As the nights lengthen, the leaves
change color, and the chill winds of autumn begin
to blow, the seasons are on everyone's mind this time of year. But it is not
only these natural seasons driven by orbital mechanics that are changing. The
most bullish seasonal time of the year for the precious metals and their
miners is nearly upon us.
The mere fact that precious metals have
seasonal tendencies is often surprising to traders. Everyone can understand
why a soft commodity like wheat is seasonal. Due to the Earth's axial tilt
and its annual revolution around the sun, there is one primary growing season
in the northern hemisphere. Thus wheat supplies typically peak just after
harvest before shrinking until the next harvest. Since the celestial seasons
affect supply, and supply and demand drives prices, the Earth's seasons play
a major role in wheat price trends.
Interestingly it is these same orbital
mechanics that drive gold seasonality. The vast majority of the world's
population lives in the northern hemisphere, so the importance of the autumn
grain harvest is universal. In places like Asia
with deep cultural affinities for gold, farmers often invest some of the
profits from their annual harvests in gold. Harvest leads to big global
surpluses of capital and some of these funds migrate into gold.
There are other cultural factors that
also accentuate gold's seasonal strength this time of year. Indian wedding
season is one of the most important. In India, the world's biggest gold
consumer, little distinction is made between jewelry
and investment. When brides get married, their families give them intricate
22-karat gold jewelry to help secure their
financial futures. The most popular time to get married is during the autumn
festival season. Thus around 40% of India's total annual gold demand
tends to arise in October and November.
I realize this seems quaint to our
Western minds, but we too have similar behaviors
woven deeply into our own cultures. Our own holiday shopping isn't all that
different. A large fraction of our total spending occurs between Thanksgiving
and Christmas, a single month that often makes or breaks the entire
year for retailers. Spending is high worldwide as the year wanes and people
start feeling closure on their financial year. Even in the West, some of this
holiday spending funnels into gold jewelry for
loved ones and bullion for investment.
So world gold demand is indeed highly
seasonal, for a variety of reasons. Understanding this is important as we
traders can increase our odds for success if we trade with these seasonal
trends. But do these gold seasonals affect the gold
stocks? Each time I write about gold seasonality I receive a blizzard of
e-mails asking how pure HUI seasonality looks. Does this flagship unhedged-gold-stock index follow gold's seasonal lead?
In order to address this excellent
question, I applied the same methodology I have used for gold seasonals to the HUI itself. This was described in depth
in my latest essay on gold seasonals,
but here are the highlights. Unlike typical multi-decade futures seasonality
studies that span bull and bear alike, I am only
interested in how HUI seasonality has unfolded within this bull market.
Past behavior within bears is probably not all that
relevant to future behavior within this bull. So
all of these charts only extend back to 2000 when today's bull was born.
To build these charts, each calendar
year's daily closing data was individually indexed. The first trading day of
each year was assigned a value of 100 and every subsequent day of that year
was indexed off of it based on absolute percentage gain. All of these
individual annual indexes are then date-matched and averaged together. The
result, when plotted, shows the seasonal tendencies of the HUI within its
bull market to date.
Since the average of annual indexing
doesn't show how dispersed the underlying data actually is,
standard-deviation bands are also rendered. The tighter the bands, the closer
the underlying annual indexed numbers were before they were averaged. The
closer the pre-average data, the higher the probability the seasonality in
that region of the chart will stay relevant going forward. Closer means it
isn't just a statistical anomaly created by a couple of extreme outlying
years. The small inset charts show the full standard-deviation bands.
While this essay is on the HUI bull seasonals, we still need to start with gold bull seasonals since the gold price is the primary driver of
the gold stocks. This chart is updated from my July essay on
gold seasonality. The primary question that led to this thread of research
was whether gold stocks tend to follow gold's seasonal lead. So before we get
into HUI-specific seasonals, we must first have a
clear picture of gold's.
Gold tends to have three big seasonal
rallies every year. Provocatively for traders today, its largest by far tends
to start in mid-October and then power higher into early February. This
reflects the fabled autumn buying season for gold. General Asian demand,
Indian wedding season, Western holiday buying, and other regional factors
lead to a major surge in gold demand and often gold prices this time of year.
Gold traders know this well and usually
really add to their long positions in anticipation of this tendency. While
gold seasonality certainly doesn't guarantee the gold price will comply every
year, it sure increases the odds. Seasonality is like a tailwind on top of
the other fundamental, technical, and sentimental factors driving gold. When
these other factors are already bullish, strong seasonality ramps up the probabilities
of imminent gains even further.
This chart has been especially
intriguing lately. Note above that gold tends to start rallying in late
August, climb even higher in the first half of September, and then really
shoot higher in the second half of September. Sound familiar? This was
exactly what happened over the last six weeks or so. But since this chart
includes data to the end of September 2007, perhaps gold's awesome
performance lately unduly skewed this chart.
Thankfully this is easy to test. In my
July essay on gold seasonals, the data only runs to
the end of June. Check out the first chart in
that summer essay. Although a bit less extreme than the chart above, gold
still had the exact same tendency to do what it did from mid-August to late
September. Its seasonal patterns then and now are virtually identical. So prior
to September 2007, gold already had a well-established tendency to rally
modestly in the first half of September and then shoot higher in the second
half.
This ought to disturb you as it calls
into question today's orthodox perceptions of last month's gold trading
action. Almost everyone today assumes that gold rallied because the Fed cut rates
while the dollar hovered on the edge of the abyss. And I agree that these
factors are almost certainly the primary causes of gold's excellent month. But
even last summer, the gold seasonality chart already showed a crystal-clear
tendency for a very similar September price pattern to occur even without any
Fed machinations.
So would gold have rallied modestly
initially last month and then shot higher in the second half even without the
Fed? Probably, as it sure has the tendency to do just that regardless of the
Fed. Perhaps traders today should be attributing more of gold's September to
usual seasonal buying and less to the Fed's throwing the dollar to the
wolves. Maybe all the Fed really did for gold was modestly amplify already
established seasonality.
Another interesting revelation from the
July chart, which is even more pronounced here, is gold's seasonal tendency
to pull back rather sharply in early October. This, of course, is exactly
what we witnessed this week. The déjà vu is pretty uncanny.
After this initial sharp pullback, gold gradually grinds lower and
consolidates for a week or two. This early October consolidation is extremely
important because it offers traders our last chance to load up on long
positions ahead of the biggest seasonal rally of the year.
And gold's tendencies right now are even
more relevant because the standard-deviation bands of its seasonality are
fairly tight right now. It wasn't a couple of extreme annual results that
distilled down to today's seasonality, but seven individually-indexed years
with a rather narrow clustering of indexed levels this time of year. This
renders today's narrow window of time in which to add long positions all the
more important.
So back to our original question, does
gold seasonality drive HUI seasonality? Absolutely! Take one more look at the
gold chart above and then quickly scroll to this HUI specimen. The HUI's big seasonal rallies, as well as its seasonal weak
spells, mirror gold's incredibly well. If I cut off the left axes that map
the magnitude of these indexed moves, these two charts would be virtually
indistinguishable to the casual eye.
When comparing these charts, realize
that the HUI's goes to 135 indexed while gold's
only goes to 114. So while they look very similar, with major peaks and
troughs throughout a typical seasonal year matching closely, the HUI
amplifies gold's volatility considerably. For example, in January and
February the HUI tends to go from 100 to 108 indexed while gold only tends to
move from 100 to 103.
This HUI leverage to gold is the only
reason why anyone invests in gold stocks. If the far-riskier gold stocks only
tended to pace gold's gains, then it would make a lot more sense to own the
much-less-risky physical metal itself. But since gold stocks have amplified
gold's gains on the order of 5.3 to 1 in their respective bulls to date, betting
on the stocks is well worth their additional risk.
Mirroring gold, the HUI also has three
big seasonal rallies each year. In indexed terms, the one ending in May tends
to rise 16 points and the one ending in September 18 points. But it is the third, and largest one, that is most interesting today. It
tends to start powering higher in mid-October and climb up 25 indexed points
by February! It shouldn't be surprising that the biggest seasonal HUI rally
of the year follows the biggest gold rally.
It is gold that drives the gold stocks. Higher
gold prices mean higher profits for mining the metal. Higher profits
ultimately translate into higher stock prices. Since the price of gold in a
secular bull tends to rise faster than the costs of mining the metal, even
during a commodities bull, it is the gold price that has the single largest
impact on worldwide gold-mining profits. So if gold is going to be seasonally
strong, the HUI should benefit tremendously as traders anticipate higher
profits.
Now this seems simple and obvious, but
an increasingly popular heresy disputes the truth in these charts. Due to a
few isolated episodes in 2007 where gold stocks fell with the general stock
markets, many PM traders believe that it is the general stock markets that
drive the HUI, not gold. It is now fashionable to believe that no matter what
gold does, if general stocks enter a bear market the
HUI will be dragged down with them.
This concern is not new, and I have
researched and written a great deal about it over the last seven years. While
the HUI can certainly fall with general stocks for a few days during
aggressive high-fear selling, overall it thrives through stock bears. From
early 2000 to early 2003, the S&P 500 lost 49% of its value at worst. Meanwhile
the HUI soared 322% higher at best within this bear. The HUI even rose
within each of its three most vicious downlegs. PM
stocks are classic alternative investments not correlated with general
stocks.
These HUI seasonal charts help
illuminate this general-stock-bear concern from another angle. The three bear
years in the early 2000s that slaughtered general stocks are also included to
arrive at this seasonal average. Thus these HUI bull seasonals
transcend general-stock bulls and bears alike. While gold stocks can be
temporarily distracted from time to time, they always follow gold in the end
since it drives their profits.
In my gold seasonality studies, I also
take a look at calendar-month seasonality. Instead of indexing calendar
years, calendar months are indexed. Each month of each year is started at a
level of 100 with the rest of the days indexed off of it. Then all the
Januaries are averaged together, all the Februaries, etc. I was curious on
how the HUI tends to perform within calendar months in this bull, so I did
the same analysis here. Realize that each calendar month is a discrete
individually-indexed unit, so one month does not connect to the next.
This additional perspective on
seasonality is interesting. It closely follows the annual-indexed approach of
course, but by distilling the data in a different way it also illuminates
additional seasonal tendencies. The HUI's best
calendar months of the year in its bull to date have tended to be August,
November, and May. And November is rapidly approaching, a great reason to
deploy more capital on this October weakness.
Now when I first saw this chart this
week, I had to chuckle at August being the strongest month in this bull to
date. On average, the HUI has soared almost 8% in Augusts since 2000. November
and May have come close to this performance on average, but August still wins
out. Obviously this past August didn't cooperate though. The index fell 5% in
a month that was marked by a brutal mini-panic in the middle.
This discrepancy between what was
expected and what actually happened helps illustrate some of the key limitations
of seasonality for traders. Seasonality is simply a tendency, a bias
for a price to move in a particular direction at a particular time of the
year. But seasonality isn't always a driving factor. Technicals
and sentiment, especially near extremes, can easily override seasonality and
drag the HUI off of its expected seasonal vector.
August 2007 was a really unique month. Sentiment
for gold stocks was horribly bad
after they had consolidated for 15 months straight. In the middle of the
month worries about the general stock markets temporarily spilled over
into gold stocks and drove a mini-panic as many traders capitulated. For our
subscribers, I explained this whole chain of events in great depth in the
September issue of Zeal Intelligence.
Fear soon got out of hand as intense
selling dominated gold-stock prices and they plummeted. This easily
overwhelmed the usual strong August seasonals. But
check out July in this chart. July tends to look like August did this year.
Yet in 2007 July witnessed a 5% gain in the HUI. The usual mid-summer selling
in the HUI that tends to hit in July came a month later this year in August. And
after that the usual subsequent rally was compressed into September. This
helps to illustrate just how elastic seasonal tendencies can be.
All traders who consider seasonality in
their decisions would do well to ponder this. Seasonality doesn't offer
precise timing, just general probabilities. So while gold and the HUI tend
to start rallying strongly again in mid-October, if their rallies start a
week or two early or late it doesn't negate the seasonal tendencies. Since seasonals aren't precise and they are so easily
overridden by technicals and sentiment, I think seasonals should never be used as a primary trading tool.
But seasonals
excel at increasing the odds for success of trades made for fundamental,
technical, and sentimental reasons. Gold continues to be a great fundamental buy
today for a wide range of reasons, including the struggling US dollar. In real inflation-adjusted terms,
its price isn't even close to looking long-term overbought yet. And it hasn't
yet stretched far enough
above its 200-day moving average to signal the end of this upleg. Gold's sentiment is certainly not euphoric either
since few have been really excited about it since May 2006. Together these
factors might give us a 75% chance for success for a long trade today.
But when bullish seasonals
are added on top of these primary drivers, they create an additional
probability tailwind. With gold's seasonal tendency to start its strongest
rally of the year in the next couple of weeks, perhaps today's probability
for success rises to 85%. Although these absolute numbers are guesses, the
relatively small impact of seasonality compared with that of primary drivers
is not. So please realize seasonality is only relevant as a secondary
indicator if primary indicators are already lining up to drive a trade.
At Zeal we are constantly studying gold
and the HUI from fundamental, technical, and sentimental perspectives. Today
the metal and stocks look to be in a very bullish position due to these
primary drivers regardless of seasonality. But with both gold and HUI
seasonality shifting massively bullish in the coming weeks as well, our odds
for success on long trades climb even higher. These seasonal tailwinds are
very welcome.
So in response to all the bullish
fundamental, technical, sentimental, and seasonal factors that are converging
today to launch gold and its miners much higher, we are aggressively adding
positions in elite PM stocks. If seasonals prove
true to their bull-to-date precedent, we have a narrow window here during
this early-October consolidation to deploy ahead of the next upleg. If you want to join us in this probable
highly-profitable ride higher, please subscribe today to
our acclaimed monthly newsletter and
mirror our new trades.
The bottom line is HUI bull seasonals track gold bull seasonals
closely, which is no surprise for students of the markets. While not a
precise primary indicator for upcoming HUI performance, when seasonals match with primary indicators the odds for
success in new trades rise considerably. Today we are in such a situation, when
bullish HUI seasonals match and buttress bullish
HUI fundamentals, technicals, and sentiment.
Provocatively both gold and HUI seasonals expected this week's sharp pullback in
early October followed by a couple of weeks of grinding consolidation. But
once this short-lived buying opportunity ends, the seasonals
project the start of the strongest gold and HUI rallies of the year. So if
you have been waiting to add new PM-related trades, you should consider
seizing this narrow window of opportunity.
Adam Hamilton, CPA
Zealllc.com
October
5, 2007
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