A Bold Call on Gold Miners

This has been a rough year for gold, and various exchange-traded funds (ETFs) confirm as much. In the world of physically backed gold ETFs, the SPDR Gold Shares (GLD) is the world's largest. GLD is down 8.9% year to date.

As is often the case when gold declines, shares of gold miners overshoot the commodity's decline. The VanEck Vectors Gold Miners ETF (GDX), the largest gold miners ETF, is down 20.9% this year. Flows data confirm investors' sour view of gold. This year, investors have yanked $4.10 billion from GLD, an outflows total surpassed by just five other ETFs. (See also: Does It Still Pay to Invest in Gold?)

Interestingly, some of the capital flowing out of GLD may be finding its way to miners ETFs. GDX has seen year-to-date inflows of $2.49 billion, good for one of the better totals among sector and industry ETFs. GDX's small-cap cousin, the VanEck Vectors Junior Gold Miners ETF (GDXJ), has added $683.59 million in new assets this year. Investors with the fortitude to allocate to gold miners and the related ETFs could be rewarded, as some analysts believe that now is the right time to revisit shares of precious metals miners.

"Although there is little evidence that inflation is accelerating (as of now) or that the end of this bull market is imminent, we argue that gold miners should be given a larger weight in investors' portfolio for the following reasons: i) the economic cycle continues to mature; ii) asset valuation multiples are expanding and asset bubbles are emerging in certain areas; iii) budget deficits are increasing at alarming rates; and iv) quarterly earnings will face tougher comps in 2019, bringing into question how much longer this record-breaking bull market can continue," said CFRA Research equity analyst Matthew Miller in a recent note.

CFRA sees positive implications for several well-known gold miners, including Agnico Eagle Mines Limited (AEM), Barrick Gold Corporation (ABX), GoldCorp Inc. (GG) and Newmont Mining Corporation (NEM). That quartet combines for approximately one-third of GDX's weight. (For more, see: 3 Charts Suggest Gold Miners Could Lead the Way.)

A potential near-term catalyst for gold and the miners is short covering, because professional speculators are heavily short gold futures. "For the week ending Sept. 25, money managers increased their speculative gross long positions in Comex gold futures by 609 contracts to 98,513, while short positions increased by 1,823 contracts to 182,190. This means that gold's net short position is 83,677 contracts," according to Miller. "The gold market could be poised for a short-covering rally, as investors are likely to start closing out their record level of short positions, given gold's resilience to not break below key levels of support."

History shows that extreme short positioning in gold is often followed by large rallies. "For example, in 1999, short positions increased fivefold to a then record level of 80,000 contracts, which was followed by a 16% increase in the price of gold over a two-month period," adds Miller. "After short positions spiked again in July 2005 and January 2016 (two times when the net long position was close to negative, or a net short position), gold prices surged 12% and 14%, respectively, during the subsequent three-month periods." (For additional reading, check out: Barrick, Randgold Merge to Form Gold-Mining Behemoth.)