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Will the Uptrend in Gold Mining ETFs Continue?

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Thanks to the global worries over militant attacks in Iraq, bleak U.S. growth data in the winter and the geopolitical tension between Ukraine and Russia, gold bullion has climbed more than 9% so far this year on its regained safe haven status.

A 20% rise was seen in net-long positions in the gold futures and options markets during the week ending July 1 and holdings in exchange-traded products rose at the best clip since 2012 (read: Any Hope for Gold ETFs in 2014?).

While these performances have been good, events have been even better in the gold mining ETF space. Products in this category generally trade as a leveraged play on the underlying commodities, so when gold prices are rising, these mining ETFs emerge as the true winners.   

In fact, the gold miner ETFs outstripped the broad market funds like SPDR S&P 500 (SPY) by a wide margin in the same time frame. The biggest gold mining fund Market Vectors TR Gold Miners (GDX) – which suffered a loss of about 55% in 2013 due to the strength in the greenback – added over 23% this year while SPY gained about 7.9%. As a result, dirt cheap valuations have opened up buying opportunities in this space.

Now, the question is whether the momentum can be sustained through the balance of 2014.

Favorable Dynamics

Jewelry Demand: The demand for gold jewelry, as well as bars and coins, has been strengthening this year mainly driven by China and India. Jewelry demand in the U.S. has been building up slowly with signs of economic recovery and lower prices.

Though the first quarter of 2014 witnessed a double-digit decline in gold demand in both the highest consuming nations, the situation will likely reverse soon as the year progresses especially given China is nearing stabilization.

Policy Easing in Europe: The surprise stimulus measure in Europe including introduction of a negative deposit rate to fight deflationary worries should help gold bullion. This in turn might boost the mining stocks (read: Gold Mining ETF Investing 101).

Cut in U.S. Growth Rate: Though in the U.S., the Fed has been steadily wrapping up its QE program (which will be now $35 billion a month from July), the Fed has vowed to keep interest rates low for longer as it trimmed the U.S. long-term growth forecast from 2.2–2.3% in March to 2.1–2.3% to reflect a frozen Q1. This should shore up gold prices ahead. Not only the U.S., a slash in the global growth forecast by the World Bank also sent gold prices northward.

Hedge against Inflation: Though a recent uptick in U.S. inflation went in favor of the price of greenback, this can be viewed as solid news for gold too as the metal is often observed as a hedging tool against inflation over the long term. Investors should note that consumer prices grew 2.1% year over year in May, the highest yearly expansion since October 2012.

Moderation in Production Hurdles: On the production front, there is also good news for gold miners for the long term. If the recent comments by Barrick Gold (ABX - Free Report) and Newmont (NEM - Free Report) are to be considered, there is an abundance of gold reserves in Nevada that have yet to be tapped. This should reduce miners’ cost structure as Nevada’s reserves carry reduced investment risk than the other politically disturbed mines across the globe, per the source.   

Lower Supplies: Though gold miners are betting on higher production to improve revenues in order to spread out its huge fixed asset base, a reduction in recycling action led to the subdued supplies in gold. The recycled gold supplies fell for the sixth successive year to the lowest level in 2013, as per the World Gold Council (read: Can Gold Mining ETFs Dazzle in 2014?).

Challenges Ahead

Volatile Oil Prices: As per a recent Bloomberg study, oil and gold prices tend to exhibit a negative correlation (measured for last 120-day) this year for the first time in five years. A revival in global economy driving energy consumption might persuade investors to “buy oil and sell gold” (read: New Gold ETF from Merk Hits The Market: OUNZ).

Technical Look

GDX is trading little below than its 9-day simple moving average but way higher than 50 and 200-day simple moving averages which signifies a strong uptrend for the ETF. The $28 level appears to be the resistance for the ETF this year while $31 level was the prior resistance noticed last year.

With fundamentals being somewhat favorable, a breakout of this level can be characterized by further gains. Notably, the $22 level is the immediate support level for the ETF. This is followed by $20 level which previously was a support while considering a one-year time frame.

The biggest fund in the space, GDX entered almost in the oversold territory as depicted from the above chart. The ETF is trading at a Relative Strength Index (RSI) value of 62.14 indicating there is room for further expansion in the price in the following a few trading sessions.

Bottom Line

That being said, we suggest investors to be watchful as several big brokerage houses including Goldman and Societe Generale SA forecasted gold prices will fall by the end of 2014. Still, we believe gold mining ETFs are likely to rule as long as the Fed keeps interest rates at rock-bottom level and occasional geo-political tension keep hitting headlines.

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