Junior gold stocks offer a place of refuge in a falling market

Junior gold stocks offer a place of refuge in a falling market
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Junior gold stocks have taken a beating alongside other stocks, but history suggests this could be the time to dive in. The Vaneck Vectors Junior Gold Miners ETF is down from where it was in February, although it’s starting to show signs that it could revive soon.

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Q4 2019 hedge fund letters, conferences and more

Crescat likes junior gold stocks

In their March update to investors, Crescat Capital said junior gold stocks retested the lows of a nine-year bear market. Small-cap gold and silver mining stocks are up a bit from where they were in March, but not much. They've continued to bounce around since then.

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The Crescat team said gold stocks tumbled 84% from their December 2010 high, marking a double-bottom retest and a probable higher low compared to the January 2016 low. At the time of their letter, they said junior gold miners hit record low valuations relative to gold. Further, they said the last time the ratio was at that level, junior gold and silver stocks skyrocketed 200% in only eight months.

They added that all precious metals fell victim to a liquidity crisis and forced margin call selling. They also said the fundamentals for gold and silver prices "have never been better." That makes junior gold stocks look even better, especially as the world's central banks continue to print money.

Gold price fails to rally

In a note this week, Saxo strategist Ole Hansen said the failure of the gold price to rally amid the spread of the coronavirus and related economic uncertainty brings back memories of 2008. In the first part of the Global Financial Crisis, investors sold off all assets to deleverage or pay for losses elsewhere. During the first weeks of the crisis, the gold price sold off 27%, falling to $725 an ounce before starting to rise, eventually climbing to $1,920 an ounce.

The rally in gold senior and junior mining stocks started before the gold price started to rally. It took a few months before the stock market finally bottomed out. For now, Saxo is watching senior gold stocks via the Vaneck Major Gold Miners ETF. Hansen noted that fuel costs, which account for 20% of mining costs, have tumbled. Thus, gold miners have not taken the huge hit that falling gold prices would otherwise cause.

Other issues for gold

Hansen believes current developments have strengthened the reasons for holding gold in the long term. He noted that interest rates have been slashed, but corporate bond yields have been rising.

"The broken transmission between central bank actions and developments on the ground is likely to trigger a major fiscal and potential inflationary response from governments around the world," he wrote. "US 10-year real yields, another major driver of gold, have risen sharply in response to much lower inflation expectations."

He believes the move is unsustainable and expects real yields to move more negative eventually. He also noted that the major selloff in crude oil hasn't helped gold either. Russia's central bank has been a strong buyer of gold, but because of the nation's dependence on oil, it could become a net seller of the yellow metal. Russia will have to cover the shortfall of oil falling below break-even, which is around $40 a barrel.

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