What Does The Swooning Commodity Index Of 2017 Mean For Gold Miners ?

If you haven't noticed, commodities are diving badly this year:

Commodities are consumed by a healthy economy, and dives like this can come before overall downturns. Gold is a commodity that historically is thought to be correlated with the CRB Index. Commodities soared along with gold in the 1970s as capital flowed into hard assets, away from a bad economy. This is all very confusing. So does the bad CRB behavior of late bode ill for gold and the miners now?

Well, if you compare gold and the CRB index over various time frames, you see a somewhat loose correlation. Sometimes they move together, sometimes they don't. But there is one thing the CRB is correlated with much more than gold, and that's oil.

Here we see a broader two year view of the CRB and oil and they look like the very same chart. Since the 2005 massive revision to the CRB index, it mainly does whatever oil does. This oil correlation of the CRB is much tighter than with gold or anything else. The energy complex is about 40% of raw index weighting, but because of the new arithmetic averaging, and oil being much more volatile than most other index components, the CRB winds up being pretty much just the oil chart.

So the real question is "What does swooning oil mean for gold miners? If we look at the year 2001, we have a comparable period where the CRB, much less slaved to oil back then, was also diving like it is this year, and the price of gold wasn't doing much:

Even back then, they were essentially the same chart. Did the gold miners, lacking any clear guidance from the gold price, follow the horrible CRB chart back then?:

Not really. Here, the miners as represented by the HUI index, did not have a bad year with the commodity dive. The gold price ended the year about right where it started, yet the gold miners did a stunning 60% return. And oil, not gold, was probably a big reason why. Gold mines are some of the biggest energy hogs on earth and when oil goes down, gold mining profits go up. You can't be quite that simplistic as gold stocks have a way of anticipating what the prices of both their product and their inputs are going to be. The gold price was beginning its long ascent the next year in 2002 and the stocks were perhaps getting wind of that. And they seemed to be a few months ahead of oil as well. But by and large, other things being equal, gold mining has a strong inverse relation with oil.

When thinking about the energy costs of gold mining, you first consider the monster trucks, bigger than your house, that carry the ore at 0.3 mpg. This is a big part of it as this article shows, giving us this chart of the climbing diesel use for the top five gold miners:

Because the higher ore grades are mined first, the declining grades mean much more rock processed to produce the same amount of gold. This has run diesel usage to a 100% increase the last 10 years producing about the same amount of gold. But the trucking is just a part of overall energy usage. Overall, gold mining is the second most energy intensive product in the world as this British engineering report shows:

Gold is literally off the charts as the arrow points to on this log scale (9000 pound sterling/kg and 6000 Megajoules/kg) and that makes sense when you consider that, as they explain:

Gold is a precious metal which can be sold for a very high price; this means that more energy can be spent in extracting it by mining rocks containing only a small fraction of gold

So they can tolerate a whole bunch of digging and energy use. This is why gold miners typically have total energy cost run roughly a third of their total cost of operation, their biggest single expense. If gold is the second most energy intensive, what is #1? It's diamond mining with many times the energy usage of gold.

Also in the expensive quarter of the above graph is all the metals that makeup the miner's massive equipment. A big chunk of what they don't spend on energy goes to buy and maintain their monster machines. Deflation is good for gold miners. Either inflation or deflation can accompany gold miner climbs as long as currency-in-the-bank is being threatened, as I discussed here. This was the case in the 1920s and '30s when the price of everything went way down, banks failed at record rates, and the gold miners were in massive climbs, both before and after the stock market crash.

As I've written before several times, I think oil will stay moderately priced ($40-$60) for a couple years at least as the shale overcapacity is gradually worked off. Gold miners did exceedingly well in gold's run to $1900 in 2011 on $100 plus oil. If we get a next bull phase for the gold price, they could do vastly better on oil at half that price. That's exactly what happened in last year's mini run up in gold. In 2009-2011, gold climbed 110% with the HUI doing 100%. In 2016, gold climbed just 28%, but the HUI blitzed for 155%. Gold CEOs will be cheering for the "horrible" CRB charts shown above and shale will be the gold miners' new best friend.

Fed Rate Hikes - The Best Algorithm For Predicting Gold Upside

As nearly the whole world knows, higher interest rates are gold investing's worst enemy. As Warren Buffett has explained, gold is something where we pay to dig it up, we pay to put it away, we pay people to stand around and guard it, and all the while it produces no goods, pays us no dividend or gives us any interest. Well, Warren, if you take the trouble to closely examine the history of Federal Reserve raises in interest rates and gold, you got some more 'splainin to do!

If you look at what happened in the 1970's gold bull market, you see that the more gold had to compete with interest bearing investment, the better it did. In fact, there was a very close, positive correlation between the two:



These were the most extreme US interest rates of all time running to well over 10% and dwarfing our current numbers. Yet they did not kill the gold bull back then. Indeed, they seemingly waved a red cape in its face.

The 70s rate cycle was not an isolated case in its correlation with gold.  Adam Hamilton presents a detailed history of this in his article this week. He notes:

Before today’s rate-hike cycle was born in mid-December 2015, the Fed had executed fully 11 rate-hike cycles since 1971. Those are defined as 3 or more consecutive FFR increases by the FOMC with no interrupting decreases. Our current rate-hike cycle to which the Fed added a fourth hike this week is the 12th of the modern era, certainly nothing new. So there’s a substantial rate-hike dataset to evaluate gold’s action.

He notes that the average reaction of gold during all 11 previous rate ramp-ups is a climb of 27% including the most recent cycle (2004 - 2006) where rates were aggressively quintupled and gold reacted with a 50% climb over that time. If you are an investor with the mindset that rising rates is a reason to sell or avoid gold, you need to read Adam's article. He points out that our present rate hike cycle is playing out as in the past:

If you look at the four rate raises so far in our current cycle, we see that you are hard pressed to find a guru or algo that predicts gold climbs any better. If you were a newsletter with this track record, you could sell a zillion subscriptions. Note that the arrows all fall on an ascending trend since the first one in late 2015. As the above chart shows, there is typically a decline in gold leading into a much talked about FOMC meeting where everyone has come to expect a rate increase. This weakness also lasts a couple weeks or so after the fact, then a vigorous climb ensues.

Because we have just had a rate increase June 14, that would schedule our current gold weakness into July, which also agrees with many wave counters and technical analysts who are saying July/August is going to be a major bottom. It also agrees with the simple up-trending channel in the above chart that would put a visit to the bottom at about $1220-$1240, probably in July/August. It also agrees quite nicely with my fractal argument presented here. But these rate hikes can also send gold straight into a tizzy as it did the last time in March. So waiting for a bottom could leave you chasing any new exposure you want.

But why would gold, with no interest return and even a cost of storage for physical ownership, behave in such a counter-intuitive way? Is this just to punish investors who try to think logically, Mr. Market's specialty? Hamilton makes the point that these rate changes are well telegraphed. The Fed doesn't like to roil markets, so they don't like to move unless at least 70% in the polling expect them to. So you could have a longer term fundamental working in the background pressuring gold higher while the buy-the-rumor-sell-the-news effect works in the short-term around the Fed meetings.

What could that longer term fundamental be? Well, I don't really know with any certainty. But I suspect it is the age old thing about gold being an alternative currency. Fed rate raising cycles always come after they have done some kind of financial rigging, and that always somehow lessens the soundness of the dollar. It also undermines the natural viability of the economy.

As I discussed in "Fractal And Fundamental Gurus Agreeing On A Gold Mega-Bull" gold has a long history of going into bull phases, along with the stock market, years ahead of some calamity involving dollars in the bank. This was true in the 1920s when the banks were the problem, it was true in the 1960s when a gold decoupling with the dollar and double digit inflation approaching made the dollars the problem. And it is probably true now with some kind of dollars-in-the-bank problem approaching.

You can only speculate on what the gold market may be seeing. But with the European banks on shaky ground and linked to all banks no matter how healthy, you could say it's the banks. And with the dollar's soundness continuing its decay as the world's reserve currency, you could say it's the dollars. There are plenty of problems to choose from. Let's hope the problems are fixed before they get here. But a gold hedge would be in order in the mean time.

The FANG Gang Is Challenging The Ascending Wedge

As we all wonder what to do with the mini "tech wreck" that is upon us, it is helpful to step back and check the big technical picture of this group. The group could be defined as big cap growth, not necessarily tech, that has produced a handful of big growth superstars. These stock climbs will sometimes produce a technical condition known as the ascending wedge, which is bearish, and typically result in a trend change, either to a stagnation period or a protracted decline.

To illustrate, let's look at a good growth stock of the recent past that can seemingly do no wrong - Tractor Supply (TSCO), the specialty "recreational farming" supply retailer. If you have ever worked on a small farm like I have, you wonder why they call this "recreational". They have somehow escaped the Amazon squash with their results, but the stock went into a wedge and was squashed anyway:

What is especially bearish is when the A/D trend (upper graph) is broken in conjunction with a wedge. In TSCO's case the trend was blasted with the monster gap down move, and you had no chance to get out ahead of the damage. When this is more gradual, the warning should be heeded.

So where is the FANG gang in relation to the ascending wedge? Not in a good place:

Here we see Netflix earnestly tracing out a wedge, but the A/D trend is intact.

Google is also wedging but with no A/D problem. But stocks often break the wedge before they break the A/D trend, as TSCO did above.

An honorary FANG stock outside of tech is ULTA, the make-up and beauty supply growth beast. It is forming a wedge and also threatening an A/D breakdown as well.

Apple isn't forming a wedge, but it hasn't had much of a chance having broken out of a big downtrend just this year. But Facebook is:

And the leader of the gang:

Amazon's wedge is the most pressuring with a break imminent.  Does all this mean the FANG move is near an end? No, because ascending wedges do break to the upside as well. A case in point is Nvidia :

And another is Dave and Buster's:

But these are the exceptions, and it takes a lot of growth horsepower to break these to the upside, especially when they are proceeding at a valuation speed limit on a basic fundamental like their cash flow:

You can see from the above numbers (from Morningstar) that it took a jump to a 60 multiple on cash flow, not to mention the 13 on sales, for Nvidia to break its wedge to the upside, a rather extreme valuation for an established growth operation. Will all of FANG make this kind of jump? It's possible, but that would be a little crazy.

The large cap growth stocks are up against something of a valuation speed limit, and also up against a trend expiration limit as well. Big trends with wedge formations typically break up before they go over five years or so, and the FANG types are in wedges pushing about four years now.

If this sector does breakup into sideways or moderate declines, it will likely be in conjunction with market leadership rotation into the other good performing but neglected areas, like the financials, especially the quality growth regional banks, materials, and the other bull market sectors.