The
gold miners’ stocks remain deeply out of favor, largely shunned by
traders. Since this sector just spent the better part of a year
grinding sideways, such bearish sentiment isn’t surprising. But
with a giant technical formation nearing a major inflection point,
things look to be coming to a head in gold-stock land. A big
breakout is nearing, and gold stocks’ deep undervaluation relative
to gold argues it will be to the upside.
Every investor’s portfolio should always include a core position in
gold bullion. As a rare asset that tends to move
counter to stock
markets, gold acts like insurance. It rallies strongly when
stocks and bonds are falling in serious corrections or bear markets,
mitigating overall portfolio losses. Gold certainly has risks of
its own, but they pale in comparison to the additional layers of
risk heaped on by gold-mining stocks.
Gold
miners face major financing, operational, geological, and
geopolitical risks that gold doesn’t. Even when gold is thriving on
strong investment demand, individual gold miners’ stocks greatly
underperform if their mines suffer troubles. Thus gold-mining
stocks must offer ultimate returns well beyond gold’s own, to
compensate investors for bearing these miners’ big additional risks
stacked on top of gold’s own risks.
Miners’ gains do amplify gold’s underlying gains during gold bulls,
as evidenced in the flagship HUI gold-stock index. Gold stocks’
last secular bull ran for 10.8 years between November 2000 to
September 2011. During that span the HUI skyrocketed 1664.4%
higher, driven by gold’s own parallel 602.9% bull market! That made
for 2.8x upside leverage for gold stocks relative to gold, right in
line with historical ranges.
The
major gold stocks that dominate the HUI and the leading GDX VanEck
Vectors Gold Miners ETF will generally enjoy 2x to 3x upside
leverage to gold in bull markets. With the big gold stocks
tending to see ultimate gains doubling or tripling gold’s, investors
are often willing to shoulder their additional risks. And among the
smaller mid-tier and junior gold miners, their collective upside
leverage to gold runs even greater!
The
reason investors are so down on gold stocks today is their
year-to-date leverage to gold has been horrendous. Despite the
Trumphoria-fueled record-high stock markets, gold has still surged
11.9% since 2017 dawned. Incidentally that has handily bested the
S&P 500’s 8.7% YTD gain. But despite gold shining, the gold stocks
as measured by the HUI were only up 11.1% YTD as of the middle of
this week.
And
that was even after Tuesday’s surge, where the HUI blasted 6.1%
higher on gold challenging $1300 again! The gold miners’ stocks,
despite their big additional risks, are actually lagging gold
so far this year with terrible leverage of 0.9x. That’s why
bearishness on this sector is so extreme today. Truly the risky
gold stocks aren’t worth owning if they fail to generate
much-greater gains than gold. Upside leverage is critical.
While this year-to-date snapshot is pretty damning, it’s a myopic
perspective. Like everything else in the markets, gold stocks’
leverage to gold flows and ebbs in cycles. We are likely at
trough leverage now, as it’s hard to imagine this sector’s
psychology becoming much worse. After exceptional underperformance
relative to gold, the gold stocks’ gains tend to surge and
outperform to gradually restore that 2x to 3x average.
Given the sometimes-extreme cyclicality of gold stocks’ upside
leverage to gold, they were actually due for a period of
underperformance. In January 2016, a new gold-stock bull was born
out of
fundamentally-absurd 13.5-year secular lows in HUI
terms. Over the next 6.5 months, the gold stocks soared 182.2%
higher on a new and small 25.2% gold bull. That was extreme 7.2x
upside leverage, far too great to be sustainable.
I
warned about gold stocks’
excessive
early-bull gains last July, that a mid-bull correction was
necessary and inevitable to rebalance sentiment. Due to a series of
anomalous events slamming gold itself in the second half of
last year, that healthy gold-stock correction grew far more extreme
than anyone expected. But after such huge outsized gains relative
to gold in 2016’s first half, a leverage mean reversion is
righteous.
So
the gold stocks have far-underperformed gold for the better part of
a year now, fully bleeding off the excessive greed their early-2016
outperformance fueled. And now the relative-performance pendulum is
once again set to swing back the other way. This chart looks at the
major gold miners’ technicals since early 2016 as represented by the
HUI. A major triangle consolidation chart pattern is nearing the
end of the line.
That
overdue gold-stock correction last summer was fast and furious in
August, with the HUI plunging a blistering 22.0% in less than a
month! That was totally normal. The gold stocks then spent
September consolidating and bottoming, typical staging for their
next upleg. But then out of the blue they got walloped by an
extreme event. Gold futures suffered
a mass stopping
as key gold support near $1300 failed to hold.
Gold’s resulting extreme 3.3% down day in early October sucked in
the gold stocks, which saw their own stop-loss-triggered cascading
selling. The HUI plummeted 10.1% in a single trading day, spawning
incredibly-bearish psychology! But that September consolidation
before the early-October plunge would start forming the upper
resistance line of the giant triangle consolidation pattern
finally nearing maturity today.
After that extreme anomaly, the gold stocks soon started grinding
higher again along the HUI’s key 200-day moving average. 200dmas
are usually the strongest support lines in ongoing bull markets.
Then unbelievably gold suffered another extreme anomaly.
After Trump’s surprise election win, stock investors started
jettisoning
gold-ETF shares like crazy on the sharp Trumphoria stock-market
rally. Gold plunged again.
And
naturally the HUI followed, as gold miners’ profits and hence
ultimately stock prices are leveraged to underlying moves in gold
prices. After that the gold stocks started consolidating again in
November, until they were hit by a mind-boggling third anomalous
event after just suffering two in two months. The gold stocks
dropped with gold in mid-December on 2017 Fed-rate-hike projections
being more hawkish than expected.
That
rare gold-futures mass stopping, the never-before-witnessed
Trumphoria stock-market surge that was contrary to all pre-election
expectations if Trump actually won, and the hawkish Fed ballooned
that healthy gold-stock correction to a freakishly-large 42.5% in
4.4 months! But as soon as those extreme gold-selling anomalies
stopped materializing, gold stocks were quick to bottom decisively
in December.
They
briefly consolidated low, starting to form the lower support line of
that triangle consolidation chart pattern of such great interest
today. After being beaten to such super-low levels relative to
prevailing gold prices, the HUI took off like a rocket in a major
new upleg. By early February, the gold stocks had surged 35.5% in
just 7 weeks on a mere 10.0% gold rally. That was strong 3.6x
upside leverage to gold!
But
that initial upleg surge stopped cold at the HUI’s 200dma. When
bull markets suffer unusually-large corrections thanks to anomalous
events, technically-oriented traders’ perceptions can shift from
seeing 200dmas as strong bull-market support to major overhead
resistance. Bulls aren’t believed to be back on track until
decisive re-breakouts above 200dmas occur. That actually happened
with gold itself in mid-April!
So
the HUI was repelled at its 200dma in mid-February, solidifying the
upper resistance line of this triangle consolidation chart pattern.
Then gold stocks retreated from mid-February to mid-March, as
Fed-rate-hike fears flared again among gold-futures speculators.
These guys dominate short-term gold price action, and are
irrationally scared of Fed-rate-hike cycles even though
gold has thrived
during them historically.
On
the very day the Fed indeed hiked again as expected in mid-March,
gold and therefore gold stocks surged dramatically. The FOMC
members controlling monetary policy didn’t up their collective
forecast for three total rate hikes in 2017, which was considered
dovish. So the HUI soared 7.8% higher in the afternoon after that
third rate hike of the Fed’s newest cycle. That solidified this
triangle’s support line.
Gold
rallied strongly from there into mid-April, breaking decisively back
above its 200dma again on rising geopolitical fears. That was after
Trump lobbed cruise missiles into Syria, sent a carrier battle group
to North Korea, and struck Afghanistan with the biggest conventional
bomb ever used in combat all within a single week! But
gold-stock sentiment remained damaged, and the HUI again failed to
overcome its 200dma.
Gold
and especially gold stocks faded again into early May, with new
record highs in US stock markets retarding gold investment demand.
Then a big stock-market down day rekindled gold’s uptrend, but the
beaten-down gold stocks only edged feebly higher really lagging
their dominant fundamental driver. That recent action further
reinforced this symmetrical-triangle consolidation pattern that’s
crystal-clear in this chart.
Since September now, the gold stocks as measured by the HUI have
seen lower highs and later higher lows. Their upper resistance line
is pushing lower right along the HUI’s 200dma. Just this week, that
big 6.1% HUI surge on Tuesday blasted it right back to its 200dma
again for the third time in five months. Meanwhile the HUI’s lower
support line keeps rising, compressing this 9-month-old triangle
consolidation pattern.
As
you can see in this chart, this symmetrical-triangle formation has
nearly closed. In a matter of weeks, the gold stocks’ resistance
and support lines will converge. That will force gold stocks into
an imminent technical breakout one way or the other. This drifting
sector has reached a major inflection point. And the
resulting move could be big, as symmetrical-triangle breakouts often
fuel big momentum buying or selling.
While a breakdown is possible, the odds favor a major upside
breakout soon for gold stocks. In my line of work, I hear from
plenty of fund managers. They understand the gold miners’
underlying fundamentals are strong, as evidenced by the
recently-reported
first-quarter results of the GDX components. They also know
gold stocks are unloved and undervalued relative to gold, with big
upside potential when sentiment shifts.
But
since fund managers have to report their performance on a quarterly
basis, many are wary of shifting capital back into gold stocks
early. They don’t want to be stuck reporting owning the
very-unpopular gold stocks at quarter-ends before this sector starts
moving again. So multiple fund managers have told me they are
waiting for a decisive 200dma breakout of the HUI or GDX.
That’s their green light to start buying.
That
will yield hard technical confirmation that gold stocks remain in
bull-market mode. And since this giant symmetrical triangle’s upper
resistance is paralleling the HUI’s 200dma, a 200dma breakout will
also be an upside consolidation breakout. Concurrent upside
breakouts of multiple major resistance lines should unleash
serious buying momentum. A decisive breakout is 1%+ above any
resistance line.
Interestingly these festering fears that a gold-stock bull might not
be in force anymore are kind of silly. As of the middle of this
week, the HUI was still up 101.1% bull-to-date since January 2016
compared to an 18.5% gold gain over the same span. And gold stocks
are only down 28.7% from their bull-to-date peak seen in early
August. That’s not much in a sector as volatile as this considering
all the late-2016 anomalies!
The
greatest argument for gold stocks’ imminent upside breakout from
their long symmetrical-triangle consolidation is actually
fundamental, not technical. The gold miners’ stocks remain
greatly undervalued relative to prevailing gold prices. In Q1’17,
the major gold miners included in that leading GDX ETF reported
average all-in
sustaining costs of just $878 per ounce. That’s $409 below
today’s gold price!
The
gold miners are very profitable today, yet their stocks are priced
as if they not only can’t earn any money now but probably never
will! That’s a ridiculous anomaly driven by excessively-bearish
sentiment, and such extremes never last for long. A great proxy for
the strong fundamental relationship of gold-mining profits and
therefore gold-stock prices to gold levels is found in the venerable
HUI/Gold Ratio, or HGR.
It
simply divides the daily HUI close by the daily gold close, so the
resulting ratio can be charted over time. As I discussed in depth
in an essay on
gold-stock-bull upside targets in mid-April, the average HGR in
the last normal market years between 2009 to 2012 was 0.346x. The
gold stocks need to at least mean revert back up to those
levels to return to some semblance of fundamental normalcy relative
to gold.
This
last chart looks at the HGR since early 2016, this new gold-stock
bull market’s entire lifespan. It is rendered in blue along with
key moving averages. The actual HUI gold-stock index level is shown
in red. But a second hypothetical HUI is included in yellow,
showing where gold stocks should be trading at that
post-panic-normal-year HGR average of 0.346x. That’s more than
double where this sector is drifting now!
If
the gold stocks were popular and loved today, trading at
historically-high levels relative to gold, I would be very bearish
on this symmetrical triangle failing to the downside. But the exact
opposite is true! This week the HUI/Gold Ratio was trading at only
0.157x. That’s still super-low historically, not too far above the
all-time low of 0.093x last seen in January 2016 when this strong
new gold-stock bull was stealthily born.
And
even when gold stocks peaked in their young bull’s first upleg in
early August, they remained way under normal levels relative to gold
by all historical standards. The HGR only hit 0.209x at best, still
far below that 2009-to-2012 normal-year average of 0.346x. Realize
that for their entire young bull market, gold stocks have yet to
trade anywhere near even normal price levels let alone high
ones warranting caution.
Interestingly the HGR itself is in a similar giant technical pattern
to the gold stocks, a descending triangle. Since early last
November, the HGR has found strong support just under 0.15x. Like
the gold stocks, the HGR is getting squeezed into an ever-tighter
trading range. So an HGR breakout is also imminent. And
like gold stocks, the odds favor that being to the upside. These
extreme-low HGR levels are
very rare
historically.
If
the gold stocks would simply mean revert back up to their 0.346x
average HGR, the HUI would trade at over 445 at this week’s gold
prices! That’s a whopping 120% higher than today’s levels. When a
sector is radically undervalued fundamentally relative to the
driver of its profits, upside potential is vastly greater than
downside risk. Gold stocks’ mean-reversion upside from here is
huge, arguing for a major upside breakout.
With
gold stocks so darned cheap relative to gold, the odds heavily favor
the nearing inflection point of this symmetrical triangle turning
sharply north. And interestingly, a potential big buying
catalyst for both gold and gold stocks is coming next week. The
FOMC is meeting to make a monetary-policy decision which is widely
expected to result in the fourth rate hike of this cycle. And
future rates will be forecast.
Despite gold-futures speculators’ paranoia of Fed rate hikes, both
gold and gold stocks surged sharply after each of the three previous
rate hikes in this cycle. Why should the fourth prove any
different? It’s also quite likely the FOMC members’ collective view
on more rate hikes in 2017 proves either stable or more dovish
than expected. After Q1’s very-weak GDP and May’s huge US jobs
miss, the Fed can’t be hawkish.
The
Fed only forecasts future rates at every other FOMC meeting, or once
a quarter, in the so-called dot plot. That showed three total rate
hikes in 2017 in mid-March, when the US economic data looked much
stronger. Traders had expected that to be lifted to four, but it
wasn’t. That’s why gold and gold stocks surged sharply that very
afternoon. If that rate-hike forecast stays at three next week,
gold should rally again.
But
between the sharp deterioration of US economic data in the past
quarter, along with the Fed’s desire to soon start shrinking its
grotesque balance sheet ballooned by years of QE, the FOMC may very
well lower its 2017 rate-hike outlook. It doesn’t even have to fall
to two, signaling this year’s rate hikes are likely over. If the
collective forecast even sheds a quarter point, gold-futures
speculators should flood into gold.
Remember mid-March’s less-hawkish-than-expected dot plot drove gold
1.9% higher the afternoon it was published. That resulted in a
major 7.8% HUI surge that very day, along with nearly a month of
follow-on rallying after that! If gold and therefore gold stocks
catch a bid on next week’s FOMC decision, this sector’s symmetrical
triangle will conclude with an upside breakout that could unleash
big buying momentum.
With
gold stocks nearing such a major technical inflection highly likely
to be resolved to the upside, you need to be closely following this
sector. It wouldn’t surprise me one bit to see the HUI’s ultimate
2017 gains approach or even exceed its big 64% surge last year. The
earlier you get informed and deploy in great gold stocks cheap, the
greater your gains will be. Buy low before most others, as
fortune favors the bold!
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The
bottom line is a major technical inflection point nears in gold
stocks. A giant symmetrical-triangle consolidation pattern formed
over the past 9 months has nearly fully converged, which will soon
force a major breakout. Odds are it will prove to be to the upside
given this sector’s strong fundamentals and severe undervaluation
relative to gold. The major gold miners are very profitable at
today’s gold prices.
The
most-visible near-term breakout catalyst is next week’s FOMC
meeting. Gold and gold stocks have rallied sharply after each of
the past three Fed rate hikes. So if gold-futures speculators see
anything the Fed releases as less hawkish than expected next week,
they will pile back into gold which will once again catapult gold
stocks higher. And given all the weak economic data lately, it’s
hard to imagine a hawkish Fed. | 
