Corrections are inevitable, but current conditions support a prolonged rally in the gold market, TD Securities says in an equity research report.

“Before we restate our bullish thesis for precious metals, we should acknowledge that positioning in the gold market is at extreme levels, with Comex net longs near all-time highs and trading volumes at near double the averages of last year,” the report says.

This type of market posture, with everyone enthusiastically lined up in one direction, often precedes a reversal and a gold correction now could be exacerbated by the magnitude of the move required to restore normalcy to the market, TD says.

Of course, the macro picture is anything but normal. TD notes that there is now broad consensus around the idea that the deteriorating U.S. and global economic outlook will mean that Fed Chair Powell’s ‘mid-cycle adjustment’ in July will turn into an extended cutting cycle, with the bond market pricing in 25-50 bps of cuts by year-end.

TD Global Rates, which called for cuts ahead of the market, is calling for 50 bps of additional easing in 2019, followed by an additional 75 bps of easing in 2020. In many countries, real rates are already negative, and the discussion is around tiering (allowing more deeply-negative yields), QE, and the potential for competitive currency devaluation, TD says,

Despite Rally, Gold Equities Undervalued vs. Gold

The GDX (large-cap) index has rallied around 35% YTD, while the GDXJ (small-cap) is up only about 31% despite having outperformed its larger brother since the beginning of June. Gold, for reference, is up around 19% YTD.

Despite this, gold equities as measured by the S&P/TSX Gold Index are lagging their historical relationship to gold, both when compared with the most recent peak in 2016 and with the peak of the last bull market in 2011, TD notes.

Rotations Key to Maximizing Returns in Prolonged Rally

In a note published in June, TD called the technical breakouts of both gold and silver from their downtrends (corrections within the bull market that began in early 2016). Both metals rallied strongly from that point, with gold up 15% and silver up 16% since then.

TD had also forecast at that time that silver will lag and then outperform gold on a continuation of the rally. Indeed, we saw the gold/silver ratio climb to multi-decade highs above 93 in mid-July before falling to 86 and since then partially retracing that move.

TD’s preferred name for high beta and liquidity, which was highlighted in the June note, was First Majestic Silver, which has rallied approximately 59% since then, strongly outperforming its peers.

TD will publish more on the gold/silver ratio when the retracement/consolidation pattern is complete as TD analysts ultimately expect much stronger gains in silver before the precious metals bull market is over.