Monday, January 5, 2015

Golden Fetters

After four difficult years, investors can be forgiven for skipping over the precious metals sector, but a recent confluence of events has us at ETFG wondering if the new era of “golden fetters” might be coming to an end?

In 2014, Gold investors watched the Market Vectors Gold Miners fund drop another 12.44% to take its three year annualized return to a negative 28.41% and watch two major rallies in the first half of the year push GDX up nearly 30% only to see the fund collapse over 36% from August 13th to November 5th as collapsing inflation expectations joined with broad equity weakness.

At first glance, there may not seem to be much room for optimism for GDX in 2015 following a 19.26% loss in the third quarter, GDX saw an asset outflow of nearly 13% in the fourth quarter bringing total assets down to $5.6 billion, a far fall from the over $9 billion the fund managed in 2011 and 2012.  However, there is a significant, recent improvement in GDX’s Quant Behavioral Score from a low reading of 40.6 on November 24th to a current reading of 54.32.  A substantial portion of this rise has been the improvement in momentum.  Our more technically oriented readers will note that GDX broke out of its downtrend channel in the second half of November and has since retested its previous lows only to finally close above the fifty day simple moving average of improving volume last Friday.  While this improving technical strength might still be met by a wave of further selling, the short interest remains high and any further strength could lead to further advances.

For those readers who need more to build a case on than Technical Analysis, the plummeting five year TIPS breakeven would hardly seem to support an advance in gold prices.  According to the St. Louis Federal Reserve, that five year breakeven rate hit its high reading for 2014 in late June at 2.03% and since then has continued to advance in a different direction, falling to the 1.17% - 1.3% range not seen since late 2011.  Despite the tenuous relationship between the actual changes in inflation and the price of gold, there does appear to be a relationship between changes in inflation expectations and gold, with the price of metal closely tracking the rising 5 year TIPS breakeven until mid-2011 when gold fever overtook fundamentals.  The relationship between the two reasserted itself in 2012 and in it was only in early 2013 that the price of gold finally fell out of the range between $1,500-$1,800 as the 5 year breakeven rate went from 2.3% to 1.65% in December 2013.  With the fall in the price of crude oil seemingly arrested for the time being and inflation expectations back to their post-2009 lows, gold (and the gold miners) could be poised to move higher in the event that expectations begin to revert back to their recent mean.

The final argument for a bullish gold outlook might come from the East as the PBOC begins to loosen monetary policy in an attempt to jump start their economy after growth rates hit lows not seen since the early 90’s.  The first cut in rates in over two years by the PBoC on November 21st capped a tremendous shift in Chinese monetary policy that has been seen by some to be the primary driver for the Shanghai Stock Exchange finally finding support before rising to close out 2014 52.87% higher than it started the year.  In what could be a clear case of “buy the rumor, sell the fact,” gold miners began gaining strength in early November as whispers that the PBoC, so far unsuccessful in stimulating growth by targeted cuts to the loan reserve ratio’s and liquidity injections, would have to take bolder measures to help the economy grow and ease overcapacity issues.  The rate cute and $65 billion of new liquidity injected into the banking system in December could help stimulate lending and further aid the rise in consumer spending.  With growth expected to slow further in 2015, investors could become confident about more easing in the future which could provide even further lift to Chinese equities and to gold.

Thank you for reading ETFG Perspectives!

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