The
gold miners’ stocks have largely ground sideways this year, really
lagging gold’s strong rally. That lack of upside has decimated
sentiment, leaving a bearish wasteland bereft of hope. But this
deeply-out-of-favor sector is actually a coiled spring, ready to
surge dramatically as psychology shifts. Sentiment, technicals, and
fundamentals all point to much-higher gold-stock prices even at
today’s prevailing gold levels.
The
main appeal of gold-mining stocks is their underlying
profits’
leverage to gold. The gold stocks are much riskier than gold,
due to many operational, geological, and geopolitical risks the
metal itself doesn’t share. So investors and speculators alike must
be compensated for these big added risks with superior returns to
gold. That hasn’t happened so far in 2017, which is why gold stocks
are so widely despised today.
All
year long, the extreme Trumphoria-fueled stock-market rally has
stolen the limelight. The flagship S&P 500 stock index is up 10.5%
year-to-date as of this week. That’s sucked all the oxygen out of
the investment world, overshadowing everything else. So investors
have shunned gold this year, while the futures speculators have
shorted it at
near-record extremes. Gold has often been mocked on CNBC all
year.
That’s pretty ironic though, as gold’s YTD performance is +10.9%!
That’s a little better than the general stock markets. That should
be enough to garner some attention, but gold can’t escape from the
stock markets’ eclipsing shadow. Gold miners’ inherent profits
leverage to gold usually enables their stock prices to amplify an
underlying gold rally by 2x to 3x. Thus the gold-stock
sector ought to be up 20% to 30% YTD.
The
dominant gold-stock index is the HUI NYSE Arca Gold BUGS Index,
which is closely
mirrored by the leading GDX VanEck Vectors Gold Miners ETF. So
far in 2017, its performance has been dismal relative to
gold. As of this week the HUI was only up 6.6% YTD! That makes for
mere 0.6x leverage to gold, unacceptable given gold stocks’ big
additional risks. That’s why psychology is exceedingly bearish
today.
Gold
stocks are underperforming so massively this year due to
sentiment. Because this small contrarian sector is languishing,
traders want nothing to do with it. And because they are widely
avoided, the gold stocks are trapped in consolidation hell. The
only thing able to start shifting sentiment back to bullish is a
meaningful gold rally igniting material gold-stock buying. The
resulting gains would win back capital inflows.
Sentiment and technicals are inexorably intertwined. No matter what
else is going on, when stocks are high traders get excited and
bullish. That’s happening in the general stock markets today,
despite their
bubble valuations and the Fed’s
quantitative
tightening ominously looming. But when stocks are down, traders
wax sullen and bearish. The markets work this way universally, the
gold stocks are no exception.
As
at all sentiment extremes, traders have assumed this vexing
gold-stock weakness will last indefinitely. But that’s a bad bet,
as sentiment perpetually meanders back and forth between excessive
greed and fear. The longer sentiment stays on one side of that arc,
and the more extreme it gets, the greater the odds for an imminent
mean-reversion swing back the other way. And those tend to
overshoot proportionally.
The
last time gold stocks drifted near lows like so far this year was in
the second half of 2015. They were hated, with nearly everyone
predicting they were doomed to spiral lower forever. Yet sentiment
shifted out of that bearish echo chamber, and the gold stocks took
off like North Korean ICBMs. In merely 6.5 months, the HUI
skyrocketed 182.2% higher! That amplified gold’s 25.2% concurrent
rally by a breathtaking 7.2x.
Gold
stocks have long exhibited a
drift-surge
pattern. Long consolidations bleeding away all bullishness are
soon followed by massive uplegs. They ignite just as traders are
capitulating and walking away. The best time to buy is late in one
of these grating drifts, because the next major upleg is just around
the corner. And that’s exactly where the gold stocks are today
technically, as this HUI consolidation chart reveals.
Last
year’s monster gold-stock upleg that has already been forgotten is
crystal-clear here. Contrarians willing to fight the herd and buy
low in late 2015 when gold stocks were shunned made out like
bandits. They nearly tripled their capital in about a
half-year! Once this sector starts moving, shifting from drift to
surge, its resulting uplegs tend to be massive. The trick is
bucking bearish sentiment to get invested early.
That
enormous upleg birthing a new gold-stock bull last year was followed
by a gigantic drop driven by gold. Since prevailing gold prices
directly drive their earnings, the gold stocks follow and amplify
moves in the metal they mine. In the second half of 2016, gold
plunged sharply thanks to a highly-improbable series of events.
Gold’s resulting freakish drop was incredibly anomalous, which is
why it bounced back this year.
First gold was hit by gold-futures
stop losses being
run, then by the Trumphoria stock-market surge in the wake of
the surprise election results, and finally by the Fed’s second rate
hike of this
cycle. Seeing an isolated event-driven selloff isn’t unusual,
but three in a row back-to-back is unheard of. I explained all of
them in depth in
past essays if you want a deeper understanding of why they were
unrepeatable one-off events.
Gold
fell 17.3% in 5.3 months, certainly a massive correction but well
shy of new-bear-market territory at -20%. Gold stocks as measured
by the HUI amplified gold’s downside by 2.5x, smack in the middle of
that historical 2x-to-3x leverage range. So the huge gold-stock
selloff in last year’s second half wasn’t outsized at all compared
to the anomalous carnage in gold. That’s the way this sector has
always worked.
Once
again gold miners’ profits leverage to gold explains their price
action. Consider an example, a gold miner producing gold at all-in
sustaining costs of $1000 per ounce. At $1250 gold, that yields
profits of $250 per ounce. If gold rallies or falls 10% to $1375 or
$1125, this miner’s profits literally soar or plunge 50% to $375 or
$125 per ounce! The higher any miner’s costs, the greater its
profits leverage to gold prices.
In
the last quarter fully reported, Q1’17, the major gold miners of GDX
reported average
all-in sustaining costs of $878. Q2’17 results haven’t been
fully released yet, but should be by next week. At $878 AISC, $1250
gold yields profits of $372 per ounce. If gold rallies or falls
10%, these per-ounce profits change to $497 or $247. That’s up or
down 34% on a 10% gold move! That’s where gold stocks’ leverage to
gold comes from.
So
seeing this sector largely drift sideways this year despite gold’s
strong 10.9% YTD gain is anomalous, it shouldn’t have happened. And
it wouldn’t have happened without stock markets’ extreme Trumphoria
rally monopolizing traders’ attention. They’ve been so captivated
that they’ve ignored gold’s superior gains in 2017, and that lack of
interest has slaughtered the gold stocks dependent on gold being in
favor.
The
result technically is the major triangle consolidation rendered
above. Since gold stocks’ deep low in December on a Fed rate hike,
their lower support has been slowly climbing. But meanwhile their
upper resistance has been trending lower. This has slowly and
inexorably compressed this sector technically, tightening the gold
stocks into a coiled spring. These converging trendlines
guarantee an imminent breakout.
And
odds overwhelmingly favor an upside resolution to this
triangle consolidation pattern. Gold stocks’ resistance line is
paralleling their key 200-day moving average. A decisive move above
their 200dma will unleash all kinds of buying from
technically-oriented traders. And that 200dma breakout will result
in the simultaneous breakout from this year’s vexing consolidation.
That will rapidly shift psychology away from bearish.
There are two major reasons why gold stocks are heading much higher
rather than lower soon. Gold has long enjoyed
a major autumn
rally which tends to catapult the gold stocks higher in the
coming months. I wrote about this in depth last week, explaining
why it happens and quantifying it. With gold seasonals so strong in
the coming months, it would be super-unlikely for gold stocks to
break down from already-low levels.
On
average in bull-market years, gold powers 6.9% higher between
mid-June and late September. That fuels an 11.2% HUI rally on
average in that same general timeframe. As gold continues powering
higher over the next month, the gold stocks will almost certainly
amplify its gains. This isn’t an academic point, as this year’s
autumn rally is already well underway. Gold’s
summer-doldrums
low came in early July.
Since then gold and the HUI have climbed 5.2% and 8.6% higher as of
this week. That resulting 1.7x leverage is still on the low side,
but rapidly improving from the 0.6x year-to-date metric. Gold
stocks are starting to outperform their profits-driving metal
again, a major sign sentiment is already shifting away from extreme
bearishness. But there’s a far-better reason to be bullish on gold
stocks than their autumn rally.
While these coiled-spring technicals are exciting, they pale in
comparison to the immense fundamental disconnect between gold-miner
stock prices and gold levels. Ultimately all stock prices
eventually reflect some reasonable multiple of their underlying
corporate profits. But the gold stocks are now collectively trading
as if gold was far under current prices, which is supremely
irrational. This anomaly has to mean revert.
This
last chart offers the most-compelling fundamental justification to
be heavily long gold stocks today. It looks at a construct called
the HUI/Gold Ratio, calculated simply by dividing the daily HUI
close by the daily gold close. This HGR acts as a proxy for that
core fundamental relationship between gold, miners’ profits, and
their stock prices. Gold stocks have rarely been as undervalued
relative to gold as they are now.
This
week, the HGR was trading near 0.152x. The HUI was running at 15.2%
of gold’s price. Of course like all indicators that means nothing
in isolation. But the context provided by this long-term HGR chart
shows how absurdly cheap the gold stocks remain relative to
the metal which drives their earnings. The only year in modern
history where gold stocks were cheaper was 2015, the end of an
exceptional secular bear.
Early in 2016 gold stocks as measured by the HUI slumped to a
fundamentally-absurd 13.5-year secular low. It made no sense
whatsoever. Though gold was trading near $1087, way above this
industry’s all-in sustaining costs, the HUI was trading at levels
last seen when gold was near $305 in July 2002! That anomaly
couldn’t and didn’t last, resulting in battered gold stocks nearly
tripling in only about a half-year.
That
coiled-spring reaction perfectly illustrates how explosive
gold-stock upside is after this sector suffers a long, low drift
resulting in extremely-bearish psychology. If today’s 0.15x HGR is
actually righteous, it would’ve been seen plenty of times in modern
history. But it hasn’t. Such extremely-low gold-stock price levels
relative to gold were only able to persist briefly after a long
secular bear. They weren’t sustainable.
Remember the Fed started
aggressively
levitating the US stock markets in early 2013, wreaking havoc on
alternative investments led by gold. The gold market’s last normal
years were sandwiched between 2008’s stock panic and 2013’s radical
Fed distortions. That’s the best recent baseline for where the HGR
ought to trade. And between 2009 to 2012, it was running way up at
0.346x. That’s over double today’s levels!
To
simply mean revert back up to those last normal levels relative to
gold, the big gold stocks dominating the HUI would have to power
127% higher from here to 441! To restore some semblance of normalcy
fundamentally, the gold stocks need to more than double from here
even at this week’s $1276 prevailing gold levels! The gold stocks
certainly can’t stay disconnected from their own earnings realities
forever.
All
markets are cyclical, including gold stocks. Extreme
undervaluations relative to gold are followed by overvaluations as
the pendulum swings back the other way. Mean reversions after
extremes never stop in the middle. Their momentum leads them to
overshoot to the opposite extreme! That makes gold stocks’ coming
upside far more impressive. A proportional overshoot heralds
radically-higher gold-stock prices ahead.
At
worst in mid-January 2016, the HGR fell to an all-time low of
0.093x. That was a staggering 0.253x under that post-panic
normal-year average HGR of 0.346x. So a proportional overshoot
would briefly boost the HGR 0.253x above that mean, to 0.599x. That
upside extreme wouldn’t last long, as greed wouldn’t be
sustainable. But it could happen in a blowoff top after gold
stocks are popular following a bull.
At
$1276 gold, that yields a potential HUI topping target of 764!
That’s a stupendous 293% above this week’s levels. Is there any
other stock sector with the potential to quadruple in the coming
years? No way. Gold stocks are the only severely-undervalued
sector left after this Trumphoria stock rally, so their upside is
unparalleled. And incredibly these simple HGR-derived gold-stock
targets are actually conservative.
They
assume gold is static, stuck at $1276. That’s exceedingly
unlikely. As these Fed-levitated stock markets inevitably roll over
with Fed
quantitative tightening dawning, gold itself will catch a major
bid as investment capital returns. As a rare asset that generally
moves counter to stock markets,
gold is hostage
to them. So when the stock markets suffer their long-overdue
major selloff, gold will soar on capital inflows.
10%,
20%, and 30% gold uplegs from here would take this metal to $1403,
$1531, and $1658. Plug in the HGR of your choice, the post-panic
average or the mean-reversion overshoot, and you get some potential
HUI targets so high they defy belief. And don’t think a 30% gold
rally is out of the question. In response to the last
stock-market correction, gold powered 29.9% higher in just 6.7
months in early 2016!
Don’t get bogged down in HUI upside targets, they only serve to
illustrate a critical point for investors and speculators today.
Gold stocks are not only radically undervalued at today’s gold
prices, but even more so compared to where gold is heading in its
own still-very-much-alive bull market. Even if you think gold
stocks only have 50% to 100% upside, that’s vastly better than
everything else in these overvalued stock markets.
Gold
stocks’ leverage to gold’s gains is already accelerating in
their early autumn rally. That is gradually starting to shift
sentiment, pushing that pendulum away from being pegged at
hyper-bearish. The more gold stocks rally, the more traders will
take notice and deploy capital. That process will soon become
self-feeding, and gold stocks will be off to the races again like in
early 2016. That will yield massive gains.
That
begs the question what are you going to do about it? Are you tough
enough mentally to invest like a contrarian, to buy low and out of
favor when few others are willing? Can you handle fighting the
crowd, making unpopular investments? Or will you take the
mainstream approach, which is waiting to buy gold stocks until
they’ve already doubled from here? The biggest gains are won by the
early birds who buy the lowest.
While investors
and speculators alike can certainly play gold stocks’ coming
breakout rally with the major ETFs like GDX, the best gains by far
will be won in individual gold stocks with superior fundamentals.
Their upside will trounce the ETFs’, which are burdened by
over-diversification and underperforming gold stocks. A
carefully-handpicked portfolio of elite gold and silver miners will
generate much-greater wealth creation.
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The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, like late in this year’s vexing
consolidation. An easy way to keep abreast is through our acclaimed
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The
bottom line is gold stocks look like a coiled spring today despite
the extreme bearishness plaguing them. Following its long drift so
far this year, this sector is ready to stage a massive breakout
surge in the coming months. Technically gold stocks’ triangle
consolidation has nearly converged, guaranteeing an imminent
breakout. But far more bullish are gold stocks’ deeply-undervalued
fundamentals relative to gold.
Gold-mining profits are heavily dependent on prevailing gold
prices. And with this industry’s costs way under gold’s current
levels, the gold miners are already earning hefty profits today.
Sooner or later their stock prices must reflect fundamental
reality. That mean-reversion process is already underway, with gold
stocks’ early-autumn-rally gains increasingly outpacing gold’s.
Their upside leverage should only accelerate. |