The following is the opening segment of this week’s Notes From the Rabbit Hole, NFTRH 276:
Somewhere along the road from the 2000 bottom in gold stocks to the 2008 flame out of inflationary hysteria, the gold stock sector went from counter cyclical first mover to ‘inflation trade’ also ran. Gold stocks put in a secular bear market bottom in 2000 just as the US and many global economies were topping out.
Then came the era that NFTRH has labeled ‘Inflation onDemand’ (IoD). The economy was successfully* inflated by Alan Greenspan early in the decade as easy monetary policy fomented an epic credit bubble, which took over and did the heavy lifting for a cyclical bull market and buoyant economy that terminated hard in 2007/2008.
During this time of IoD ‘inflation bulls’ and commodity bulls who had all the answers for a newly inflation-phobic public emerged and took center stage. Misperceptions were formed, cemented and driven home. Nowhere were the misperceptions more intensely and dangerously embedded than the gold stock sector, which at its core is different than most commodity sectors and indeed, most stock sectors. Introducing another one of our ‘busy’ charts to illustrate…
Okay, article over… the chart says it all. No more words necessary!
The chart is a confusing jumble you say? Okay then, let’s take it point by point.
- Gold miners ended a long bear market in 2000 as the ‘real’ price of gold, as measured against broad commodities (Gold-CCI, bottom panel) bottomed [and turned up].
- Gold-CCI then began 6-year phase of mostly flat lined consolidation. This occurred while gold stocks merrily went higher (even though gold declined vs. major gold mining cost driver crude oil) along with cyclical items like the CCI and the stock market (S&P 500). HUI’s topping pattern of 2007-2008 was fundamentally justified. There was no conspiracy against gold stocks.
- A huge and readily identifiable opportunity cropped up in the massive liquidation of 2008 after gold stocks crashed even as Gold-CCI took an impulsive leg up.
- Then gold stocks rose once again during another phase of consolidation in Gold-CCI. HUI made new all time highs against consolidating (at best) fundamentals in 2009-2011.
- HUI then topped out despite a ramp upward in Gold-CCI as a confusing phase marked by dysfunctional market indicators (speaking personally) took hold.
- This was notably a phase when the US Fed took its policy to a new level of hands on market management; first with the brilliant Operation Twist, and its inflation sanitized manipulation** and then by $85b per month in long-term Treasury bond and distressed MBS purchases.
- The result of inflation-sanitized monetary policy was a Goldilocks scenario for US stocks, a muting of commodities despite their positive correlation to the global economy and an outright crash in gold, silver and precious metals stocks during what would be an identifiable (well ahead of time) economic growth phase.***
Which brings us to the here and now and the segment’s ultimate theme, that gold miners are counter cyclical. When the bull market in the gold miners began in 2000/2001 the sector had just come off of an extended bear phase as gold went nowhere vs. commodities and had crashed in terms of the US stock market.
Then began a phase of intense, hands-on inflationary monetary management by Greenspan and later Ben Bernanke in response to chronic economic deceleration. One side effect of this was a casino mentality among market participants that replaced the quaint old notions of the likes of Peter Lynch (“invest in what you know”). Inflated assets alternately bubbled and popped as hot money got in the game and boom and bust cycles were promoted. A growing hedge fund presence only exacerbated the gaming.
Regarding Lynch’s quote, one thing many people thought they knew was that inflation is good for gold mining. But when oil/energy, materials and human resources are becoming more expensive in an inflationary phase – especially when they are doing so in relation to gold – it is a decidedly dangerous backdrop for gold mining investors, whether or not gold stocks are rising at the time. Add in a bullish stock market (keeping investors in the traditional realm of stocks) and you have the worst of all worlds for gold mining.
So what have we witnessed over the last year in the gold mining sector? As the chart above points out at its far right, the gold mining sector has been declining in line with its deteriorating fundamentals!
Anyone who had been touting that the sector’s fundamentals were good and that the gold stock decline was illogical has been chasing inflationary dogma and not reading the actual economy over the last year. Gold-CCI is counter cyclical and so are gold stocks.
Yes, monetary base has risen impulsively and that is normally a positive for gold. But there have been several mitigating factors in play on this cycle, not least of which is that money supply has gone hand in hand with corporate profits, the S&P 500 and finally, economic growth just as we surmised one year ago as personal ‘boots on the ground’ upbeat Semiconductor manufacturing information came in and several ratios of gold to positively correlated assets had turned down.
The oft-shown chart below makes the clear point that it was now a turn for the ‘right’ assets to go up in an inflation. The S&P 500’s Hump #1 was the blow off phase of a secular bull market in stocks (bubble was in stock valuations). Hump #2 was a bubble in commercial credit, which boosted corporate profits and the stock market (along with so many commodities). Hump #3 was a bubble in officially sponsored inflation (green line), which boosted corporate profits, stocks and to a degree, the economy.
While 2013 started out with the gold sector’s implied fundamentals looking pretty good (ref. 1st chart above), things ultimately did line up with the projected economic growth scenario. That scenario was discounted out of hand by so many back then.****
Today the gold sector is in line with its implied fundamental backdrop and this has not been good for some time. Hence, our currently positive view of the gold sector is intimately tied to our view that a macro rotation will take place in 2014. This rotation would be back to chronic economic deceleration and a rising ‘real’ price of gold as measured in commodities as well as stock markets and other positively correlated items.
A macro pivot is expected by mid-2014 (+/-), which is the length of the ‘leash’ we are giving the US stock market for a final top. In line with that view, fundamentals need to turn up as represented by gold’s ratios to commodities, stock markets, etc. in order to maintain a bullish view on the sector. No ifs, ands, buts or rationalizations.
* Chickens came home to roost in a deflationary liquidation of that Ponzi racket in 2008.
** I do not use the word “manipulation” lightly. But the act of buying long-term and selling short-term Treasuries to sanitize inflation signals was pure manipulation.
*** We used personal information about the Semiconductor capital equipment sector and various technical tools to allow for the likelihood of an oncoming economic growth spurt.
**** Here again we reference a family member (a CFA) who advised that the best and brightest fund managers were “in cash” and expecting a market meltdown as recently as Q4 2012 during the hysterical Fiscal Cliff non-starter. “Bullish!” replied this letter writer, not feeling the need to get overly wordy.