Treasury supply at a rapid pace or the market’s desire to hold Treasury debt will have to increase substantially. The latter could occur in response to a sizable decline in the US stock market or a crisis outside the US.

Within a week of its mid-October announcement we wrote that the Fed’s promise to inject $60B/month of new ‘permanent’ money was a potential game-changer, in that it could extend the current cycle (prolong the equity bull market) and lead to more “price inflation” than earlier programs. We continue to think that a cycle extension could be on the cards, but if so the recession warnings that were generated by leading indicators during the second half of last year must disappear within the next couple of months.

[This post is an excerpt from a recent TSI commentary]

Over the past three months the year-over-year rate of growth in US True Money Supply (TMS), a.k.a. the US monetary inflation rate, has jumped from a 12-year low of 1.5% to a 2.5-year high of 6.1%. Refer to the first of the following charts for the details. This is due to the combination of the Fed’s new money-pumping scheme, which we are told is not QE even though it is identical to QE in terms of its effect on bank reserves, the money supply and the financial markets, and the expansion of commercial bank credit at close to its fastest pace in 10 years. The second of the following charts shows the year-over-year rate of change in commercial bank credit. If the commercial banking system continues to expand credit at the current pace and the Fed runs its new asset monetisation program until at least the end of March, then by the third quarter of next year the US monetary inflation rate will be above 10%. What does this mean for the financial markets and the economy?

Once a boom turns to bust there is nothing the Fed can do to stop or even delay the hardship that most people experience during periods of economic recession or depression. There also is very little the Fed can do after the boom-bust transition has occurred to prevent asset prices from tumbling. However, before the boom collapses, as eventually it must, it can be given a second (or a third or a fourth or a fifth) wind by a substantial new injection of money. Therefore, IF the boom is still mostly intact then the strong rebound in monetary inflation could prolong the cycle.

Given that the senior US stock indices are at all-time highs in dollar terms and are yet to signal long-term downward reversals in gold terms, it’s possible that the boom is intact. This means that the rebound in monetary inflation COULD prolong the boom phase of the current cycle. Whether it actually will is not knowable at this time. One of the ‘tells’ will be whether or not there is a sizable pick-up over the next three months in new manufacturing orders.

If the boom phase of the cycle is extended by the monetary inflation rebound it will be bullish for oil, industrial metals and the stocks of cyclical companies (the more cyclical the better), and bearish for gold, T-Bonds and “defensive” stocks.

Like old soldiers, old beliefs never die. In the financial world, one of the many old beliefs that clings to life despite a pile of conflicting evidence is the one about gold being primarily a hedge against, or a play on, so-called “CPI inflation”.

The belief that big moves in the gold price are primarily driven by “price inflation” as measured by the CPI was spawned by what happened during 1972-1982. As illustrated by the following chart, there was a strong positive correlation between the gold price and the 12-month rate of change in the CPI during this period. However, it is clear that the positive correlation of 1972-1982 did not persist over the subsequent 37 years. In particular, the chart shows that the most recent two major rallies in the gold price (the rallies that began in early-2001 and late-2008) had nothing to do with “CPI inflation”. These rallies got underway in the midst of steep declines in the CPI’s growth rate and were at no time supported by a rapidly-rising CPI. The chart also shows that 2019’s significant up-move in the gold price had nothing to do with a rising rate of “CPI inflation”.

All substantial gold rallies are driven by falling confidence in the monetary authorities. The fall in confidence can be associated with so-called “price inflation”, but it certainly doesn’t have to be. As was the case with the major gold rallies that began in 2001 and 2008, it can be associated with stock market weakness, concerns about future economic growth, stresses in the banking system and minimal “price inflation”.

At some point within the next 10 years there could be a major bullish trend in the gold price that is linked to a large rise in the CPI, but that’s not the most likely scenario. There’s a better chance that the next major gold rally will be set in motion by a long-term trend reversal in the US stock market. In fact, even the gold bull market of the 1970s had more to do with a long-term bearish trend in US equities (the US stock market peaked in the late-1960s and bottomed in 1982) than rapid “price inflation”.

Naturally, the US$ gold price will rise over very long (50+ year) periods as the US$ depreciates, but so will the US$ prices of many other assets. Within this group of assets that tend to rise in terms of depreciating currency over the very long term, gold’s unique property is its counter-cyclicality. Gold racks up the bulk of its long-term appreciation during the bust phases of economic cycles.