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As Gold Corrects Consider GOAU- A Gold Mining ETF That Favors The Royalty Model (NYSEARCA:GOAU)

The first eleven months of 2020 have been an eventful period in the gold market. After closing 2019 at $1520 per ounce, the price rose to over $1700 in March. Risk-off conditions took the yellow metal below the 2019 close to around the $1450 level. The March low gave way to a massive rally that lifted the precious metal above the 2011 all-time peak in July on its way to a record high of $2063 on the continuous futures contract in early August. Gold had rallied to new all-time highs in virtually all currencies in 2019 and 2020. The move in US dollar terms was the final shoe to drop as gold eclipsed the $2000 level. The gold price has moved higher over the past eight consecutive quarters. A close above $1890 on December 31, 2020, would market the ninth. As of December 2, the price was around $60 below that level.

Since the bull market in gold began at the turn of this century at the $250 per ounce level, every price correction has been a buying opportunity.

Gold mining shares tend to outperform gold futures on a percentage basis on the upside and underperform when the price corrects. The mining stocks carry idiosyncratic risks of management and specific producing properties. However, products that hold a portfolio of mining shares diversify the idiosyncratic risk.

The US Global GO Gold and Precious Metals Miners ETF product (GOAU) holds a portfolio of gold mining stocks. This product’s twist is that it has a substantial percentage of its net assets invested in mining stocks that use a royalty model.

Gold has corrected and looks bearish as we are in the final month of 2020

The nearby COMEX gold futures contract moved from $1450.90 in mid-March to a record high of $2063 in early August, a rise of 42.2% in under five months. Since the all-time high, gold has been correcting, making lower highs and lower lows.

Source: CQG

As the weekly chart highlights, gold futures corrected to a low of $1762.30, 14.6% from the August high, and were trading around the $1830 level on December 2. The weekly chart shows that the total number of open long and short positions in the COMEX futures market has edged lower to below 540,000 contracts for the first time since June. Weekly price momentum and relative strength indicators were below neutral readings with the slow stochastic trending towards oversold territory at the beginning of December. Weekly historical volatility at just below 19% is below the midpoint of 2020, a very volatile year in the gold market.

While the weekly chart does not look all that bearish, the trend of lower highs and lower lows indicates that the current correction may not have found a bottom. The next technical support level below the most recent low stands at $1668.60, the early June 2020 low. Meanwhile, the monthly chart put in a dangerous bearish technical pattern at the end of November.

Source: CQG

The monthly chart shows that the gold price rose to a higher high in November than October and then closed below the previous month’s low. The gold market put in a bearish key reversal trading pattern last month. Over the first days of December, the price has recovered, but time will tell if the monthly chart formation will lead to lower lows in the coming weeks.

A seasonal selloff could lead to higher prices in 2021 if history is a guide

The final months of the year tend to be a seasonally weak period for the gold market. In 2015, the yellow metal fell to a significant bottom at $1046.20 in December. In 2016, the price dropped to a higher low of $1123.90 during the year’s final month.

Meanwhile, buying gold in December has resulted in profits in the next year over the past seven consecutive years as the precious metal moved above the December peak each year.

While historical trends can change, the pattern presents a compelling case for buying gold during the current correction in late 2020.

The gold royalty model keeps expenses low

There are many unleveraged and leveraged products that move higher and lower with the price of gold. Leveraged derivatives use options and other products to turbocharge percentage performance. However, the price tag for leverage is time decay as options lose value over time when the market flatlines or moves in the opposite direction. When it comes to bullish positions in the gold market, mining shares offer leverage without the risk of time decay. Gold mining is a risky business as producers invest massive capital in a hole in the ground with the hope of finding and extracting the metal at a production cost that is below the market price. Meanwhile, the higher the price of gold moves, the more producers can afford for the output, which creates leverage. Junior gold miners that explore for gold have even more leverage as their activities amount to boom or bust results.

Within the gold mining community, some of the leading companies operate under a royalty model. A gold royalty company is a specialized financier that helps fund exploration and production projects for cash-strapped mining companies. In return, the royalty company received royalties on whatever the project produces or rights to a stream or agreed-upon amount of gold. Royalty business models can profit when gold prices rise and fall as they often set fixed prices for output. They have very low overhead as they do not have fixed costs for infrastructure and operating costs. Royalty companies have very low debt levels, making them efficient capital allocators. They do not have many employees, so fixed costs are low during bull and bear markets. Finally, royalty companies own diversified portfolios of mining streams, mitigating specific idiosyncratic risks of single projects.

In an article on Seeking Alpha a year ago on December 4, 2019, Peter Arendas wrote about the leading precious metals royalty and streaming companies, including:

Source: Seeking Alpha

In a highly capital-intensive business, gold royalty companies have very low expenses. They specialize in using their expertise to identify and finance only the best prospects when it comes to gold prospectors and producers.

GOAU is a gold mining ETF

The fund summary and top holdings of the US Global GO Gold and Precious Metals Miners ETF product (GOAU) include:

Source: Yahoo Finance

As the chart shows, GOAU’s portfolio is over 43% invested in shares of companies covered in Peter Arendas’ article. GOAU has net assets of $110.71 million, trades an average of 61,879 shares each day, and charges a 0.60% expense ratio. The price of gold rose by 42.2% from the March 2020 low to the August record peak. The correction took the yellow metal 14.6% below the high at the recent low last month.

Source: Barchart

As the chart illustrates, GOAU rose from $8.96 to $26.77 per share or 199% from March through early August as the ETF product provided a leveraged return compared to the yellow. During the recent correction, the shares fell to a low of $19.11 last month, 28.6% below the high as the ETF underperformed gold on the downside. However, the risk-reward favors the upside when it comes to the ETF product that holds a substantial portion of its net assets in gold mining companies that employ the royalty model.

Scale-down buying for next year during the current correction

Gold and most other assets look great when they are rallying and awful during corrections. With gold under pressure and Bitcoin at highs, we hear voices telling us how the digital currency will replace gold because it has so much more utility. Meanwhile, central banks continue to hold gold as an integral part of their foreign currency reserves. Bitcoin has been around for a decade, and gold for thousands of years.

At the $1830 level on December 2, the price is over $230 below the August high, and the path of least resistance remains lower after the bearish reversal in November. Picking highs or lows in markets is a challenge. Better put, it is a fool’s game in markets that often causes traders and investors to lose lots of money.

If history is a guide, the price weakness at the end of 2020 will give way to higher prices in 2021. Central bank liquidity and encouragement of a higher inflation rate, government stimulus, record low interest rates, and a falling US dollar are extremely bullish factors for gold. I would use the current period of price weakness as an opportunity to buy the precious metal on a scale-down basis, leaving lots of room to add on further declines. Markets have a habit of moving a lot higher than most people expect during bull markets and lower than anyone thinks possible during bearish periods and corrections.

The gold royalty model is attractive for investors looking to turbocharge long positions during corrective periods. GOAU is a diversified product that holds shares in the companies that specialize in diversifying their risk to gold producers worldwide.

The Hecht Commodity Report is one of the most comprehensive commodities reports available today from a top-ranked author in commodities, forex, and precious metals. My weekly report covers the market movements of over 20 different commodities and provides bullish, bearish, and neutral calls; directional trading recommendations, and actionable ideas for traders. 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

The author is long gold.

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