BANK WEAKNESS BODES WELL FOR GOLD STOCKS

Gold stocks look like they might be, just maybe, on the verge of a breakout. Maybe…

Can we believe it this time?

Any breakout in gold stocks needs to be taken with a healthy dose of skepticism. We have been through this before. It has been a decade of pain.

But… this time could be different. We have had a long consolidation. Central bank policy are at their backs. Valuations are very undemanding.

As well, one of my favorite contra-sectors to gold stocks – the banks – are breaking down hard.

Bank stocks are acting VERY sick right now. The SPDR Regional Banking ETF (KRE – NYSE) has taken it on the chin. It has failed to recover even as the market has put together a nice rally

Source: Stockwatch.com

Since putting in a top in early January, the KRE has stumbled hard. 

That only accelerated in the past couple of weeks.

Canadian banks are following suit. The Horizons Canadian bank ETF (HEWB – TSX) has also slipped – putting in an ominous head and shoulders pattern followed by a similar move down.

Source: Stockwatch.com

HOW DOES THIS IMPACT GOLD?

Banks and gold stocks do not always run-in opposition. In fact, on bear market bottoms both banks and gold often rally together. 

In 2016, after the market bottomed in February, both GDX and KRE rallied together for 8 months. After the COVID bottom of March 2020, banks and gold stocks rose together until the late summer.

But these are exceptions not the rule. More often these sectors move in opposition.

Past breakdowns in gold stocks have foretold big moves in the banks. This happened after the 2011 peak in gold stocks. It happened again after the 2016 bear market rally in gold stocks and again after the COVID rally.

Source: Stockcharts.com

What we have today is the opposite. If we are on the verge of a breakdown in the banks, could this forecast run in gold stocks?

There are a lot of reasons to think so.

THE WAR RALLY IS ON ITS LAST LEGS?

In my last blog post I gave you my view that this is a war rally.

This is not a fundamentally driven rally.  But it is also not driven by your usual bear market dynamics.

The stocks that have taken off are the same-ole names – meme, SaaS, momentum.

But the stocks that do depend on economic strength have hardly rallied at all!

The most economically relevant sectors are TAKING IT ON THE CHIN even as the market has rallied. Industrials, trasnports – especially trucking – have all been weak.

The banks have been most concerning of all.

In the United States the most comprehensive bank index is the S&P Regional Banking Index, which is the index the KRE tracks.

That is a broad ETF of 141 banks. None of these banks has more than 1.8% weighting in the index.

These are not too-big-to-fail banks. Citigroup (C – NYSE), Bank of America (BAC – NYSE), Goldman Sachs (GS – NYSE) that generate profits from trading and deal making: none of these are in the index.

The KRE is made up of its namesake – regional banks. These are the banks that do the heavy lifting for the United States – the job of making loans to businesses, developers, and homeowners.

Source: S&P Global

That makes the index a measure of the health of lending in the economy. 

Yet the KRE has been in free-fall the last two weeks. We saw a nasty reversal down off the inflation report Tuesday.  That means it is slipping on good news. Never a good sign.

WHAT IS DRIVING THE WEAKNESS IN THE BANKS?

Bank stocks are falling as investors question how they are going to make money.

Banks borrow short (deposits) and lend long (loans). That means that they need short term rates to be less than long term rates.

We are on the verge of the opposite – a negative yield curve. A negative yield curve means short term rates are higher than long-term rates – something that happened a couple weeks ago. While the spread has reverted back, it is still narrow, meaning a tough lending environment for banks.

Second, banks have recession risk. Recessions equal more bad loans, more charge-offs, and lower earnings.

No surprise that bank performance has gone south since the start of the Russian invasion and has not really recovered since.

Source: Bank of America Global Research

WHAT IS BAD FOR THE BANKS

IS GOOD FOR GOLD STOCKS

Gold stocks thrive on this environment. Uncertainty in geopolitics is good for gold. Recessions – or slow economic growth – is also good for gold stocks, as long as the risks don’t escalate to being systemic.

But it is real rates that are the big driver the yellow metal. While the short-term gyrations of gold are hard to make sense of, over the longer-term gold moves inversely with real rates.

Source: Bank of America Global Research

WITH GOLD STOCKS – NOTHING IS A SURE THING

Gold ALWAYS marches to its own drum. If you think it is about to break out – it won’t. If it looks like a sure short – it’s not.

It has been a VERY LONG TIME since we have had a strong rally in gold stocks.

Take another look at that chart at the beginning of the post. Since 2012 the gold miners have basically done nothing. While bank stocks have rallied some 300%!

Keep a healthy skepticism! But there are several factors lining up right now.

Looking at gold supply, one overlooked fact is that Russia produces a lot of gold. China produces even more.

Source: Bank of America Global Research

Gold company insiders are acting like something is up. According to Ink Research, gold insider activity remains “in a strong bullish pattern”.

Gold companies face the same inflation headwinds as everyone else. But most mines operate outside of the United States. While revenue is in US dollars, operating costs are in local currency. The US dollar has been relentless the last year, which has helped keep costs down. 

Finally, the charts sure look good. The chart of the largest gold stocks looks primed to break out. The Van Eck Gold Miners ETF (GDX – NASDAQ) looks primed to break out after consolidating at highs last seen in May.

Source: Stockwatch.com

Where am I looking for ideas? At mid-tier miners.  The mid-tier miners trade at a big discount to the seniors, even though in many cases they have better growth prospects.

Mid-tier miners are trading at just about net asset value (NAV). Senior miners are 70% higher!

Source: Bank of America Global Research

That gives A. room for catch-up and B. room for take-over premiums.

It has been 10 years – 10 YEARS! – since the last true gold bull market. 

We’re due! Maybe, just maybe this move in the banks is signalling an end to the drought.

EDITORS NOTE: I have an incredible gold stock coming to you very soon. It has The Dream Team geologically, and in raising money. Financed by billionaires. Explosive share structure. STAY TUNED!