Over the years we have made many notes of small things we observe in various market sectors, as they often come in useful when pondering trading decisions. In the bear market of the highly cyclical gold sector in recent years, one of the things that seems to be happening with unwavering regularity, is that as year-end approaches, many of the stocks that have been beaten down the most will suddenly begin to recover and often rally sharply for several weeks.

Partly this is due to tax loss selling effects wearing off. Most institutional investors finish their tax loss selling shortly before the end of October, while individual investors will as a rule tend to engage in tax loss selling until December. Traders know that beaten down small cap stocks that are especially weak into year-end will tend to outperform early in the new year, as tax loss sales are often reversed as the new year begins. As an example, consider the action in the junior gold miners ETF GDXJ in late 2014 – early 2015:

1-GDXJGDXJ during the 2014 tax loss selling period and the rally thereafter into late January 2015. Almost 45% were gained in the space of five weeks – this is not to be sneezed at – click to enlarge.

Naturally, movements in the gold sector are also driven by the action in the precious metals, but the strong influence of the tax loss selling period is undeniable, especially if one considers the action in gold mining stocksrelative to gold in the time period shown above:

2-GDXJ-gold ratio, 2014-2015GDXJ relative to gold in the 2014-2015 tax loss selling period and its aftermath. This nicely illustrates the impact of tax loss selling and strategies trying to profit from it – click to enlarge.

Since traders try to anticipate this effect, it usually starts and and ends earlier than one would normally expect. Thus, as soon as anticipatory buying aimed at benefiting from the rebound in January outweighs the remaining tax loss selling pressure, the price low is put in and prices reverse. The lead and lag times vary slightly, but have been quite similar in recent years.

However, the title of this post says “Marginal Gold Producer Takes Off”, which brings us to a specific stock, the action of which we have (we think) a fairly good handle on, and which we have actually often used as a leading indicator when it started behaving in an unusual manner.

Please note that this is emphatically not a recommendation to chase this stock, especially as it has just risen so much in such a short time that it seems quite ripe for at least a short term pullback (which may came now or later – we simply don’t know). Readers must decide for themselves how they want to use the information presented here. However, we will provide links to more background information at the end of this post for those who wish to research the situation further.

Harmony Gold as a Plaything and an Indicator

South African gold mining company Harmony Gold hasn’t had it easy in recent years. Once led by Bernard Swanepoel, a star manager who seemingly could do no wrong and appeared to have found a fool-proof formula for turning around aging South African deep level gold mines, it fell on hard times after a failed attempt to take over Goldfields in the mid 2000ds.

The litany of woes is well known: South Africa’s gold production seems to be in perennial decline, and the companies operating the oldest mines all struggle with declining grades, rising costs and lately with a stagnant gold price as well. Note that the gold price has actually just broken out to a new all time high in Rand terms, but it has been close to this level for more than four years now, hence we are saying it was “stagnant”.

3-gold in randGold in terms of the South African Rand – click to enlarge.

Stagnant won’t do when your work force demands raises between 10% to 15% every two years, often goes on strike (sometimes for reasons unrelated to wages) and your state-owned electricity provider is in such a god-awful mess that it cannot guarantee an uninterrupted power supply and moreover constantly jacks up its prices, as it is unable to meet demand.

Harmony Gold has tried various ways to escape the trap it is in. One consisted of making a huge high grade copper-gold porphyry discovery in Papua New Guinea, 50% of which it sold to Australia’s Newcrest, as Harmony wouldn’t be able to swing the necessary investment to develop it on its own. “Huge” by the way means a minimum of 40 million ounces of gold-equivalent at grades that far surpass those of many currently operating gold-copper porphyry mines in South East Asia. Given that production is still years away and the market currently values this asset at less than zero, we can state that the plan hasn’t yet worked as intended.

The other thing Harmony (and other South African miners as well) is implementing, is to deploy ever more sophisticated mining technology. There have recently been breakthroughs in mechanized deep level mining that allow for much more selective and effective mining methods. We refer you in this context to the sudden turnaround at Goldfields’ South Deep operation (formerly known as Western Areas), one of the biggest gold deposits on the planet, where these new techniques have been successfully established. Harmony’s quarterly production at its SA mines has increased by 17% last quarter, which at least in part seems to be the result of such efforts as well.

What one needs to know about Harmony as a trader and investors is mainly the following: the company is a marginal producer, but cash-flow positive at current gold prices (although it still reports headline losses). In fact, among mid-sized producers (1-2 million ounces p.a.), it is probably the most marginal. Its advantage is a fairly solid balance sheet with a small debt load (it has actually reduced its debt by ZAR 1.1 billion in early December. Previously – as of 30 Sept. 2015 – its net debt amounted to ZAR 2.64 bn.). This means it can survive for quite some time, even when faced with difficult problems.

The other thing one needs to know is that the stock has some peculiar characteristics. In the past it has often tended to lead short term turns in the gold sector. There was a time when we used it as an “intra-day trading alarm”. If the entire gold sector was trading down, but HMY turned up, it was a signal to go long the sector for a trade. This leading indicator function hasn’t worked as well in recent years as during the bull market, but traces of it remain. At the moment we may be in a time period in which the currency effect becomes an overwhelming driver of the stock – this happened e.g. also in the 2000-2001 period. Anyway, the tax loss selling effect is very pronounced in HMY as well and the stock tends to really move big when its time comes. Here is what is has done lately:

4-HMY, daily, todayAfter getting clobbered in the usual tax loss selling waves, HMY rises by 64% in two weeks – click to enlarge.

Although the news reported by the company recently were surprisingly good, it has actually not reacted much to these news. Tax loss selling has simply overwhelmed everything else. Now however, the stock has woken up. Note that there is one additional reason why HMY performs especially well at this time of the year: it is summertime in South Africa, and electricity tariffs are lower. Traditionally, this is its strongest quarter – so it gets an extra fillip from that.

Let us look at what happened in the 2013/14 and the 2014/15 tax loss selling periods:

5-HMY-2013-2014 rallyAfter the mid-December tax loss selling low, HMY rose from $2.35 to $3,80 in three months; a rising gold price extended the move in terms of time. The company was in poor shape operationally at the time, something that has recently changed – click to enlarge.

6-HMY-2014-2015 rallyThe 2014-2015 instance wasn’t too shabby either – a rally of 107% in the space of a little over 9 weeks (from $1.54 in early/mid November to $3.18 in mid/late January) – click to enlarge.

Well, what a nice trading sardine, with a built-in timer to boot! Our personal opinion is that the recent advance – as big as it has already been in percentage terms – is likely only the beginning of this year’s turn-of-the-year rally (even though as we noted above, it seems now short term overbought and due for at least a pullback). Of course, there is the big caveat that Ms. Yellen’s planned rate hike could upset the apple cart if no “buy the news” scenario eventuates in gold. Nothing is ever certain, and this year we are certainly facing exceptional circumstances.


We we have both a recurring short term trading opportunity here, as well as a potential signal for the entire gold sector. After all, why would the stock of the most marginal producer be leading to the upside at present? Very often this is a hint that the gold price will soon start to rise as well (of course the Rand gold price has indeed just broken out, so keep the currency effect in mind – the dollar gold price may only follow with a lag, as e.g. happened in 2000/2001).

In any case, there are also interesting fundamental developments at HMY, given the recent sharp improvement at its SA operations. Luckily for investors it has a truly excellent and highly informative web site, where all relevant data are presented in painstaking detail.

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