Gold Technically Oversold, Ready for a Price Reversal

December 28, 2016 1:37pm NYSE:GLD

gold-bars

In more ways than one, 2016 was a roller coaster year. One need only look at gold’s performance to confirm this. After rallying more than 30 percent in the first half, the precious metal stalled in the days before the U.S. election, then retreated on a weekly basis, under pressure from a strengthening dollar and tightening monetary policy.


As you can see in the oscillator below, gold is now down more than two standard deviations from its mean, or average, dollar amount. The reason I show you this is because, in the past, this was a good time to begin accumulating, as mean reversion soon followed.

Gold vs. 2-Year Treasury Yield Percent Change Oscillator
click to enlarge

The 2-year Treasury yield, meanwhile, is looking overbought and set to correct, based on our model. I’ve explained several times before how gold has tended to share an inverse relationship with Treasury yields. The math suggests a nearly 90 percent probability that mean reversion will occur over the next three months, with yields falling and the gold price rising back to its mean.

Even though gold stocks have given up a large portion of their gains since the summer, they were still up close to 40 percent for the 12-month period, as measured by the NYSE Arca Gold Miners Index. Over the same period, blue-chip stocks were up 12 percent, with the Trump rally driving most of it. Therefore, a portfolio composed not just of S&P 500 equities but also gold stocks and bullion would likely have performed better than one composed only of equities.

Gold Miners Had a Phenomenal Year
click to enlarge

I always recommend a 10 percent weighting in gold, with 5 percent in gold stocks, the other 5 percent in gold bars, coins and jewelry.

Looking Ahead in the Near Term

U.S. debt dynamics are expected to turn positive for gold in 2017. That’s according to ICBC Standard Bank, which makes the case that the costs of higher yields are being overlooked. The Congressional Budget Office (CBO) calculates that net interest payments on the nearly $14 trillion of U.S. debt will amount to about $250 billion in 2016—or 1.4 percent of U.S. gross domestic product.

“If we apply an 80 basis point increase to the CBO’s net interest forecasts and keep the other variables unchanged, then by 2026 the Treasury would be paying an additional $185 billion in interest annually, and interest will have increased to 3.3 percent of GDP,” the bank writes, with emphasis my own.

Effect of 80 Basis Points Increase on U.S. Treasury's Interest Costs
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In the note, Tom Kendall, head of precious metals, stresses that the financing costs for the U.S. have already jumped. But under President-elect Donald Trump’s policies—which may or may not have a positive impact on U.S. growth—the effects will likely lag. Any disappointments on the growth front, then, combined with higher interest costs and contentious negotiations on raising the debt ceiling in the first quarter, could well result in a more bullish scenario for gold.

Looking Ahead in the Long Term

Gold’s rarity is one of the key reasons why it’s so highly valued across the globe and for most of recorded human history. Back in August, I shared with you that the precious metal makes up only 0.003 parts per million of the earth’s crust.

“Peak gold” has been a topic for years now, with major discoveries on the decline. According to a recent Bloomberg article, the number of new gold deposits discovered in 2015 was down a whopping 85 percent since 2006.

This means annual production is expected to peak in 2019, followed by a steady decline until at least 2025.

Global Gold Output Expected to Top Out in 2019 Before Declining
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Regardless of when peak gold might occur, it’s pretty widely accepted that all of the low hanging fruit, with regard to major deposits, has already been picked. As a consequence, we’ll likely see an increase in gold recycling, but the metal’s price could also rise as supply becomes restricted.

The SPDR Gold Trust (ETF) (NYSE:GLD) was trading at $108.61 per share on Wednesday afternoon, up $0.05 (+0.05%). Year-to-date, GLD has gained 7.05%, versus a 11.41% rise in the benchmark S&P 500 index during the same period.

GLD currently has an ETF Daily News SMART Grade of C (Neutral), and is ranked #1 of 29 ETFs in the Precious Metals ETFs category.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 9/30/2016.

About the Author: Frank Holmes

frank-holmesFrank Holmes is the CEO and chief investment officer of U.S. Global Investors. Mr. Holmes purchased a controlling interest in U.S. Global Investors in 1989 and became the firm’s chief investment officer in 1999. In 2006, Mr. Holmes was selected mining fund manager of the year by the Mining Journal, and in 2011 he was named a U.S. Metals and Mining “TopGun” by Brendan Wood International. He is also the co-author of The Goldwatcher: Demystifying Gold Investing. More than 30,000 subscribers follow his weekly commentary in the award-winning Investor Alert newsletter which is read in over 180 countries.

Under his guidance, the company’s mutual funds have received recognition from Lipper and Morningstar, two trusted independent financial authorities. In 2015, Mr. Holmes led the company into the exchange traded fund (ETF) business with the launch of the U.S. Global Jets ETF, which invests in the global airline sector.


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