Time To Load Up On Gold Miner Stocks (NYSEARCA:GDX)

While we’ve seen commodity prices go on an unprecedented run during the last two years, hitting historic highs, one other commodity has been lagging, which is gold.

After a brief run-up after Covid-19 hit in March 2020 and peaking in early August, gold prices have consolidated over the last 1.5-2 years. However, gold hit a new high again, early this year, as the war in Ukraine escalated, before retracing along with other commodities.

Despite the correction, conditions are aligning for gold and gold equities to move higher in the coming months.

Attractive Technical Picture

Gold prices have been consolidating over the past two years before breaking out of its sideways pattern in mid-Feb just before the Russian-Ukraine conflict. I believe the recent correction has been constructive given gold has gone up sharply in a short period; the current retracement should provide a stronger base for prices to move higher in the coming months.

Year-to-date, the price of gold is up 7.02% through April 8.

Meanwhile, after lagging gold spot for a while, gold miners have been showing real strength with the VanEck Vectors Gold Miners ETF (NYSEARCA:GDX) and the VanEck Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) returning 15.5% and 23.9%, respectively, through April 8.

Rising Macro Risks

Historically, gold has usually performed well during times of increased uncertainty and market volatility – and we’re in the midst of it right now, with an uncertain outlook moving forward.

Market risks have heightened due to spiking inflation, a hawkish Fed, rising bond yields, the Ukraine-Russian war, negative real rates, and declining equity and bond markets, making gold and gold stocks more attractive as all other investment alternatives tank.

Inflation

The Fed has been wrong on inflation; it has spiked higher and has been more persistent than expected. The U.S. consumer price index registered a 7.9% increase in February – the highest in 40 years – driven by rising food and services prices, strong demand for consumer goods, and continued supply-chain constraints.

Also, the February figure only caught the early spike in energy and commodity prices caused by the Russian invasion of Ukraine; expect March inflation readings to remain high as the CPI reflects the full effect of the fallout from the Ukraine-Russia crisis on oil and commodity market disruptions.

It’s more than likely that inflation will continue to remain high for some time given continued supply-chain disruptions, labor shortage, the structural deficits in energy and the commodity markets, low interest rates, and pent-up demand as nations open up post-pandemic.

Moreover, after making initial headlines in the U.S., inflation is now everywhere and has become a global issue. Over the past few months, we’ve seen an inflationary wave hit not only the developed markets but also emerging markets.

Fed Is Deeply Behind The Curve

The sharp rise and the persistence of inflation have placed the Fed in a difficult spot: (1) if it tightens faster than expected and raises rates, it could lead an already slowing economy into a further slowdown and at worse, a recession, and tank the markets; (2) if it keeps interest rates low and stays accommodative, this could lead to breakaway inflation and higher bond yields, which will also put pressure on the stock market, increase credit risk, and also increase the risk of an economic slowdown.

Therefore, while the market may be pricing in an extreme hawkish view, the Fed may not respond as expected as it doesn’t want to tighten into an economic slowdown and will let inflation “run hot”.

Gold Performs Well During Rate Hike Cycles

The conventional opinion is that rising interest rates are bad for gold -higher rates make fixed-income investments and the US dollar more attractive. On contrary, gold has actually done well during most Fed hiking cycles, as long as the pace of the hike is slow.

Negative Real Yields

Gold is perceived as a great store of value and acts as a hedge against the loss of purchasing power which is why, historically, gold has performed well during periods of high inflation and also negative real interest rates.

Moreover, while the Fed is more hawkish and is expected to hike at least six more times this year, it’s in a tough spot and will hike slowly and tolerate above 2% inflation, to avoid crashing the economy, which would mean real rates will stay low, which should continue to benefit gold.

Moving Away From the US Dollar

The U.S. and its allies’ decision to freeze Russian central bank assets will have huge implications for the US dollar. World central banks are now going to ask themselves if it’s still prudent to hold most of their reserves in US dollars given what happened to Russia.

I believe we could start to see world governments start to lessen their exposure to Western debt and US dollar-based finance; countries may start moving into other currencies or assets such as gold.

While this shift may take years to play out, we have seen it start already. Russia has already demanded “unfriendly” countries to pay for gas exports in rubles and gold. While Saudi has mulled accepting Yuan instead of dollars for their oil. The US dollar’s share of global forex reserves has been declining for the past 20 years.

And over the past couple of years, world central banks have already been increasing their gold holdings.

China

China hasn’t been hiding its desire for the Yuan to replace the U.S. dollar as the world’s global currency. And seeing the back-breaking sanctions against Russia could only spur it to fast-track its plans of decoupling from the U.S. dollar even more.

China holds around $3.21 trillion in forex reserves, currently, with gold accounting for around 3.7% or $119.6 billion. Just a small increase for its gold allocation would be huge for the gold market. If they switch their allocation to at least 20%, that would mean buying roughly $522 billion of gold in total during the next few years.

Gold Market Tight

However, there was only around $269 billion of gold mined in 2021 (4,666 tons X average gold price of $1,799/oz.). Meanwhile, The largest gold bullion ETF, the SPDR Gold Trust ($GLD), only has $67.84B in assets.

Once world central banks, pension funds, and investment funds start buying, even a small shift could potentially lead to explosive moves in gold prices.

Gold Miners Offer Compelling Value

Gold mining equities offer compelling value right now with the gold miners/gold ratio at historic lows implying huge undervaluation.

With gold prices higher, this has led to higher margins and higher free cash flow for gold mining companies.

Improving Fundamentals

Gold miners and junior gold miners have been doing well with revenues up across the board and generating a lot of cash flow as gold prices have gone up.

Here are the top ten components of GDX and GDXJ and their results for the past year. Most have seen sharp increases in revenue and earnings resulting in attractive dividend and free cash flow yields.

GDX and GDXJ Bullish Formation

GDX and GDXJ are still inside their sideways consolidation of the past 1.5-2 years and could remain on correction mode over the next few months.

But both appear to be breaking higher and are forming a bullish cheat: GDX between $36-$40 and GDXJ between $45-$49 range; a breakout from this pattern could see both ETFs challenge their previous highs during the next few weeks or months.

Moreover, on a longer time frame, zooming out, both have already broken out of a nearly decade-long base reversal pattern. With conditions lining up favorably for gold currently, I expect prices to resolve higher in the coming months.