• Gold corrects from the August 2020 all-time high
• All the action is in the digital currencies, the new gold
• Do not discount the yellow metal for three compelling reasons
• Gold mining stocks provide leverage without time decay
• GDX is a diversified gold mining product

With the stock market near all-time highs, every stock with a ticker appears to be a growth stock these days. The levels of central bank liquidity and government stimulus have weighed on money’s purchasing power, causing most asset prices to climb.

While the stock market continues to make new highs, it may only be keeping up with the declining fiat currency values. The unprecedented monetary and fiscal stimulus to stabilize the financial system during the global pandemic comes with an inflationary price tag.

Gold is an asset held by the world’s central banks as an integral part of their foreign currency reserves. The world’s governments validate gold’s role in the global financial system with their holdings. Moreover, most central banks have been buyers of the yellow metal over the past two decades, with China and Russia leading the way.

The Chinese and Russians are significant gold-producing countries, and each has vacuumed in domestic production to add to their holdings. Since commodity production and strategic reserves are state secrets, it is challenging to assess the actual levels of gold reserves that China and Russia hold.

At the turn of this century, gold was trading below the $300 per ounce level. The United Kingdom decided that gold was a barbarous relic and sold half their reserves. The price never looked back and climbed to over $2,000 in 2020. Meanwhile, the ascent of Bitcoin and other cryptocurrencies is causing some market participants to look at gold as a relic again. Do not discount the potential for gold to make even the most respected experts look like fools.

Gold mining stocks tend to outperform the metal on the upside and underperform during bearish periods. Gold miners provide leverage without the time decay cost of other market products that offer gearing. The current bearish price action in gold could be the perfect time to load up on a portfolio of the leading companies that extract the yellow metal from the earth’s crust.

The VanEck Vectors Gold Miners ETF product (GDX) holds shares in the world’s leading gold producers. GDX could be a growth stock for the coming months and years after the correction since August 2020.

Gold corrects from the August 2020 all-time high

Gold broke out above its technical resistance level at the July 2016 $1377.50 high in June 2019. The price moved steadily higher, above the all-time 2011 $1920.70 high, and to a peak of $2063 in August 2020.

Source: CQG

As the chart shows, the price turned lower since last August, falling to its most recent low at $1,673.30 this month. Gold retraced more than 50% of the move from the 2016 breakout level to last August’s high. The retracement level stands at just over the $1,720 level. The gold market’s price action has been bearish over the past seven months, but the nearby futures contract settled last week at the $1741.70 level, above the midpoint level.

All the action is in the digital currencies, the new gold

One factor that could be draining demand from the gold market is the ascent of the digital currency asset class. Some market pundits call Bitcoin the new gold, but I find that most of those “experts” are just trying to sell a service for crypto trading or investment account.

Meanwhile, the flow of capital into Bitcoin and the other 8,888 cryptocurrencies is a significant commentary on the faith in traditional fiat currencies and the decline in government’s credit with people worldwide. Bitcoin is only a little over a decade old. The leading digital currency was six cents in 2010.  

Source: CQG

Last week, Bitcoin futures traded to a high of $61,255 per token. The cryptocurrency asset class’s market cap rose to over $1.8 trillion, an impressive rise. However, it remains below Apple’s (AAPL) market cap which was over the $2 trillion level at the end of last week.

There is room for additional gains in the crypto market, but I would argue they are an alternative, not a replacement for gold. The ascent of the digital currencies supports gains in the yellow metal despite the price action over the past months.

Do not discount the yellow metal for three compelling reasons

Markets rarely move in a straight line. Even the most aggressive bull market tends to experience corrective declines. I believe gold is resting and consolidating before it decides to move to new highs over the coming months and years. Three factors are likely to push the precious metal higher.

• Gold’s bull market began at the turn of this century at the $250 level. The correction from $2,063 did nothing to negate the long-term bullish trend.
• Gold has a long history as a currency and a commodity. Central banks hold gold as an integral part of their foreign exchange reserves. Over the past years, they have been buyers of the metal, adding to reserves. While governments can print fiat legal tender to their heart’s content, they can only increase the gold supply by extracting more from the earth’s crust. Monetary and fiscal policies that increase the money supply are inherently inflationary, which supports gains in gold.
• Control of the money supply is a key component of government power. Cryptocurrencies threaten that control. We are likely to see digital currency regulations that run contrary to the market’s philosophy. Meanwhile, since governments hold a substantial percentage of above-ground gold stockpiles, the yellow metal does not pose a threat to control.

Gold is resting and consolidating after moving to new record highs in all currencies in 2019 and 2020. The yellow metal may move to even lower lows, but that would likely be a compelling buying opportunity. Over the past years, each time gold fell out of favor with investors turned out to be the best time to buy the metal.

Gold mining stocks provide leverage without time decay

Leverage magnifies an asset’s performance when it moves in the desired direction. Most leveraged products come with a price tag, which is time decay. Typically, creating leverage requires options or derivatives that have limited duration.

Gold mining stocks are unique, as they tend to provide leverage to the metal’s price, outperforming gold on the upside and underperforming on the downside. However, the companies that extract gold from the earth’s crust do not have expiration dates, so while they may underperform during downside corrections, they do not expire worthless like put and call options.

GDX is a diversified gold mining product

When approaching gold mining stocks, I prefer a diversified portfolio approach the mitigates idiosyncratic risks. Each company’s shares come with the risk of management decisions and actions and specific mining projects. A portfolio dampens those risks.

The top holdings and fund summary of the GDX include:

Source: Yahoo Finance

GDX has net assets of $13.42 billion, trades an average of over 24 million shares each day, and charges a 0.53% expense ratio. GDX is a highly liquid product.

In March 2020, nearby COMEX gold future fell to a low of $1,450.90 before moving to a high of $2,063 in August, a rise of 42.2%. Gold was trading near the $1,740 level at the end of last week, 15.57% below the August peak.  

Source: Barchart

Over the same period, GDX rose from $16.18 to $45.78 per share and fell to $33.89 at the end of last week. GDX outperformed gold on the upside with a 182.9% gain and underperformed on the downside with a 25.97% loss.

If gold’s correction ends and the metal moves to a new high, following the trend over the past years, GDX is a growth instrument that holds a group of gold stocks that provide leverage without the risk of time decay.

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GDX shares fell $0.36 (-1.06%) in premarket trading Monday. Year-to-date, GDX has declined -6.77%, versus a 4.39% rise in the benchmark S&P 500 index during the same period.

About the Author: Andrew Hecht

Andy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles. More...

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