Weekly Sound Bite: Mining mania: sell in May?

When we started our weekly Roundhouse Radio commentary on January 14th, I suggested that with Federal Reserve Bank policy and related outcomes more uncertain, the case for investors to hold some gold stocks in their portfolios had strengthened. Since that broadcast, the iShares S&P/TSX Global Gold Index ETF (XGD) is up a whopping 64%, while the junior Venture Exchange Index is up 32% (as of Wednesday). In the weeks following the first commentary, I told listeners to keep an eye on the U.S. Dollar Index.

In particularly, I said the Index needed to stay below 100. It has and is now around 93, helping to give commodities and Canadian stocks a boost. Not surprisingly, after such a strong run the technical conditions for the XGD gold mining benchmark ETF was back to overbought conditions as we started the week, trading above the upper boundary of its Bollinger Band and its Relative Strength Index (RSI) was above 70 as of Friday. I say back again because this is the third time so far this year that both of these overbought conditions have been met.

In early February, after surging the ETF went through about a two-month consolidation period before shooting back to overbought territory in early April at which point the ETF pulled back briefly before soaring into month end.

So will it be three-times lucky for the gold bears?

Another pullback or consolidation period from current levels is a distinct possibility. Indeed, gold and gold stocks have been trading down this week and are no longer overbought. Meanwhile, insiders continue to signal that the mining group offers value for investors with time frames of one-year or longer.

For those investors who have a strong desire or need to invest into the mining group over the next few weeks, within the group insider sentiment is pointing to junior miners as offering potentially the most value for those who can tolerate the high risk associated with the group. Our INK Venture Indicator which tracks sentiment on Canada's junior stock exchange continues to ride high above the 200% level (at which point there are twice as many stocks with key insider buying for every one with selling).

While the indicator has dropped significantly from where it was at the start of the year, such a move is what we would expect given that the Venture Index has rallied so much. Indeed, the fact that the Venture benchmark has lagged senior global producers is another data point suggesting that bargain hunters may find the most opportunity in the junior part of the market.

Other factors in favour of gold stocks over the medium term (between 6 and 18 months):

• No less than 30 of our May Top 40 INK Edge stocks are from the Basic Materials sector and the vast majority of those are junior mining stocks.
• A big jump in the amount of money insiders have placed into junior companies through financing deals.
  • Over the past 90 days (as of last Friday) Basic Materials Officers and Directors have invested more than $35 million via private or prospectus offerings. The vast majority of that cash went into junior stocks.
  • The total is nearly three times the amount committed during the same period a year ago.
• US political uncertainty is the other wild card that could benefit gold.

There are of course factors that could work against gold and gold stocks:

• Investors may start to believe again that the Federal Reserve is heading back onto its tightening path.
  • All it may take is one strong jobs report for the FOMC to turn hawkish again.
• Seasonality: according to Equityclock.com gold tends to do poorest between mid-May to mid-September.
  • Venture stocks are notoriously weak traders in the summer.

While seasonal factors such as a drop off in Indian gold demand may work against gold right now, the risks around central bank policy remain wide open for either an up or downside surprise. For investors to start favouring the US dollar over gold again, we believe the Fed must be able to implement one more rate hike, but this time without an adverse market reaction like what we experienced after the December 2015 rate hike. Should the Fed be able to lift rates without any capital market hiccups, before getting bearish on the gold group we would first watch to see if mining insiders react negatively to that scenario.

The other big central bank wild card for gold is the Bank of Japan. Should it do something extreme in terms of pumping yen into the economy, that could prompt a move out of the yen into dollars. It would remain to be seen if that would be gold positive or negative. If US economy is seen on the upswing, gold could be vulnerable in greenback terms.

We will get our next clue on the relative strength of the US economy tomorrow with the unemployment report. Short of a positive jobs surprise, a stock market melt-up, or greenback collapse over the next 6 weeks, we doubt that practical conditions for a Fed rate hike will be in place until after the November US elections at the earliest.

For Canadian-based investors, the case for hanging onto some physical gold got a boost this week from poor Canadian trade numbers. It is not clear how the Bank of Canada will react to this development which is likely to knock down GDP growth. Although there is little evidence that inflation is weakening, Stephen Poloz our central bank governor seems as concerned about helping exporters as he is about inflation. If he tries to talk down the loonie again, gold could provide some much needed Poloz insurance.

Listen to Ted Dixon on Roundhouse Radio FM 98.3 every Thursday for his weekly financial markets commentary at 7:30 am Pacific Time. If you missed the live interview, catch the replay here.

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