After soaring in a powerful upleg, the gold miners’ stocks have been
grinding lower for a couple months now. This ongoing correction is
increasingly draining enthusiasm for this small contrarian sector,
working to rebalance sentiment. Gold-stock price levels relative to
gold suggest this necessary and healthy selloff hasn’t fully run its
course yet. But once this passes, current valuations remain very
bullish for the gold miners.
Unlike the vast majority of other industries, gold miners’ earnings
are almost totally dependent on a single variable. That’s the
price of gold. The profitability of excavating and selling gold
directly levers prevailing gold prices. The costs of producing this
metal are largely fixed, mostly determined during mine-planning
stages when engineers decide which gold-bearing ores to mine, how to
dig to them, and how to process them.
Because gold prices are dynamic while mining costs are effectively
static, prevailing gold levels are the overwhelming driver of
corporate profits. And these earnings compared with stock prices
are the only ingredients in valuation analysis. The classic
valuation metric is trailing-twelve-month price-to-earnings ratios,
which are current stock prices divided by actual profits earned over
the last four reported quarters.
Plenty of major gold miners’ stocks are very cheap per this
classic measure! The popular GDX VanEck Vectors Gold Miners ETF is
this sector’s leading benchmark and trading vehicle. Its components
include all of the world’s biggest and best gold miners. Right
after every quarterly earnings season, I do a deep fundamental dive
into the elite GDX gold miners’ results. The
latest covering
Q2’20 was done in mid-August.
Using conventional TTM P/Es, plenty of massive gold miners were
quite cheap. Newmont and Barrick Gold are GDX’s biggest and
dominant components, which then commanded 13.0% and 12.1% of this
ETF’s total weighting! As that last-reported earnings season
wrapped up, they were trading at only 14.3x and 16.1x earnings.
This week their valuations are even lower at 12.8x and 10.9x, making
for big bargains.
Another major gold miner Kinross Gold sported a similar 13.2x P/E
then, which has contracted to 12.0x now due to the subsequent
gold-stock correction. There’s lots of undervaluation in the major
gold stocks per normal price-to-earnings multiples. But given the
gold-mining industry’s unique nature of profits being almost totally
dependent on prevailing gold prices, other proxies better reflect
gold-miner valuation levels.
One
I’ve long used in my detailed quarterly analyses of gold-stock
fundamentals compares average gold prices with miners’ average
costs. In Q2’20 for example, the top 25 GDX gold miners reported
average all-in sustaining costs of $984 per ounce. That’s what it
cost them to both produce gold and replace that depletion. Deposits
are expanded into new areas of gold-bearing ores to ensure gold
output is sustainable.
Gold
itself averaged a lofty $1714 per ounce in Q2, implying that sector
profitability was running way up at $730 per ounce! That soared a
stupendous 66.2% year-over-year from Q2’19’s $439, which resulted
from much-lower $1309 average gold prices and $870 average AISCs.
Gold-miner earnings leveraged gold’s 30.9% YoY gains by 2.1x, right
in their normal historical range of 2x to 3x. Gold prices
drive profitability.
And
all gold-stock speculators and investors should be super-excited for
the major gold miners’ upcoming Q3’20 results. These all-important
fundamental reports are generally released between 3 to 6 weeks
after quarter-ends. So I can’t wait to dig into this latest quarter
in mid-November, as it is looking utterly spectacular. Gold
averaged a dazzling record $1912 in this just-finished Q3, soaring
11.6% quarter-on-quarter!
Average all-in sustaining costs are likely to decline, as
Q2’s were artificially-high due to all the disruptions from national
lockdowns to slow the spread of COVID-19. Gold-mining operations
were largely spun back up in late Q2 and early Q3. And the better
mines’ production, the more ounces to spread their big fixed costs
across. Thus increased gold output lowers AISCs, so Q3’s should
retreat considerably from Q2’s high.
In
Q3’19, the major GDX gold miners averaged $883 AISCs. Over the past
four reported quarters ending in Q2’20, they averaged $933. So
that’s as good of estimate as any for the upcoming Q3’20 results.
That implies the gold miners earned an epic $979 per ounce
last quarter! If proven true, gold-stock earnings yet again
rocketed up 65.7% YoY. No other sector in the stock markets can
rival such incredible profits growth.
Rising earnings naturally lower valuations. So once these
Q3’20 numbers drop into the rolling totals from the latest four
reported quarters, gold-stock P/E ratios will sink even farther.
Unless prevailing gold-stock prices stage a dramatic rebound before
mid-November, some major gold miners will see their TTM P/Es plunge
into the single digits! That is deeply undervalued by any standard,
and incredibly cheap for gold stocks.
Wading through dozens of gold miners’ quarterly results, and
building big spreadsheets to analyze them over time, is challenging
and tedious. And they can only be updated four times a year, which
is a pretty-low-resolution read on gold-miner valuations. But
there’s a great gold-stock-valuation proxy available in real-time.
And it really helps traders better game gold-stock uplegs and
corrections to time buying and selling.
It
simply looks at the ratio between prevailing gold-stock and gold
price levels. While there are various permutations, the
most-relevant one today is the GDX/GLD Ratio. This GGR divides the
daily close of that leading GDX gold-stock ETF by the daily close of
the dominant GLD SPDR Gold Shares gold ETF. When charted and
analyzed over time, this ratio reveals whether gold stocks are
relatively cheap or expensive.
This
GGR chart encompasses gold stocks’ entire secular bull since
mid-January 2016. Between then and this sector’s latest interim
peak in early August, GDX has soared 256.7% higher over 4.5 years.
That amplified gold’s 87.7% gain in that same span by 2.9x, yet
again confirming the major gold stocks’ great leverage to gold of 2x
to 3x. Despite low gold-stock valuations, the GGR suggests their
correction isn’t over yet.
 
While gold-miner valuations are undoubtedly very low, this GDX/GLD
Ratio proxy for them indicates they are likely to head lower
still. The GGR illuminates the swings in gold-stock valuations
driven by their bull markets’ normal upleg-correction cycles.
Gold-stock valuations relative to gold naturally rise in uplegs,
then retreat in the inevitable subsequent corrections to rebalance
sentiment. So tracking the GGR is essential.
GDX’s last major upleg that climaxed in early August was a monster,
rocketing 134.1% higher in just 4.8 months after mid-March’s
COVID-19-lockdown-fueled stock panic. That upleg was born in
extreme gold-stock undervaluations relative to gold driven by that
epic maelstrom of fear. When GDX bottomed in mid-March at just
$19.00, the GGR had collapsed to just 0.133x! That was a brutal
4.1-year low in this metric.
In
other words, GDX’s share price was trading at only 13.3% of GLD’s
share price. Gold-stock prices hadn’t been lower compared to gold
prices since early February 2016 right after this gold-stock bull
was born! And massive mean reversions higher erupt out of
extreme anomalous lows in the tight relationship between gold-stock
and gold price levels. I wrote about this extensively during and
just after that stock panic.
In
my March 20th essay on
mid-tier gold
miners’ fundamentals when GDX was still way down at $20.55, I
concluded at that time, “after
this insane COVID-19 stock panic crashed this sector, these stocks
are trading at some of their steepest discounts to current
fundamentals ever! That gives them epic potential to mean revert
radically higher as fear fades and gold recovers, yielding huge
gains to early contrarians.”
We backed up the
truck to aggressively deploy capital around those super-cheap and
unsustainable lows, buying and recommending dozens of
fundamentally-superior gold-stock and silver-stock trades to our
newsletter subscribers who keep us in business. Those blossomed
into
massive realized gains
as this latest gold-stock upleg matured, averaging over +80%
absolute and +300% annualized when stopped out!
This is relevant
today because gold-stock valuations per this GGR proxy were one of
the screaming buy signals triggered by that stock panic. At a scary
time when most gold-stock traders were selling low to flee this
burning sector, gold stocks were so radically undervalued relative
to gold that huge fast mean-reversion gains were very likely. This
same fantastic timing tool is now warning
gold stocks’
correction isn’t over.
Ahead of GDX
cresting at $44.48 in early August, the GGR surged to a 4.0-year
high of 0.241x. This gold-stock ETF was trading at 24.1% the price
of the leading gold ETF. That level was very interesting because it
was right where this gold-stock bull’s mighty maiden upleg failed in
early August 2016. With huge gains of 151.2% even besting this
latest upleg’s 134.1%, a correction was necessary to rebalance
sentiment.
Bull-market uplegs
in both gold stocks and gold require big capital inflows. As long
as growing ranks of traders are actively deploying increasing
amounts of money bidding the precious metals higher, uplegs can
persist. But eventually their fast gains get so large that everyone
interested in buying in anytime soon is already in. That peak greed
marks upleg toppings, when near-term buying
is exhausted
leaving sellers in charge.
In August 2016
that point when major uplegs inevitably have to fail into
rebalancing corrections hit as the GGR stretched to 0.244x. August
2020’s 0.241x peak GGR was right in line with that. With the gold
stocks relatively high compared to gold after soaring in a massive
upleg, they really needed to sell off to eradicate all the excessive
greed at that major upleg topping. And that has indeed been
happening since.
A month ago I
wrote an essay on gold stocks
being in
correction mode, focusing on their lingering really-overbought
technicals. I won’t rehash that still-valid analysis here, but
looking at this sector instead
from a valuation
angle
arrives at that same conclusion. At worst since early August, GDX
has retreated 15.4% as of late September. That dragged the GGR as
low as 0.215x, right about where it still traded this week at
0.216x.
The problem is
these GGR levels aren’t low enough, and haven’t fallen far enough,
to flag the likely end of this healthy correction. Today’s
correction is the fourth of gold stocks’ secular bull. During their
first three corrections following uplegs, the GGR retreated an
average of 0.065x to bottom at an average of 0.155x. So far in our
current correction, this GGR valuation proxy has only slid 0.026x to
that 0.215x level.
So based on
bull-to-date precedent, only about 40% of the expected gold-stock
correction has happened compared to prevailing gold prices. And the
GGR itself is still 39% above the tight average levels that marked
correction bottoms birthing new uplegs earlier in this bull. Even
if the GGR doesn’t retreat all the way back to 0.155x, it still
needs to head much lower before the last upleg’s residual greed is
vanquished.
Over time this
GDX/GLD Ratio
forms tradable trends,
with gold-stock valuations relative to gold moving in sustained
patterns. Since the deep gold-stock lows of September 2018, the GGR
has been meandering higher on balance with the big exception of this
year’s extreme stock-panic anomaly. The support line for that
gold-stock-valuation uptrend is running just over 0.190x now.
Another interesting level converges there.
Since gold stocks
are so incredibly volatile, their bull and bear markets are often
considered based on gold’s own. During the 4.8 years today’s
secular gold bull has run, the GGR has averaged 0.190x. After this
gold-stock bull’s second-largest upleg that enjoyed big and fast
134.1% gains, it’s hard to imagine the GGR not at least reverting
back to that mean. The GGR revisiting 0.190x will be a
more-favorable time to buy.
Because we humans
aren’t very good at parsing small decimals, gold-stock valuations
falling from 0.216x to 0.190x in GGR terms doesn’t sound like much.
But it could mean
considerably more
downside
before this correction gives up its ghost. The major gold stocks’
2x-to-3x leverage to gold is a double-edged sword, working in both
directions. So weaker gold prices forcing GLD lower will exacerbate
this GDX selloff.
A few weeks ago I
wrote an essay on
gold’s own correction, which certainly wasn’t over due to
festering overboughtness since its own parabolic early-August peak.
That analysis revealed gold would likely have to correct back down
to its 200-day moving average. While this critical technical
support zone for bull-market corrections continues to rise, this
week it is still way down near $1735. That’s
another 8.1%
lower!
Expressed in
GLD-share-price terms, a 200dma approach implies $163.18. Applying
that 0.190x GGR multiple to that yields a GDX-share-price downside
target of $31.00. While still relatively high by this gold-stock
bull’s standards, that is still
another 19.2%
lower
from this week’s levels! So even if the major gold stocks bottom at
higher valuations compared to gold, they could still have
considerable selling to go.
Interestingly this
correction scenario would extend GDX’s total selloff to 30.3%. That
is more in line with this bull’s correction precedent averaging
36.5% losses. At any rate, buying gold stocks today won’t be
prudent if they have another 10%-to-20% downside left in this
correction. Patient gold-stock traders who watch valuations should
have plenty of opportunities to add positions
at lower prices
in the near future.
As I discussed in
another essay a couple weeks ago, the gold stocks are now in their
biggest seasonal
selloff of the year. That could exacerbate and compress their
necessary correction over the next few weeks or so. This gold-stock
selloff needs to run until greed and euphoria are eradicated. And
plenty of these topping emotions lingered after gold stocks peaked,
because they consolidated high for weeks after that.
But while this
immediate GGR outlook is short-term bearish for gold stocks, from a
longer perspective these valuation-proxy levels
are wildly bullish
for the gold miners! As secular bulls mature making both
speculators and investors more comfortable with holding gold stocks,
their price levels relative to gold climb on balance. So we can
expect this GDX/GLD Ratio to continue rising way above this bull’s
precedent.
The last secular
gold-stock bull peaked when GDX hit $66.63 in September 2011.
During the two years leading up to that climax, the GGR averaged
0.419x. That implies much-higher gold-stock prices are probable in
coming years as more bull-market uplegs march higher. Imagine gold
at $2250, a lowballed conservative outlook just 19.2% above this
week’s levels. In GLD terms that works out to roughly $211.
At that 0.419x
late-bull-average GGR, $211 GLD would catapult GDX up over $88 per
share! That’s 131% higher than this week’s levels. So if you can
weather a 30%ish correction psychologically, and be brave enough to
buy back in low when most others are too scared to, you should be
able to ride the major gold stocks’
third
doubling-plus upleg
of this bull. From a longer perspective, gold-stock valuations are
cheap.
The key to
multiplying your wealth in gold stocks is to trade with bull
markets’ inevitable upleg-correction cycles instead of fighting
them. Buy relatively low late in corrections, then sell relatively
high late in uplegs! GGR levels help flag both key conditions.
When considered along with other technical measures of oversoldness
and overboughtness, this gold-stock valuation proxy is an excellent
buy-sell timing tool.
At
Zeal we started aggressively buying and recommending
fundamentally-superior gold and silver miners in our
weekly and
monthly
subscription newsletters back in mid-March right after the
stock-panic lows. We layered into dozens of new positions before
gold stocks grew too overbought, which were stopped out recently at
huge realized gains running as high as +199%! Our subscribers
multiplied their wealth within months.
To
profitably trade high-potential gold stocks, you need to stay
informed about their technicals, sentiment, and fundamentals. And
what is moving gold, their dominant primary driver. Our popular
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Corrections are the time to do your gold-stock homework, preparing
to redeploy as they pass.
The
bottom line is gold-stock valuations remain low. These companies
are earning profits hand over fist with such high prevailing gold
prices, forcing down their conventional valuations. Huge
stock-price gains in future uplegs are fully justified by the epic
profits growth this contrarian sector is achieving. But before this
gold-stock bull’s next major upleg, real-time gold-stock valuation
proxies suggest this correction isn’t over yet.
Since their last monster upleg peaked in early August, the gold
stocks still haven’t retreated far enough to rebalance sentiment.
The leading gold-stock ETF hasn’t given up enough ground relative to
prevailing gold prices to signal a high-probability
correction-bottoming. Short-term valuation analysis implies major
gold stocks still have another 10%-to-20% downside to go before
their next big bull upleg can get underway. | 
