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Gold Summer-Doldrums Risk

Adam Hamilton
Jun 24, 2016

Gold's recent weakness has dampened bullish sentiment, but the entire precious-metals complex has actually enjoyed record early-summer strength. The summer doldrums have always been a vexing time for gold, silver, and the stocks of their miners. Without any recurring seasonal demand surges in June and July, sideways-to-lower drifts are common in this seasonally-weakest time before big autumn rallies.

Traders' sentiment, their collective greed and fear, drives nearly all short-term price action. Most of the time, sentiment is heavily influenced by expectations. If gold rallies 5% in a month where traders expected 10% gains, disappointment and bearishness will flare. But if gold rallies that same 5% when the outlook was for no gains, traders will grow excited and bullish. Performance versus expectations colors reality.

Gold entered the summer of 2016 with high expectations for strong continuing gains. Between its mid-December 6.1-year secular low the day after the Fed's first rate hike in 9.5 years and the end of April, gold blasted 23.1% higher. These gains were driven by massive investment buying at levels not seen in many years. Huge capital inflows catapulted gold into its first new bull market since way back in 2011.

Most traders had no reason not to believe this young-bull-market strength would continue into summer, and it really has in a lot of ways. But even within the strongest bulls, June and July together are the weakest time of the year seasonally for gold. When I think of gold in summers, that early-1990s Gin Blossoms song "Hey Jealousy" comes to mind. "If you don't expect too much from me, you might not be let down".

After decades of trading gold, silver, and the stocks of their miners, I've come to call this time of year the summer doldrums. June and July are usually a desolate sentiment wasteland for precious metals totally devoid of recurring seasonal demand surges. These summer months simply lack any major income-cycle or cultural drivers of outsized gold demand like those seen throughout much of the rest of the year.

So expectations for precious metals' summer performances should always be tempered by what they've actually done in past summers, even within mighty secular bulls. Gold's last secular bull ran from April 2001 to August 2011, a 10.4-year span that saw gold power 638.2% higher! Gold was the world's best-performing asset class, trouncing the lauded S&P 500 stock index's miserable 1.9% loss over that exact span.

While gold peaked in late August 2011, it didn't formally enter bear-market territory at a 20% loss until much later in April 2013. That was when the gross market distortions from the Fed's unprecedented open-ended QE3 bond-monetization campaign were really mounting. So gold's great-bull-market years ran from 2001 to 2012. It's important to see how gold fared in them with 2016 being the first bull-market year since.

Quantifying gold's summer seasonal tendencies during bull markets requires all relevant years' price action to be recast in perfectly-comparable percentage terms. That's easily accomplished by individually indexing each calendar year's gold price to its last close before summer, which is May's final trading day. That's set at 100 and then all gold-price action that year is calculated off that common indexed baseline.

So gold trading at an indexed level of 105 simply means it's up 5% from May's close, while 95 shows it's down 5%. This methodology renders all gold summers in like terms regardless if gold was near $300 or $1900. These charts distill down all this seasonal data, first for gold then later silver and the flagship HUI gold-stock index. Understanding precious metals' summer seasonals helps maintain realistic expectations.

These charts show gold's price action indexed to May's final close for the bull-market years between 2001 to 2012, and 2016 summer-to-date. The yellow spilled-spaghetti mess is all years between 2001 and 2012. While individual summers are unfollowable in this format, far more important is the central tendency of all summers combined. All these past bull-market summers are averaged in the red line.

Superimposed on top is this summer's gold action so far in blue. Gold has actually enjoyed a record bull-market early-summer advance this year! The yellow metal has never before rallied so far so fast in June during all the modern bull-market summers. This anomalous strength is a double-edged sword, revealing how strong gold investment demand remains but ramping odds for a mean reversion lower.

Gold's summer doldrums are very real even within the mightiest bull markets, which is why I'm wary of getting excited about gold in June and July. Between 2001 and 2012, gold's average performance in June from the end of May was a 0.8% loss. While that summer-to-date loss narrowed to a -0.1% average by the end of July, that's still weak summer performance. Boring sideways grinds dominate gold summers!

Thankfully this summer-doldrums phenomenon is limited to June and July. Gold starts gathering steam in August as its major autumn rally gets underway. Gold's average full-summer performance since the end of May surged to +2.4% by then between 2001 and 2012, the vanguard of a major seasonal rally averaging 7.5% gains by early October. August is when key Asian-harvest gold buying starts kicking in.

That's one of the major recurring seasonal surges of outsized gold demand fueled by income-cycle or cultural drivers. They also include Indian-wedding-season buying, Western Christmas buying, Western surplus-income buying after year-end, and Chinese New Year buying. I've explained all these recurring gold-demand-spurring events in great depth in past essays, but they're beyond the scope of this essay.

My focus today is 2016's anomalous precious-metals strength. The blue line shows that gold has never enjoyed early-summer action anywhere close to the powerful surge witnessed in the first half of June. By June 17th, gold had rocketed 6.8% higher since the end of May! That compared to 2001-to-2012 average June performance as of that same day of a 0.6% loss. Gold has enjoyed record early-summer strength!

Any price action way outside of historical norms demands traders consider both why it has happened, and whether or not it's likely to be sustainable. Gold's incredible early-summer gains this year are the result of a fascinating interplay between mean reversions and Fed-rate-hike expectations. This great gold strength has been directly fueled by major buying on them by both investors and gold-futures speculators.

Gold entered the summer of 2016 after an uncharacteristically-weak May. Last month gold plunged 6.1% on mounting expectations for another Fed rate hike at the FOMC's mid-June meeting. That itself was odd. During all 11 previous Fed-rate-hike cycles since 1971, gold enjoyed average gains of 26.9%! Gold's biggest gains, averaging a staggering 61.0% in 6 of these rate-hike cycles, emerged with two conditions.

Gold had to be relatively low in a secular sense when these Fed-rate-hike cycles started, and they had to be gradual. Of course both these have been met in spades in our current joke of a rate-hike cycle. So market history shatters futures speculators' widely-believed myth that Fed rate hikes are somehow gold's nemesis. Just the opposite is true, but these hyper-leveraged traders won't take the time to understand this.

Last month's big 6.1% gold plunge was counter-seasonal, defying average strength between 2001 to 2012 that made May one of gold's stronger months of the year with average gains of 1.4%. So after an abnormally-weak May, a mean reversion higher despite the summer doldrums isn't a huge surprise. All throughout the global financial markets, big down periods are followed by big up periods and vice versa.

As the blue line shows, May 2016 was nearly the weakest out of all the gold-bull years between 2001 to 2012. So the case can be made that gold's record early-June strength was simply a mean reversion out of an exceptionally-weak lead-in to the market summer. If that's it, gold's summer downside risk from here is likely modest. Still, summer doldrums shouldn't be discounted before late July's major seasonal low.

But unfortunately more is going on this summer than a mere mean reversion out of May weakness. The overwhelmingly-dominant reason gold has enjoyed a major counter-seasonal bid this month is traders' growing expectations that more Fed rate hikes aren't coming anytime soon. This started on June's first Friday when May's US monthly jobs report was a horrendous miss, just 38k jobs created versus +164k expected!

That led traders to believe the Fed's hands were tied on that mid-June rate hike it had recently started to lay the expectation groundwork for. So gold blasted 2.7% higher on June 3rd as that terrible jobs report reset Fed-rate-hike expectations to dovish. This popular dovish bias grew as the FOMC's June 15th meeting neared, propelling gold even higher heading into it. Then the FOMC proved more dovish than expected.

The FOMC gave no hints of a coming rate hike at its next meeting in late July. The hawkish regional-Fed presidents didn't dissent, the mid-June decision not to hike was unanimous. And the collective projections of federal-funds-rate levels in future years by top Fed officials fell rather sharply. Yellen's uber-dovish Fed somehow managed to come across as even more dovish than traders had previously thought!

So gold continued rallying after that FOMC decision too, soon hitting its first new bull-market high in nearly 7 weeks last Friday. But gold faces two major risks after its biggest early-summer rally witnessed in modern times if not ever. Both dovish-Fed expectations and American speculators' near-record gold-futures long positions can't go much higher, so the odds overwhelmingly favor them reversing sharply.

The Fed has long been itching to hike rates, and it hates this situation it finds itself in with virtually no credibility with global markets. After crying hawk so many times, traders simply no longer believe the Fed will carry through on any rate hikes it implies. As of the middle of this week, the federal-funds-futures-implied odds of rate hikes at the FOMC's next 3 meetings were at rock-bottom at just 10%, 31%, and 33%!

With traders' expectations so lopsided towards no more rate hikes anytime soon, there's a high chance they will mean revert the other way between now and the end of the summer doldrums in late July. Top Fed officials will either resume their 2016 modus operandi of talking tough and hawkish between FOMC meetings, or some US economic data will surprise to the upside so traders' implied rate-hike odds will surge.

That's not likely to be kind to gold. Since it was extreme Fed dovishness that drove gold's record early-summer gains, the inevitable coming Fed hawkishness will likely unwind some of them. This selling will be exacerbated by gold-futures speculators' near-record long positions just witnessed in mid-June. These ultra-short-term hyper-leveraged traders live and die by the Fed, so hawkishness will really spook them.

Unwinding their excessive near-record longs will require much gold-futures selling, which is certainly an ominous portent. Not only does futures selling tend to quickly cascade, but there are no recurring gold demand surges in the summer doldrums to absorb mass futures liquidations. Heavy selling by the leveraged futures speculators will quickly overwhelm even the strong ongoing gold investment demand.

American stock traders have been aggressively buying GLD shares far faster than gold itself is being bought. While this very-atypical strong investment demand in the summer doldrums will mitigate the adverse price impact of gold-futures selling, it will still be temporarily overpowered. Futures speculators can dump the equivalent of 150+ tonnes of gold in a single week, while GLD's June-to-date build is only 47.2t.

So if you're itching to add gold exposure to your portfolio via this leading GLD SPDR Gold Shares gold ETF, the near-term downside risks remain abnormally high in these summer doldrums. Odds are you will get a better entry price sometime around late July after futures speculators' near-record longs have some time to be whittled back down on rising Fed hawkishness or at least waning dovishness. Be patient here.

Naturally silver and the precious-metals miners' stocks are closely slaved to gold, simply mirroring and amplifying the yellow metal's price action. So since the summer doldrums as well as this year's record early-summer strength apply to gold, they must also apply to silver and that leading HUI gold-stock index. Record early-summer strength this year has indeed been witnessed in these favorite derivative gold plays.

Since silver tends to leverage gold's action, silver's early-summer-strength anomaly this year is even more extreme than gold's. Silver has rocketed as high as 9.9% above its May close in 2016, peaking on a day where silver's average summer loss between 2001 to 2012 was 4.1%! And silver has less of a mean-reversion-rally case in June than gold, as May 2016 wasn't even among the top-3 worst Mays in this dataset.

On average in the summer doldrums between 2001 to 2012, silver ended June, July, and August at 4.9%, 1.2%, and 1.0% losses relative to its final close in May. With silver so abnormally strong this June thanks to gold, anything that forces gold back into more-normal summer-doldrums behavior is going to hammer silver. This includes not only more Fed hawkishness and gold-futures selling, but silver-futures selling.

Like gold futures, speculators' silver-futures longs are way up near record levels. So if anything spooks these hyper-leveraged traders to rush for the exits en masse to limit their losses, silver is going to get hit hard. So just like gold, if you want to add silver positions the odds favor you waiting until the end of the summer doldrums in late July. And silver's major seasonal low even comes after that, actually in mid-August.

This year's anomalous summer-doldrums situation in the gold stocks and silver stocks naturally mirrors gold's. The HUI gold-stock index, which is effectively tracked by the leading GDX VanEck Vectors Gold Miners ETF, started soaring higher on Friday June 3rd after that colossal jobs-report disaster. That day the HUI skyrocketed an astounding 11.6% higher, which was gold stocks' biggest daily rally in 7.5 years!

At best this June, the HUI was up a wildly-unprecedented 16.8% from its May close. That came on the June trading day where this flagship gold-stock index had averaged a 1.7% summer-to-date loss between those same bull-market years of 2001 to 2012. 2016's record early-summer performance is far beyond anything witnessed in gold stocks' epic 1664.4% secular bull run over 10.8 years ending in September 2011.

On average between 2001 to 2012, the HUI suffered a 0.6% summer-to-date loss in June which soon deepened to -2.5% by the end of July. It was only in August that gold stocks started recovering in gold's big seasonal autumn rally, with the HUI's average summer-to-date gains surging to 3.9%. That's why late July has long proven the optimal time seasonally to buy gold stocks in the middle of any calendar year!

Since gold stocks remain radically undervalued relative to prevailing gold prices, I remain super-bullish on them for the rest of 2016 and the next couple years. But long, hard experience has taught me to be wary of the summer doldrums. And since gold stocks soared so anomalously in June, there is a much-higher risk than normal that they will mean revert back down to typical summer-doldrums performance soon.

When gold inevitably gets hit by a mass exodus of speculators from their near-record gold-futures longs, likely on market-implied Fed-rate-hike odds rising, gold stocks are going to get sucked into that selling maelstrom. And in the market summer when investors' interest is low as their attention is diverted to vacations and leisure, sellers will likely easily overwhelm buyers. You can't expect much in summer doldrums.

So there remains a good-if-not-high chance that the gold stocks will get pushed back down to normal bull-market summer-doldrums levels between now and late July. If the HUI is driven back down to flat on the summer, we're looking at a steep 11.5% loss to 201.3. If the HUI is forced back down to normal average 2.5% summer losses by late July, that rises to a 13.7% loss to 196.3. That's serious short-term risk!

Thus it seems prudent to wait until late July before deploying any significant new capital into the gold stocks and silver stocks. We may get lucky this summer, with speculators' gold-futures selling being slow enough to be absorbed by the big investment buying. Maybe the gold stocks will remain high all summer, bucking their weak seasonals. But the odds certainly favor a summer selloff, which could be large.

Gold stocks' upside after June's record early-summer performance seems modest at best, while their downside risk to revert to normal summer-doldrums behavior is considerable. So make sure you have stop losses on any current precious-metals-stock positions you own. And given the great asymmetry in near-term risks, you ought to hold off on new GDX or individual-stock buying until the summer doldrums have passed.

At Zeal we've long studied all kinds of market cycles so we can leverage them to big gains instead of foolishly fighting them. The summer doldrums are simply a fact of life in the precious-metals realm, and can be used advantageously to time buying with major seasonal lows. Thriving in the markets requires staying informed and gaming probabilities, not blindly trading and hoping for the best. We're here to help.

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The bottom line is gold, and therefore silver and their miners' stocks, have always suffered the summer doldrums even during the strongest secular bulls. June and July are simply devoid of the big recurring gold demand surges seen during much of the rest of the year, leaving them weak. The entire precious-metals realm tends to grind sideways to lower in June and July before gold's autumn rally accelerates in August.

This year the summer doldrums still present considerable downside risk. Extreme Fed dovishness and futures buying catapulted gold, silver, and their miners' stocks to record early-summer performances in 2016. But with Fed hawkishness due to mean revert higher and futures speculators having to soon unwind their near-record longs, there's plenty of risk of mean reversions lower to normal summer-doldrums levels.


Jun 24, 2016
Adam Hamilton, CPA

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