It’s been frustrating several months for the gold (GLD) bulls, and the past month hasn’t been any easier. This is because we had incessant calls for $2,500/oz and $3,000/oz gold heading into Q4 of last year, and instead, we’ve seen the rug pulled out from underneath the precious metals. This is why it’s always wise to reduce exposure when the chants of 50% higher prices come out and only look to incrementally add back exposure when despondency begins to creep back into the market.
Fortunately, with the yellow metal down 17% from its highs, the chants are now drowned out by predictions of $1,400/oz and many calls that gold is worthless given its poor performance in a backdrop of unprecedented monetary stimulus. This shift in sentiment conveniently is occurring simultaneously, as gold is resting on a key long-term support level, which suggests we’re likely nearing a bottom. Let’s take a closer look below:
Source: TradingView.com
The recent price action in gold is disheartening, to say the least, but it’s important to put the current correction in context and show that 17% – 20% corrections are completely normal, even in bull markets. In the chart below, we can see a 50-year history of the gold price, and it’s clear that there have been some nasty corrections along the way. However, one indicator has typically helped to define bull and bear markets, and this is the metal’s long-term quarterly moving average (grey line).
If the metal is above this indicator, one can be bullish long-term, and if the metal breaks below this indicator and can’t reclaim it immediately, one should switch to neutral at a bare minimum or lean bearish. In two of three instances after major yearly breakouts, gold broke out only to re-test this moving average after its initial run higher.
This occurred in the late 1970s and again in 2008, with the corrections from these seemingly failed breakouts being significant. However, after a brief shakeout below this key level, the bulls managed to regain their composure, and we saw violent rallies. It’s quite rare that multi-year breakouts fail, but it’s not rare that we see significant turbulence after them, so the next few months should be very important to tell us if this was indeed a failed breakout or just a violent shakeout.
Source: TC2000.com
If we look at the current chart of gold, we have a very similar look to what we saw in 2008, with the metal breaking out a multi-year base and then correction for over nine months into its breakout level. The metal briefly traded below its quarterly moving average by 5% but immediately regained this level, and was at new all-time highs within 13 months following this re-test. Within 18 months following the re-test, gold was up over 70%, and we are currently at this critical juncture if this pullback continues.
Currently, this key moving average comes in near $1,690/oz, and this is the level we want to see the bulls defend. A breakdown below this level is not the end of the world, but regaining it within a month would be ideal. Assuming that this is just a shakeout and a replay of the 2008 correction, we could see gold at $2,100/oz in Q1 of next year, and potentially as high as $2,600/oz if it follows the 2008 playbook.
Obviously, there’s no guarantee that past performance mirrors the action of the previous two breakouts. Still, I don’t see any reason to give up on the big picture unless the metal breaks down towards $1,650/oz and is unable to bounce at all.
The good news is that coupled with this significant re-test of a major breakout level; we also have the worst sentiment we’ve seen in years. This is evidenced by bullish sentiment for gold finishing last week at below 15% bulls and likely to hit single-digit levels if this correction continues. Similar to the technicals, there’s no reason that sentiment can’t get worse and head a little lower before a bottom is struck. However, this sentiment indicator would argue that the worst is likely over this correction, and it’s time to be open-minded for a bottom, rather than get caught up in the sentiment that gold is worthless and could head back to $1,400/oz.
Source: Daily Sentiment Index Data, Author’s Chart
So, what’s the best course of action?
I remain long gold from an average price closer to $1,450/oz and have not added to my position yet. This is because I am waiting for a reversal or bullish setup to add to my position, which would increase the probability that the lows are in. However, with many gold producers trading for less than 10x earnings, I continue to add to my position in Kirkland Lake Gold (NYSE:KL), with the stock set to report $3.90 in annual EPS in FY2021, sitting on over $4.00 in cash, yet trading at just $32.00 per share.
This leaves the company trading at barely 7.2x earnings, and sentiment surrounding the stock is the worst it’s been in years due to anxiety about one of its mines running out of reserves.
Given the company’s track record of replacing reserves and making significant discoveries, I believe the worries about its Fosterville Mine are priced at current levels. Besides, if we do see a major discovery at its Fosterville Mine, we could see the stock up over 10% overnight, given that the current valuation has basically written the mine off. It’s worth noting that the stock pays a more than 2.30% yield at current prices as well and has one of the most aggressive buyback programs in the industry, with the potential to buyback over 7% of its float. Given that I’m being paid to wait with KL, this is one area where I continue to add, and I have an average cost closer to $37.00.
While the stock could head lower, I see much more upside with KL than I do with the gold price, so this is where I remain focused. Looking ahead, I don’t see any reason to give up on this gold bull market, and I would expect any dips to $1,650/oz will likely get bought up, and I may look to add to my position here.
Disclosure: I am long GLD, 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.