Gold Defies Stock Bear Rally
By: Adam Hamilton
Gold has spent much of the past couple months consolidating, vexing traders and bleeding away most of early 2016's enthusiasm that catapulted the yellow metal higher. But this sideways grind has actually been a very impressive show of strength. Gold managed to hold its massive gains despite an incredible stock-market rally, which can really sap gold investment demand. This portends another major gold upleg.
Gold's performance this year has been nothing short of remarkable. This unique portfolio-diversifying asset that tends to move counter to stock markets was universally loathed as recently as December. It actually fell to a 6.1-year secular low the day after the Fed's first rate hike in 9.5 years.
The vast majority of investors scoffed at gold, believing it was doomed to spiral lower indefinitely with the Fed tightening.
But such popular antipathy was a dream come true for hardened contrarians who really strive to buy low. With gold hated, the sellers had already sold and its price was way too low relative to its worldwide supply-and-demand picture. On New Year's Eve when gold closed slightly above that secular low at $1060, I published an essay "Fueling Gold's 2016 Upleg" arguing "a mighty new gold upleg in 2016" neared.
And indeed that soon came to pass. Fed-rate-hike cycles are actually very bullish for gold historically, contrary to the bearish hype surrounding that first rate hike. The Fed has executed 11 cycles of 3 or more consecutive rate hikes since 1971, and gold's average gain throughout all of them was 26.9%. In the 6 where it rallied, the more gradual ones launching with gold near major lows, it soared 61.0% on average!
During the last Fed-rate-hike cycle between June 2004 and June 2006, gold powered 49.6% higher. This was despite the Fed hiking 17 consecutive times totaling 425 basis points, more than quintupling its federal-funds rate to 5.25%! So late last year's popular notion among futures speculators that gold was going to get slaughtered in a rate-hike cycle was utterly ridiculous in light of all historical precedent.
With the dominant bearish-gold theory staked, there was no reason not to be heavily long. Gold started rallying right out of the gates in January as the Fed-levitated US stock markets began selling off. The deeper that selloff grew, the more investors returned to left-for-dead gold. Falling stock markets made them finally remember the millennia-old wisdom of prudent portfolio diversification using the yellow metal.
All this culminated with gold soaring 17.5% in the first 6 weeks or so of 2016 while the flagship S&P 500 stock index plunged 10.5%. The false belief carefully cultivated by central bankers in recent years that they can engineer stock markets to rise indefinitely without material selloffs was starting to implode. So even American stock investors defied their endless Wall Street anti-gold training to flock back to gold.
This was evident in the holdings of the world-leading GLD gold ETF. They surged by 11.5% during that initial 6-week stock-market selloff. Stock investors hadn't bought gold so aggressively since early 2009, in the early months of a massive gold bull market. Naturally gold excitement was really growing, since everyone loves a winner. But then in mid-February, that major stock-market selloff reversed into a rally.
That stock buying quickly accelerated and drove a gigantic rally that was still forging new highs last week. With stock markets surging, the perceived need to diversify portfolios away from being all-stocks largely evaporated. Thus gold started falling out of favor again, as recent years' dominating buy-stocks and sell-gold psychological paradigms came roaring back. This could very well have crushed gold.
But it didn't! Gold defied what is almost certainly a bear-market rally in general stocks, by consolidating high and holding its strong early-year gains. This first chart looks at the gold price superimposed over the benchmark S&P 500 (SPX) over the past 15 months or so. Gold's resilience and even progress in the face of an exceptional stock-market rally that was a major threat to gold's sharp gains was amazing.
Between mid-February and early April, the SPX rocketed 13.3% higher in just 7 weeks! That made for one of the biggest intra-quarter recoveries the US stock markets have ever witnessed. Working with Dow 30 data since its history extends back much farther than the S&P 500's, researchers at a company called My401kPro.com did a fascinating study on intra-quarter rebounds. They started way back in 1900.
It turned out Q1'16 was only the fourth quarter since 1900, out of 465 calendar quarters, where the US stock markets finished positive after falling 10%+ within a quarter. So the rally we saw in the second half of Q1'16 was extreme and exceptional. This study dug deeper, expanding intra-quarter rebounds to recovering 8%+ after a 10%+ intra-quarter selloff. That happened 26 other times since 1900 in the Dow 30.
Here's the kicker. It turns out that fully 24 of those 26 massive intra-quarter rebounds happened within secular bear markets! There are near-certain odds what we just witnessed was a bear-market rally. The reasons a new stock bear is awakening are legion, and the technical profile of that surge just happened to perfectly match that of bear-market rallies. It erupted sharply in fear off major lows fueled by short covering.
But as that short covering petered out, the pace of the surge moderated in anemic low-volume up days. There was little buy-side conviction, with serious asymmetry between the high volume of the preceding major selloff and fading volume of the subsequent sharp rally. It perfectly executed the mission of bear-market rallies, to eradicate the excessive fear at recent selloff lows and rekindle widespread complacency.
Even at this bear-market rally's apex last Friday, the SPX was still seeing a long series of lower highs since its all-time record peak late last May. The stock markets have been rolling over on balance for almost an entire year now, their lower highs and lower lows forming a powerful technical downtrend. Such developments simply aren't seen in bull markets, the Fed-distorted stock-market cycles have finally turned.
Nevertheless, this enormous stock-market rally radically changed investors' psychology from those mid-February lows. Instead of being fearful of more selling to come, they've once again come to believe that everything is awesome and there's nothing but smooth sailing ahead for stocks. Wall Street analysts have led this bullish-sentiment charge, almost universally calling for 2016 to see double-digit SPX gains.
So naturally with gold prices tending to move counter to stock-market levels, this huge sentiment shift among investors is certainly hostile to gold investment. Why diversify with gold if stocks are poised to yet again rally indefinitely courtesy of super-easy central banks worldwide? This same Pollyannaish stock-market psychology that pervaded 2013 to 2015 could very well have driven a major gold selloff.
Gold was certainly overbought on a short-term basis after rocketing higher into mid-February. And the Wall Street rhetoric attacking this unpopular asset was as bearish as ever. But gold didn't collapse or even correct, instead it merely consolidated high while the stock markets surged! During the exact span of that mighty 13.3% SPX bear-market rally, gold merely slipped 1.9%. That is absolutely remarkable.
After soaring $186 between New Year's Eve and the day the SPX bottomed in mid-February, gold had only given back $24 by the SPX's bear-market-rally peak last Friday. That's just 1/8th of early 2016's outsized gains! Gold held on to 7/8ths of its progress even when all the sentiment cards were heavily stacked against it. As if that's not bullish enough, this metal even advanced within this high consolidation.
In early March as over 2/3rds of the typically-front-loaded SPX bear-market rally had already happened, gold shot up to a 20.1% gain off its mid-December secular low. That surpassed the 20% threshold for a new bull market! Gold hadn't been in an advancing bull market since 2011, so this milestone marked a major secular reversal. A week later, gold's total bull gain extended to +21.0%, decisively across that marker.
So gold not only consolidated high and held the vast majority of its huge early-year gains as the stock markets surged, it continued advancing and entered its first bull market in many years! Such relative gold strength in the face of such a gigantic stock-market rally slaughtering contrarian sentiment is well beyond anything gold investors could've hoped for. Gold resolutely defied a powerful stock bear-market rally!
How did this happen? If you'd have asked even gold enthusiasts back in mid-February how gold would fare if the stock markets were soon going to soar 13%+ to take the SPX within less than 3% of its all-time record high, they would've universally said lousy. And after central-bank-levitated stock markets gutted gold investment demand in recent years, that was certainly the high-probability bearish outcome for gold.
But gold investors didn't fold as widely expected, they weathered the storm of complacent stock-market sentiment to not only maintain their new gold positions but aggressively add to them. They championed gold, rallying to its support. Nowhere is this more evident at this point than in the gold-bullion holdings of the world flagship GLD SPDR Gold Shares gold ETF. It offers the best daily window into gold investment.
In addition to being one of the only records of daily capital flows into physical gold bullion, GLD towers over the rest of the world's gold ETFs. As of the end of Q4, the World Gold Council reported that GLD's holdings represented over 40% of all gold ETFs'. And the next biggest competitor was under 10%, so GLD is unchallenged. GLD's holdings reveal why gold was so strong in defiance of that stock bear-market rally.
This last chart looks at GLD's physical gold-bullion holdings held in trust for its shareholders, rendered in metric tons. They are reported every trading day, effectively showing gold investment by American stock traders. Each monthly draw or build in GLD's holdings is noted, in both percentage and tonnage terms. All this GLD-holdings data is again superimposed over the S&P 500, highlighting its sharp surge.
GLD's physical gold-bullion holdings have skyrocketed in 2016, particularly in February. That month alone saw GLD add 108.0 tonnes of gold, growing its holdings by 16.1%! This was an extraordinary build, the biggest in absolute tonnage terms since May 2010 and the biggest in percentage terms since February 2009. That was early in a major bull market that would see gold power 166.5% higher in 2.8 years.
And that strong gold investment buying didn't falter as the SPX's bear-market rally rocketed higher. In the exact span of that 13.3% stock-market surge, GLD's holdings actually blasted 14.3% higher! Stock investors not only didn't flee gold, but they aggressively added to their positions as complacency in the stock markets soared. It was this heavy investment buying that drove gold's strength, without any doubt.
GLD's mission is to track the price of gold. But GLD shares have their own unique supply-and-demand profile totally independent from gold's. So the only way GLD can mirror the gold price is by actually acting as a conduit for stock-market capital to flow into and out of gold. Excess buying or selling pressure on GLD shares must be equalized directly into gold bullion, or else GLD's price would decouple from gold's price.
When GLD's holdings are rising, stock-market capital is flowing into gold. Differential buying pressure on GLD shares is pushing them up faster than gold is climbing, threatening GLD to fail its tracking mission to the upside. So its managers issue enough new GLD shares to offset this excess demand. They then plow the proceeds from these sales directly into physical gold, which boosts GLD's gold-bullion holdings.
From New Year's Eve to the stock markets' mid-February low, stock investors' differential buying of GLD shares forced this ETF to buy 73.6t of gold. That was the most seen in years, and it all could've been unwound as the stock markets surged higher. But during the subsequent bear-market rally where the SPX surged 13.3%, stock investors actually stepped up their buying forcing GLD to add another 102.1t!
Gold defied stocks' bear-market rally because American investors continued aggressively buying GLD shares despite the fierce sentiment headwind from surging stock markets. Despite Wall Street's tired old self-serving and false message that all portfolios need are stocks and bonds, investors not only kept on diversifying into gold but accelerated their buying. Their capital inflows enabled gold to consolidate high.
And this new massive gold investment buying is exactly what makes 2016's gold rally so incredibly bullish. Gold had seen a half-dozen major rallies between 2013 and 2015 as the stock markets levitated thanks to the Fed's zero rates, money printing, and jawboning about more easing. But all were just fueled by American futures speculators primarily covering their hyper-leveraged shorts, which soon exhausted itself.
When speculators stopped buying gold futures, gold's rallies all fizzled out because there was little investment buying. Gold rallies can't transition into bull markets unless investors, with their vastly-larger pools of capital, little or no leverage, and long time horizons take the gold-buying baton from the futures speculators. 2016 is the first time gold has enjoyed major investment buying since way back in 2011!
And it's not just American stock investors buying GLD shares. When the World Gold Council releases its latest Gold Demand Trends report for Q1'16, the most-comprehensive read on global gold supply and demand available, world gold investment demand will certainly have exploded higher. GLD is merely a handy proxy for overall gold investment demand since its gold-bullion holdings are published daily.
If American stock investors kept on aggressively adding gold to their portfolios in the past 7 weeks or so even as the stock markets surged and complacency soared, imagine how their buying will intensify and accelerate as this stock bear-market rally inevitably rolls over! Just like in early February, falling stock markets will ignite massive new gold demand from legions of investors who've neglected diversification.
The SPX's bear-market rally extended so far in March because it was artificially goosed by dovish talk and actions from central banks no fewer than 4 separate times as it was losing momentum. There was a dovish regional-Fed-president speech in China as March dawned, a bazooka-sized European Central Bank easing a week or so later, then a surprisingly-dovish FOMC meeting, and finally a dovish Yellen speech.
With a big lull in major central-bank meetings now and Q1'16's earnings season upon us, which is expected to be terrible with SPX component-company profits falling 8% YoY, odds are this exceptional bear-market rally is already giving up its ghost. As stock markets start sliding decisively again, there is no doubt 2016's strong gold investment demand will grow and spread. This will fuel a major new gold upleg.
So gold is now poised to surge again in a major spring rally, right in line with its bull-market seasonals. Investors and speculators can position for this young bull market's next major upleg in physical bullion or GLD shares, or GLD call options. But as always, the biggest gains by far will come in the stocks of the gold miners. They recently fell to fundamentally-absurd secular lows, and their profits greatly leverage gold's gains.
While gold stocks have soared so far in 2016 trouncing the performance of every other sector, their baby bull remains tiny. They still have vast room left to rally merely to mean revert to normal levels relative to gold, which of course drives their profits and hence ultimately stock prices. The gold stocks will keep on far outperforming gold as investment capital continues to return to gold and fuel its next major upleg.
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The bottom line is gold utterly defied the massive bear-market rally witnessed in the stock markets since mid-February. Despite soaring complacency, investors kept on aggressively buying gold to continue diversifying their stock-heavy portfolios. This pushed gold into its first new bull market in years right in the midst of the stock-market surge, and kept the yellow metal beautifully consolidating high on balance.
And if gold investment demand is already accelerating despite that fierce sentiment headwind from bullish stock-market psychology, it's going to explode again as stock markets inevitably roll over and head lower again. Nothing fuels gold investment demand like bear markets in stocks, since gold moves counter to stock markets. Both the stock-market bear and gold's new bull have only barely begun.