The Roadmap From A Gold Bottom To A Mania

On the heels of historic movements in key global markets, today 40-year veteran, Robert Fitzwilson, put together another tremendous piece.  Fitzwilson, who is founder of The Portola Group, laid out the roadmap from a gold bottom to a coming mania.  Below is Fitzwilson’s outstanding and exclusive piece for KWN.

Fitzwilson:  On June 27th, in a note to clients and friends of the firm, we suggested that the panic in the metals and mining sectors was so extreme that it had to be a bottom by everything we have experienced and studied in our careers.  The chart below suggests that our call was correct, at least based upon what has ensued so far.

The top line is the Amex “Gold Bug's Index” (HUI) which represents a basket of gold mining companies.  The bottom two are for the S&P 500 and gold.  The returns in the chart are for the period since our call to the close of trading last week.  As you can see the Index nearly tripled the return of gold itself.

“It is also interesting that the Index nearly tripled the return of the S&P 500 Index in that same period.  Hardly a trading session goes by without the headline being “The S&P 500 and the Dow Jones Indexes hit new highs”.  The reality is that the bulk of the stock market strength that had been so loudly touted occurred during the first quarter of this year. 

The gains for those two indexes have been good, but the HUI has significantly outperformed  traditional stocks since our call for a bottom.  Just last week alone, the HUI advanced almost 7% against a 1% move for the S&P 500 Index.  For a few of the marquis mining names, the returns have been as much as a double over that of the HUI since late June.

There is a long way to go to recoup the declines that began late last year, let alone reaching the heights one typically sees in the mania phase.  However, if this is a new bull market for the mining companies, it will most likely be a grind to reclaim the lost ground in the short-term characterized by sharp moves to the upside and then consolidation.  For one reason, the sentiment against the miners is probably the worst for any sector that we have ever seen. 

In late June, it was not just disdain for the sector, but something near to hatred.  It will take time and higher prices to bring back the investors that panicked and sold, let alone the new wave of investors that much higher prices will bring.  What makes for a great bottom in any asset class is that transition from “it will never go down” to “I’ll never own that dog again”.  It reminds us very much of the bottom in the mid-1970s for stocks.

The other factor that could slow down the recovery in prices for the miners is the pricing of the underlying products, gold and silver.  The decline has not been about economics.  You cannot have a global, massive run on available stocks of anything in a declining production environment and expect to see major price declines.  Whoever or whatever is causing it is everyone’s favorite topic for speculation, but we know that the decline has no basis in economic or market theory.

It is true that part of the fundamentals are working against the mining companies such as the rising price of energy and declining ore grades, but those factors should have been handily offset by the surge in demand and subsequent scarcity.  Followers of King World News are well aware that none of the pricing makes any sense at this point.

If the status quo prevails and the prices of the metals grinds higher, we should expect the stocks to grind higher as well.  However, if there is to be an event in the physical gold market as backwardation is suggesting, you could very well see an explosive move to the upside, dwarfing what we have witnessed since June 27th.  As Art Cashin suggested, there is dry tinder everywhere in these markets.  One “match” such as force majeure in the gold markets could trigger waves of short covering and a violent reversal of the declines for the miners since late 2012.