Gold: Bulls Back in CONTROL

We’ve finally seen the bulls wake from their multi-month slumber in gold (GLD), with the metal reversing from down 2% last week to up over 2% to finish the week. This reversal was the first real chance of character we’ve seen since the election, which has been met with a dearth of bids on any strong gaps lower and suggests that we might finally be nearing the end of this arduous trend lower in the yellow metal.

The even better news is the fact that it’s hard to find any bulls left in the trade, with bullish sentiment dropping to just 14% last week, the lowest reading in nearly two years. While there’s no guarantee that we’re out of the woods just yet, I continue to believe that the worst of the correction is over, and any drops below $1,750/oz will likely market the low for this cyclical correction. Let’s take a closer look below:

(Source: Daily Sentiment Index Data, Author’s Chart)

Beginning with the bullish sentiment, we’ve seen a complete sea change from August, with bullish sentiment plunging from a high of 93% in early August to a reading of just 14% last week. This suggests that sentiment in the sector has shifted from extreme complacency to excessive pessimism, which is quite rare for an asset class that’s still outperforming the S&P-500 (SPY) year-to-date.

In fact, the S&P-500 is up 13% for the year with 85% bulls currently, and gold is up 22% for the year with a reading of less than 30% bulls. While this pessimism could continue, it is clear which trade is beginning to get crowded and which one has lots of room for upside. Generally, the best time to buy gold is when sentiment dips below 15% bulls as there’s lots of fuel to convert market participants to bulls, which translates to buying power when upside momentum works.

Therefore, while some die-hard gold bears continue to discuss that this is a crowded trade that’s just registered a long-term top, I would argue that this couldn’t be further from the truth. In fact, being bearish on gold is getting crowded, and markets rarely top shortly after the initial breakout from a new all-time high. Instead, the first major correction following the all-time high typically gets bought.

(Source: Author’s Chart)

If we move over to the fundamentals for gold, there are lots to like here as well, with the 3-month treasury bill rate minus the 12-month rate of change (ROC) in US Consumer Price Inflation (CPI) sitting in deeply negative territory.

For those unfamiliar, this is a very bullish reading for gold as there is little opportunity to cost out there to owning gold. Conversely, when this reading is in positive territory, investors do have an opportunity cost to owning gold as there are interest-bearing assets out there they can park money in, namely the real 3-month treasury bill yield.

The previous three occurrences when we had deeply negative readings like this were 1975 through 1981, 2002 through 2005, and 2007 through 2008. These were all-powerful periods for the gold price, and periods when the gold price significantly outperformed the investment of choice for most: the S&P-500.

(Source: TC2000.com)

Finally, if we take a look at the technical picture, we have a rare occurrence of gold dipping below its medium-term channel line. While the metal can spend an eternity below this medium channel line in gold bear markets, it rarely spends much time below this level in secular bull markets.

Given that we had a new all-time high this year, the odds would suggest that this is a new secular bull market for the metal. As we can see above, the current range for the metal is $1,625/oz to $2,125/oz, suggesting that the bulls finally have the odds significantly back in their favor. Obviously, this oversold reading in this channel does not preclude a re-test of the recent lows near $1,760/oz, but I would expect any pullbacks to this area to find strong support.

So, what’s the best course of action?

While I have yet to add to my gold position, I have been busy buying the best miners, with positions in Kirkland Lake Gold (KL) and Newmont Corporation (NEM) in multiple accounts. These two names are highly leveraged to the gold price and paying 2%+ dividend yields, allowing investors to be paid to wait if this correction continues and to get growth at a very reasonable price.

Currently, both names are trading at less than 13x FY2021 annual EPS estimates, and I have a conservative fair value of $73.00 on NEM and a conservative fair value of $60.00 on KL. This offers significant upside for current levels and strong leverage to the gold price if we do make new highs.

Meanwhile, in terms of gold, I continue to hold a long-term position and would look to add to my position if the metal breaks $1,750/oz. For now, I continue to favor the miners, but if we do see gold break its recent lows at $1,760/oz, I will look at it as a buying opportunity.

Disclosure: I am long GLD, NEM, KL

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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The SPDR Gold Shares (GLD) was trading at $175.84 per share on Tuesday morning, up $0.95 (+0.54%). Year-to-date, GLD has gained 23.05%, versus a 16.08% rise in the benchmark S&P 500 index during the same period.

GLD currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #6 of 34 ETFs in the Precious Metals ETFs category.

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