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Gold and its
miners’ stocks are rocketing higher as speculators and investors
alike return to this left-for-dead sector. This sudden deluge of
capital inflows has crowned gold stocks the best-performing sector
of this young new year by far, shocking traders. And this stunning
reversal of fortunes in both the metal and the companies producing
it is only starting, so it’s exceedingly important to understand
what’s going on.
Gold was
inarguably the world’s most-hated investment in recent years. No
one wanted anything to do with it, because no one felt any need for
it. The world’s stock markets were relentlessly levitating, thanks
to record easing by the world’s elite central banks. And with
stocks seemingly destined to do nothing but rally indefinitely,
there was little demand for counter-moving gold for prudent
portfolio diversification.
But as global
stock markets started sliding in 2016, the bubble in central-bank
confidence rapidly started to burst. Central banks indeed
quickly stepped in to try and stave off the waves of selling, but to
no avail. Extreme central-bank jawboning and actions that would’ve
dramatically goosed stocks in years past failed to have much impact,
helping shake traders awake from their years-long
central-bank-induced stupor.
These newly-alert
traders started remembering that markets are forever cyclical,
they can’t move in a straight line forever. What’s high and in
favor after rallying for years will inevitably roll over and head
the other way, a bearish portent for central-bank-levitated stocks.
Conversely what’s low and out of favor after years of selling will
inevitably mean revert higher. Thus investment demand for gold is
rekindling.
The dazzling 2016
gold story truly is that simple. Stock markets are rolling over
into a long-overdue
new cyclical bear
that central banks artificially held at bay for years. So investors
are diversifying into gold, which generally moves counter to
stocks. And with investors migrating back, speculators are flocking
in as well to ride gold’s momentum. With this strategic context in
place, let’s dig into what’s been moving gold.
The recent seeds
for 2016’s new gold upleg were sown late last July. Years of
central-bank-levitated stock markets had left gold with major
secular support between $1150 and $1200. As gold slumped to the
lower end of that zone in its usual summer doldrums, a large bearish
speculator decided to press his bets in spectacular fashion late one
lazy Sunday evening in July in a
record
gold-futures shorting attack.
Within one minute
around 9:30pm, nearly 24k gold-futures contracts controlling about
$2.7b worth of gold were sold short! This brazen attempt to shatter
gold’s support worked, blasting it almost $50 lower in that single
minute. With $1150 broken, gold would drift down near $1084 by
early August. But with bearish futures speculators’ selling
exhausted, gold rebounded sharply in what would become a multi-month
uptrend.
The American
futures speculators who dominantly manhandled gold in 2015 had been
overwhelmingly bearish on the yellow metal. Their core thesis was
very simple. Since gold yields nothing, the coming Fed rate hikes
would decimate investment demand for this metal. Higher yields in
bonds would make zero-yielding gold even less attractive, and the
resulting capital flight would smash gold way under $1000.
The Fed’s Federal
Open Market Committee meeting in late October played right into this
bearish-gold outlook. The very morning of that decision, gold was
trading near $1182 and had more than recovered its
record-shorting-attack losses. But the FOMC surprised that day
coming across as very hawkish, by declaring it might very well hike
rates for the first time in a decade at its next meeting
coming in mid-December.
So American
futures speculators dumped gold with a vengeance, at rates so
extreme several major new all-time records
for gold-futures
selling were hit. That frenzied gold-futures selling petered
out by early December, with gold pounded back down near $1053.
There were almost no gold bulls left, with even those who called
themselves bulls universally predicting another drop down into
the $800s before gold bottomed.
But for a handful
of contrarian students of the markets including me, this was
supremely irrational. Gold too is forever cyclical, its price
can’t fall forever. And with literally everyone hyper-bearish
on this metal and utterly convinced it was doomed to keep spiraling
lower indefinitely, peak fear had to be near. When a trade
gets that epically one-sided, everyone susceptible to being scared
into selling low has already sold.
And the
seemingly-logical core case for this extreme gold bearishness, that
a new Fed-rate-hike cycle would devastate zero-yielding gold, was
totally false historically! I started researching gold’s
behavior during past Fed-rate-hike cycles last summer. If higher
rates indeed suck capital out of gold, that would be crystal-clear
in the historical record. Surely the gold-futures speculators had
done their homework, right?
It turns out there
have been 11 Fed-rate-hike cycles since 1971, a large sample size
over many decades. On average during the exact spans of all 11,
gold rallied 26.9%. In the 6 where gold climbed, its average
gains were a staggering 61.0%! And in the other 5 where gold
retreated, its average losses proved to be an asymmetrically-small
13.9%. Historically
Fed-rate-hike
cycles were actually exceedingly
bullish for gold!
The lower the gold
price when a Fed-rate-hike cycle is launched, and the more gradual
that cycle’s hiking, the bigger gold’s gains within it. With the
Fed’s imminent rate-hike cycle coming with gold near major secular
lows, and promised to be the most gradual ever, it was hard to
imagine a more bullish scenario for gold. Yet the goofy futures
speculators were so caught up in their masturbatory groupthink they
were blind.
These traders make
mind-bogglingly-risky hyper-leveraged bets where they can double or
lose all their capital with a mere few-percent move in gold.
They can’t afford to trade on bad information. Yet they didn’t even
remember that gold soared 50% higher during the last rate-hike cycle
between June 2004 to June 2006, where the Fed more than quintupled
its federal-funds rate to 5.25% through 17 consecutive hikes.
Believe me, I
didn’t keep this critical research to myself. I originally
published it in an essay back
in early September,
and deepened it considerably
in mid-December
just days before that FOMC meeting. I did everything I could to
alert investors and speculators to the epic contrarian opportunity
in gold, and was ignored, mocked, and ridiculed for it. People hate
hearing when they are wrong for succumbing to groupthink.
The Fed indeed
hiked rates for the first time in 9.5 years in mid-December, the
very event that American futures speculators had long been waiting
for to crush gold. And the next day gold indeed suffered a kneejerk
plunge, falling 2.1% to a marginal new 6.1-year secular low of
$1051. But in the subsequent days leading into year-end, gold
didn’t collapse. That was a massive clue consensus was dead
wrong.
On New Year’s Eve
when gold remained loathed and closed at $1060, I published an essay
“Fueling Gold’s
2016 Upleg”. In it I explained why “gold is poised for a mighty
upleg in 2016”. Speculators had to do vast gold-futures buying to
mean revert their excessively-bearish bets back to normal levels,
and investors had to do vast gold buying to mean revert their own
meager gold portfolio holdings to normal levels as well.
And that’s indeed
coming to pass already, just as I advised investors it would.
During the first 4 weeks of 2016 for gold-futures speculators, they
boosted their long holdings by 22.3k contracts while slashing their
shorts by 22.2k. That’s the equivalent of 138.4 metric tons of gold
buying from this group of traders alone! And these guys still
have another 163.3k contracts or 507.9t left to buy to fully
mean revert to normal.
To put this into
perspective, the World Gold Council reports that global gold
investment demand during the first 9 months of 2015 (latest data)
averaged 76.0t per month. Meanwhile on the investment front,
American stock investors have already put so much differential
buying pressure on GLD gold-ETF shares that its gold-bullion
holdings have surged 47.7t or 7.4% higher so far this year! Gold
demand is really back.
But how can this
be when gold yields nothing? Why do investors flock to it during
Fed-rate-hike cycles? The answer is simple. A tightening Fed is
the arch-nemesis of stock markets levitated for years by epic
record Fed easing. As Fed-inflated stock prices crumble into a new
cyclical bear, smart investors have no choice but to diversify their
portfolios. And gold has been the premier portfolio diversifier for
millennia.
This investment
gold buying is only just starting, as is the powerful new gold upleg
it is driving. Late last year, American stock investors had just
0.115% of their portfolios invested in gold
per the ratio
between the value of GLD’s holdings and the S&P 500’s collective
market capitalization. Between 2009 and 2012 before the Fed’s
third
quantitative-easing campaign radically distorted markets, that
was 4.1x higher at 0.475%!
There’s no doubt
this new stock bear as the
Fed’s gross
distortions unwind will easily push this ratio back over 0.5% in
the next year or two. And that’s going to require vast gold buying
by American stock investors alone. During 2012 before QE3, GLD’s
holdings averaged 1294.2t which is another 88% higher from this
week’s levels. That gold investment helped support gold’s average
price of $1669 in 2012.
Just as
stock-market-investment cycles take years to unfold, so do
gold-investment cycles. So realize the gold buying and resulting
rallying we’ve seen so far in 2016 is just the tiniest tip of the
iceberg. Gold is not only going to fully mean revert out of recent
years’ extreme central-bank distortions, but overshoot towards the
opposite extreme. We are truly looking at gold rallying on
balance for years as investors return!
Investors can ride
this great mean reversion back to normal gold-investment levels with
physical gold bullion or the flagship GLD SPDR Gold Shares gold
ETF. Speculators can buy call options on the latter. Gold is
conservative and
rallies during stock bears, which is far superior to cash. But
if you really want to multiply wealth as gold mean reverts higher,
the gold miners’ stocks will greatly amplify gold’s coming gains.
The gold stocks
are ultimately just a leveraged play on gold prices. Since
their mining costs are largely fixed when mines are built, the price
of gold overwhelmingly determines the profitability of mining it.
And stock prices always eventually gravitate towards some reasonable
multiple of the earnings of their underlying companies. Since
rising gold prices lead to exploding mining profits, gold-mining
stocks skyrocket.
Let’s backtrack
and get some perspective here, just like in gold. Last July’s
record gold-futures shorting attack pounded the premier gold-stock
index, the HUI NYSE Arca Gold BUGS Index, to a brutal 13.0-year
secular low. If you think sentiment in gold was bad, it was
practically rapturous compared to the dark hell gold stocks have
suffered through! Everyone, and I mean literally everyone,
viscerally loathed this sector.
But such
gold-stock price levels were fundamentally-absurd, as I
argued aggressively
in late July,
again in
mid-November, and a third time
in late January.
Trading near 105 per the HUI, the gold stocks languished at levels
last seen in July 2002 when gold was trading near $305 and
had yet to exceed $329 in its young secular bull. Yet even at
gold’s deep post-rate-hike low near $1050, it was 3.4x higher than
that.
The elite gold
miners’ stocks are all included in the HUI as well as the GDX Market
Vectors Gold Miners ETF. Per the latest full quarterly data
available which is Q3’s, these leading gold miners had average
all-in sustaining costs of $866 per ounce. In other words,
they can produce gold and do all the exploration, mine building, and
reclamation necessary to sustain those levels of gold production
indefinitely for $866.
I wrote a whole
comprehensive essay detailing the gold miners’ costs
in mid-November,
and will likely do another one soon incorporating Q4 data. But when
an entire industry can mine gold at essentially a $200-per-ounce
profit near recent gold lows, does it make any sense at all for
the gold stocks to trade as if gold was just over $300? Those
gold-stock prices were ludicrous, truly
fundamentally-absurd by any standard.
So even as gold
drifted lower after that initial HUI 105 print in early August, the
gold stocks held strong. With this industry priced as if it would
cease to exist within weeks, everyone susceptible to being scared
into selling low had already sold. This selling exhaustion gave way
to a monster rally in early October as gold caught a bid, but that
was quickly scuttled after gold plummeted in the wake of that
hawkish FOMC surprise.
While gold plumbed
dismal new secular lows in November and December, the gold stocks’
key support at HUI 105 held. The left-for-dead gold stocks had
actually started to carve a new upleg way back in mid-November,
which held strong despite gold’s new post-rate-hike secular low in
mid-December. As 2015 waned, I argued that gold stocks would be
the
best-performing sector of 2016 by far as they mean reverted.
This entire sector
couldn’t trade as if gold was $300 when it was earning profits on
the order of $200 per ounce even not far above $1050 gold! Since
gold drives gold-mining profits, and profits ultimately drive stock
prices, reasonable gold-stock price levels can be approximated
through the
HUI/Gold Ratio. And that declared the gold stocks’ prices
needed to quadruple merely to reflect then-prevailing low gold
prices!
And indeed the
last time gold had hit those mid-December lows near $1050 back in
October 2009, the HUI had been trading near 390 instead of 106.
I’ve been writing about this extreme gold-stock pricing anomaly for
months on end, and aggressively buying and recommending elite gold
stocks and silver stocks to capitalize on this stunning disconnect.
But unfortunately naive traders bristle at contrarian thought.
Just as expected,
gold stocks surged out of the gates in early 2016 to extend their
uptrend with gold. But this sharp early-year rally soon stalled out
and gold stocks started plunging. Even though gold was only
retreating in a minor pullback, gold stocks plummeted in an utter
collapse. This culminated in a bizarre episode of what had to be
heavy capitulation selling that shattered the HUI’s 105 support in
mid-January.
There was no
reason whatsoever for this, it was just as irrational as most of the
gold-stock trading during recent years. The major gold miners of
the HUI usually leverage gold’s moves on the order of 2x to 3x. Yet
in just 7 trading days ending at the HUI’s new 13.5-year secular
low, this index had plummeted 17.6% on a mere 2.1% gold slide!
At worst the HUI should’ve been down 6%. Triple that reeked of
capitulation.
In hindsight it
looks easier to make that call, but it sure as heck wasn’t that day
when gold-stock trades were getting hammered to stop losses en
masse. Yet as I wrote in our weekly newsletter that afternoon
to our subscribers, it felt like a final capitulation even then so I
aggressively bought and recommended a half-dozen gold stocks that
very day when everyone else was forecasting big cascading losses to
come.
Stock prices can’t
stay decoupled from their underlying fundamentals indefinitely, and
gold stocks’ epic disconnect from gold has to be one of the greatest
in all of stock-market history. So not surprisingly out of that
last-hurrah capitulation likely triggered by mechanical stop-loss
selling, gold stocks started to rebound immediately. Just one week
after those extreme lows, they were back within the HUI’s new
uptrend.
And their gains
accelerated dramatically from there, culminating in this week’s
long-awaited breakout back above the HUI’s 200-day moving average.
In just over two weeks, the gold stocks as measured by the HUI had
rocketed 31.7% higher! And as of this Wednesday (the data cutoff
for this essay), the HUI was up 19.3% year-to-date compared to 7.8%
for gold and a 6.4% loss in the broad-market S&P 500 index.
But like gold,
this new gold-stock buying is only just starting. Even
though gold had rebounded all the way back up to $1143 by the middle
of this week, it still cost the elite miners an average of just $866
per ounce to produce. That yields profits of $277 per ounce.
That’s up a staggering 50% from profitability at gold’s mid-December
low, on a mere 9% gold rally! Gold stocks’ profits leverage to gold
is utterly amazing.
As gold continues
powering higher as investors return to prudently diversify their
portfolios in the face of the
looming stock
bear, investors and speculators are also going to continue
pouring capital into the beaten-down gold stocks. There is simply
no other sector in all the stock markets with stellar odds of at
least quadrupling during a general-stock bear. Gold stocks will
have to power higher for years to mean revert!
This sector has
always been volatile, so that advance certainly won’t be in a
straight line nor will gold’s. But for smart contrarian investors
and speculators willing to take a strategic perspective based on
real fundamentals, this sector can multiply fortunes. During the
last secular gold bull, the HUI blasted an unbelievable 1664% higher
between November 2000 and September 2011! Gold stocks can really
run.
While investors
and speculators can certainly play this sector in that GDX
gold-stock ETF, the gains of the best of the miners will dwarf those
of the sector as a whole. Intra-sector gains inevitably fall out
into a bell-curve distribution, with a few big losers, most average,
and a few huge winners. Smart stock picking of the elites with the
fundamentals likely to generate right-tail performance will enjoy
seriously-outsized gains.
At Zeal we’ve long
specialized in gold-stock research and trading, so you need us in
your corner. Since 2000 I’ve spent several tens of thousands of
hours researching and studying the financial markets from a
contrarian perspective. In the long span since we’ve done hundreds
and hundreds of gold-stock and silver-stock trades based on our
comprehensive research, earning fortunes over the years for our
subscribers. We publish acclaimed
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The bottom line is
gold and gold stocks are already rocketing higher in 2016.
Investment demand for gold is returning as evaporating confidence in
central banks is pushing global stock markets into a new bear. And
as investors seek to re-diversify their risky stock-heavy portfolios
with gold, the left-for-dead gold miners’ stocks are also catching a
massive bid. They are this young year’s best-performing sector by
far.
And these major
new gold and gold-stock uplegs are only just beginning. Gold
investment was forced so darned low by years of extreme central-bank
market distortions that it will take years more of buying to
normalize. And gold stocks have so far to rally merely to mean
revert, let alone reflect higher prevailing gold prices, that
they’re destined for years of heavy investment buying. We’ve hardly
seen the tip of the iceberg.
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