The
gold miners’ stocks suffered a rare capitulation selloff over the
past month or so. Selling cascaded to extremes as stop losses were
sequentially triggered, battering this contrarian sector to
exceedingly-low levels. While very challenging psychologically,
capitulations are super-bullish. They rapidly exhaust all near-term
selling potential, leaving gold stocks wildly oversold and
undervalued which births major new uplegs.
Capitulations are quite rare which makes them inherently
unpredictable. The vast majority of selloffs end normally well
before they snowball into capitulation-grade plummets. But very
seldomly heavy selling just continues to intensify rather than abate
like usual. The word capitulation means “the act of surrendering or
giving up”. That’s exactly what happens in these extraordinary
selling events, traders stampede for the exits.
Exceptionally-bearish sentiment definitely plays a major role in
capitulations. As serious selling mounts, the resulting technical
carnage leaves speculators and investors alike incredibly
disheartened. The pain is so great that all but the most-hardened
contrarians give up and sell low. But forced selling is
equally if not more important in fueling capitulations. That likely
played a bigger role than sentiment over this past month.
All
prudent traders protect their capital deployed in stocks with
stop-loss orders. They are essential in a sector as super-volatile
as gold stocks, as significant-to-serious individual-company and
sector-wide risks always lurk. Stop losses are typically set loose
enough to weather any normal volatility. But when selling grows
severe, stock prices are bashed low enough to trigger stops
unleashing a vicious circle of selling.
The
lower stock prices fall, the more stop-loss orders are tripped.
That adds to the selling pressure and pushes prices lower still,
hitting even more stops. So even the most-rational traders grounded
so deeply in fundamentals that nothing scares them contributed to
the capitulation plunge via mechanical stop-loss selling. We are in
that camp, suffering quite a few stoppings in our trades despite no
emotional distress.
The
resulting cascading technical carnage was extreme by any measure.
This first chart is updated from my early-June essay on
gold’s summer
doldrums. It shows how gold stocks have behaved in summers of
all modern bull-market years as rendered by their flagship HUI NYSE
Arca Gold BUGS Index. Every year is individually indexed to 100 as
of May’s final close, with all gold-stock action recast off that
common base.
This
approach leaves gold stocks’ summer trading perfectly comparable in
percentage terms regardless of prevailing gold-stock price levels.
The yellow lines show how the HUI performed in the summers from 2001
to 2012 and 2016 to 2017. They are all averaged together in the red
line, which reveals this sector’s normal summer tendencies.
Typically gold stocks are flat to weaker until late July, then start
rallying again.
But
the recent extreme capitulation anomaly made the summer of 2018
one of the worst on record for the gold stocks, as the blue line
divulges. Gold stocks usually have a center-mass drift in market
summers running +/-10% from May’s final close. But at worst in
mid-August, the gold stocks had plummeted a nauseating 22.8%
summer-to-date! That was way beyond even the weak seasonal norms of
market summers.
So
realize there was nothing normal or foreseeable about gold stocks’
recent brutal plunge, everything about it was exceptional.
Again very few selloffs keep on cascading into
full-blown-capitulation territory. When such events rarely and
surprisingly arise, all speculators and investors can do is hunker
down and ride them out. Understanding what odd confluence of events
fueled them clarifies what is likely coming next.
This
next chart shifts to the leading GDX VanEck Vectors Gold Miners ETF,
the most-popular gold-stock investment vehicle. Gold miners’ stocks
are ultimately leveraged plays on the gold price, which directly
drives their profits. Gold itself actually remains in a bull market
birthed in mid-December 2015, so the gold stocks are too still
considered to be in bull-market mode despite this recent extreme
capitulation anomaly.
After hitting a
fundamentally-absurd all-time low in GDX terms in January 2016,
gold stocks skyrocketed in a powerful new bull. GDX soared 151.2%
higher in just 6.4 months, driven by a parallel 29.9% new gold
bull! Then a normal and healthy bull-market correction from those
resulting wildly-overbought levels was greatly exacerbated. After
Trump won the presidency, stock markets surged dramatically which
hit gold hard.
Gold
is the ultimate contrarian investment, tending to rally when stock
markets weaken. When stocks are powering to seemingly-endless new
record highs, gold investment demand really wanes. Thus gold and
the stocks of its miners were trapped in long consolidations as
stock markets surged over the past couple years or so. GDX settled
into a meandering consolidation basing trend between $21 support to
$25 resistance.
That
held rock-solid from late December 2016 to early August 2018, a long
19.3-month span. Before this recent extreme capitulation anomaly,
GDX’s key $21 support was challenged no less than 5 times in that
timeframe. It held every single time, soon bouncing gold
stocks back up higher into their consolidation trend channel. These
long-term pre-capitulation technicals offered little warning of an
impending breakdown.
While gold stocks had carved lower highs in the first half of 2018,
that had happened before in the first half of 2017. Yet out of
their summer-doldrums lows that July, gold stocks surged
dramatically in their
usual autumn
rally which drove GDX above its $25 resistance. Pretty much
everyone was bearish on gold stocks leading into August 2018, but
that’s normal when they’re low in their trend during market summers.
So
there was nothing unusual technically or sentimentally leading into
gold stocks’ latest capitulation plummeting. I’ve intensely studied
and actively traded this sector for decades now, and still can’t
find any way to divine when normal selling will suddenly snowball
into capitulation-grade selling. I sure wish these exceedingly-rare
events were predictable, but the sad truth is they’re not.
Capitulations are incredibly anomalous.
But
they can definitely be understood after the fact. The gold stocks
were actually faring reasonably well for most of this past summer.
GDX and the HUI entered June at $22.34 and 180.1, relatively-low
levels reflecting the bearish sentiment plaguing gold stocks. In
mid-June then early-July, they closed as high as $22.66 and 182.2
then $22.68 and 179.7. Gold stocks were flat in the middle
of their consolidation basing trend.
Gold
itself peaked at $1302 in mid-June, faring really well for the early
summer doldrums. But then out of the blue selling ignited. Gold
price action is dominated by gold-futures speculators, which
use extreme leverage to wield outsized influence. On June 14th the
European Central Bank announced it would finally wind down its
massive
quantitative-easing campaign at year-end. That oddly hammered
the euro 1.8% lower.
While ending QE money printing was inarguably hawkish, the ECB tried
to mitigate that blow by tapering a final time and promising no rate
hikes before the summer of 2019. The latter was a surprise. As the
euro accounts for over 4/7ths of the US Dollar Index’s weight, the
dollar surged on that falling euro. Overnight gold-futures
speculators sold aggressively on the strong dollar, hammering gold
1.7% lower the next day.
That
unleashed the events that would ultimately snowball into the
gold-stock capitulation over the next couple months or so. The
rallying US dollar spawned extreme short selling in gold
futures, which forced gold lower. The falling gold prices combined
with strong stock markets motivated investors to flee as well. This
pressured the world’s leading gold ETFs led by GLD to spew much
physical gold bullion into the markets.
That
bashed gold prices lower still, leading gold-futures speculators to
press their advantage with even more short selling. The more they
sold short, the more gold fell. The more gold fell, the more they
sold short. This culminated in speculators’ gold-futures short
positions soaring to record extremes far beyond anything ever
witnessed before! My essay last week
explained all
this in depth, it’s critical to understand.
With
spec gold-futures shorts skyrocketing and investors hemorrhaging
gold in sympathy, the gold stocks remained surprisingly resilient.
During the first 5 weeks of this epic gold selling leading into late
July, gold plunged 6.1% from $1302 to $1223. Normally gold stocks
leverage gold’s downside by 2x to 3x, but GDX and the HUI only slid
4.8% and 6.3% in that span! Such relative strength certainly didn’t
herald a capitulation.
I
suspect the main reason gold stocks weren’t down a normal 12% to 18%
by then was most of the weak hands had long since exited this
battered sector. Only the hardened contrarians remained, and they
rightfully weren’t worried about $1225 gold. Why? GDX’s major gold
miners were reporting their Q2’18 all-in sustaining costs, which
would eventually average just
$856 per ounce.
$1225 remained very profitable.
But
gold kept drifting lower still into late July as already-record-high
spec gold-futures shorts ballooned even higher. On August’s opening
trading day, gold fell 0.6% to $1216 which was a fresh year-to-date
low. August is normally gold’s
4th-best month
of the year seasonally, enjoying big average gains of 2.2% in modern
bull-market years! That mounting disconnect drove GDX and the HUI
lower to $21.11 and 164.5.
That
was right at GDX’s major $21 support line that had held strong for
over a year and a half, do-or-die time technically. Complicating
matters, GDX and the HUI were down 5.5% and 8.7% summer-to-date at
that point. The major gold miners’ stocks were nearing levels
where tight stop losses were set. Since this sector is so
darned volatile, I’d define tight to loose as 10% to 25% trailing.
Tight stops were within range.
Sectors always look terrible technically and feel miserable
sentimentally when they slide down near their major support zones.
So even into the first week of August there was no indication of an
impending rare extreme capitulation plummeting. GDX was stabilizing
right around $21, despite gold drifting a bit lower. It closed
between $1208 to $1213 in August’s initial few trading days, and
gold stocks largely held steady.
Considering the epic record-extreme gold-futures short selling and
heavy
differential-GLD-share selling, gold was holding up impressively
well. As of August’s first Friday, gold had fallen 6.8% since
mid-June on roughly 111.0k contracts of spec gold-futures shorting
and a 4.1% GLD draw. Those were the equivalent of 345.3 and 33.9
metric tons of selling respectively! GDX and the HUI had only lost
6.6% and 9.6% in that span.
Again that was relatively light compared to gold, with gold stocks
leveraging its fairly-big summer-to-date losses by just 1.0x and
1.4x. With all the information available even at that point, there
was no reason to expect an extreme capitulation anomaly. Technicals
and sentiment were on a precarious edge, but that’s the way they
always look at major support approaches. They finally
started to give way Monday August 6th.
Gold
fell another 0.5% to $1207 that day on speculators continuing to
short sell gold futures. That must have been when tight stop losses
started to trigger, as GDX and the HUI both fell 1.2% that day.
Despite gold bouncing 0.3% the next, those gold-stock losses
accelerated with 1.1% and 1.7% follow-on drops. That pushed GDX
decisively under its strong $21 support for the first time,
meaning more than 1% below.
But
even after that sharp lurch lower, gold and the gold stocks again
stabilized for the next several trading days. While the
capitulation had started in hindsight, even as late as Friday the
10th it was impossible to discern in real-time. Unfortunately it
would hit with full force overnight the following Sunday, the dam of
stop losses breaking as heavy selling triggered them in rapid
succession. The catalytic spark was quite odd.
The
USDX had surged strongly in early August because of a mounting
emerging-market-currency crisis led by Turkey. Month-to-date by
Monday the 13th, the Turkish lira had cratered by nearly half!
Turkey’s central bank was getting desperate, so at 1am EDT it
released a statement promising it would “take all necessary
measures” to defend the lira. Among other things, it said it was
ready to release $3b worth of gold.
At
$1209 that would represent 77.2t, a big slug of gold to hit markets
fast. It wasn’t clear whether that central bank actually sold any
gold or not, but within minutes heavy futures selling slammed
gold. It plunged 1.5% to $1193 that Monday, breaking below $1200
for the first time since mid-March 2017. That is important
technical and psychological support for gold, so seeing it falter
unleashed serious gold-stock selling.
That
day GDX and the HUI plunged 2.8% and 3.4% on stop losses being
triggered. That continued the next despite a slight gold bounce,
with additional 1.1% and 1.3% losses. Then on Wednesday the 15th at
peak vulnerability, another 1.5% gold selloff on speculators’
extreme gold-futures shorting hammered it down to a 19.3-month low
of $1176. GDX and the HUI plummeted another 5.9% and 6.1% that
brutal day!
That
extreme largely-mechanical forced selling persisted another
day as well with further 2.4% and 3.0% losses. In just 4 trading
days, GDX and the HUI had collapsed 11.7% and 13.1%! That was a
full-blown capitulation by any definition. The gold stocks hadn’t
been lower since early February 2016. And down a catastrophic 18.7%
and 22.8% summer-to-date, the great majority of stops had been
triggered and executed.
Capitulation climaxes mark major, major bottoms because those
extreme anomalous selloffs suck in and exhaust all available
near-term selling. And that looked like the end of it since gold
and its miners’ stocks all enjoyed solid bounces over the next 4
trading days. The radically-oversold gold stocks soared 5.0% in
both GDX and HUI terms in that span! Contrarian traders were
increasingly redeploying stopped capital.
That
really should’ve capped the capitulation, but unbelievably in late
August and early September something of an echo capitulation
erupted. Gold once again slid under $1200 on specs adding even more
shorts to their already-crazy-extreme pile. So over 7 trading days
straddling the start of this month, GDX and the HUI plummeted
another 7.3% and 8.4% to insane deep new capitulation lows of $17.61
and 134.0!
Some
of this was newly-deployed gold-stock trades in the heart of
mid-August’s original capitulation getting stopped out again. That
would mostly be the tight stops too restrictive for this
super-volatile sector. With bearishness off the charts after that
first capitulation plummet, there were virtually no buyers in this
echo one. So any selling in individual gold miners on bad news
mushroomed unchecked, it was a bloodbath.
This
extreme capitulation anomaly left gold stocks radically oversold and
wildly undervalued, poised for a massive mean-reversion rally
higher. Symmetrical V-bounces are common after
capitulations, making them among the best-possible times to back up
the truck and buy low. Trading at miserable 2.6-year lows, these
fire-sale gold-stock prices weren’t fundamentally-righteous. Their
operations remained very profitable.
At
the major GDX gold miners’ average all-in sustaining costs of $856
per ounce in Q2, they were still collectively earning strong profits
of $339 per ounce at $1195 gold! These are hefty 28% margins that
most industries would kill for. Yet gold stocks were priced as if
they were spiraling into bankruptcy, it was crazy. The major gold
miners’ Q2’18
fundamentals were quite strong, so super-low stock prices
aren’t righteous.
A
great fundamental proxy for gold-stock price levels relative to
prevailing gold prices is the HUI/Gold Ratio. It distills down the
core relationship between gold prices, gold-mining profitability,
and gold-stock prices. Thanks to the stunning capitulation selloffs
over this past month, the gold stocks are now almost as undervalued
relative to gold as they’ve ever been. This week the HGR
plunged down to just 0.112x!
That’s way below the 0.207x seen at worst in late 2008’s
first-in-a-century stock panic, the most-extreme fear event of our
lifetimes. After that extreme sentiment anomaly that wasn’t
justified fundamentally, the gold stocks more than quadrupled.
Over the next 2.9 years GDX and the HUI skyrocketed 307.0% and
319.0% higher! Extreme lows in gold-stock prices relative to gold
simply aren’t sustainable fundamentally.
The
all-time-low in the HGR of 0.093x was last seen in mid-January
2016. That’s actually not much lower than today’s crazy levels.
Gold stocks again soared out of that extreme anomaly, with GDX and
the HUI enjoying huge gains of 151.2% and 182.2% in just over a
half-year! Once again today we are faced with an extreme situation
that can’t last forever. Gold stocks must and will mean revert
dramatically higher.
And
their potential upside from extreme capitulation lows is huge. From
2009 to 2012 after that stock panic, the HGR averaged 0.346x in
those last normal years before the
Fed’s QE3
levitated the US stock markets. Assuming gold stays around
$1200, that implies gold stocks ought to mean revert far higher to
around 415 in HUI terms. That’s a triple from here, and
conservatively assumes no overshoot or gold rally.
Mean
reversions out of extreme lows seldom stop at the averages, but
surge on towards the opposite extreme. That implies a
much-higher HGR the next time gold stocks are really back in
favor. And gold is heading way higher too on the proportional
extreme
gold-futures short covering inevitable after the epic record
shorts that fueled the recent gold plunge. Higher gold prices make
for much-greater gold-stock upside.
There’s no sector in the world more hated and thus more undervalued
than gold stocks today. Yet they just like all stocks must
ultimately trade at reasonable multiples of their underlying
earnings. When gold starts powering higher consistently again,
likely on long-overdue
stock-market
weakness, the gold stocks will start returning to favor. Their
prices will rapidly regain ground relative to gold as investment
floods back in.
While it’s hard to buy low after a capitulation when bearishness is
suffocating, that’s when fortunes are won. The gold stocks are a
coiled spring ready to explode higher again after years of neglect,
probably the best contrarian investment in all the markets. While
inherently-unpredictable capitulations are very hard to weather
psychologically, their aftermaths are exceedingly bullish
since stock prices get dragged so low.
While investors
and speculators alike can certainly play gold stocks’ coming mean
reversion with the major ETFs like GDX, the best gains by far will
be won in individual gold stocks with superior fundamentals. Their
upside will far exceed the ETFs, which are burdened by
over-diversification and underperforming stocks. A
carefully-handpicked portfolio of elite gold and silver miners will
generate much-greater wealth creation.
At Zeal we’ve
literally spent tens of thousands of hours researching
individual gold stocks and markets, so we can better decide what to
trade and when. As of the end of Q2, this has resulted in 1012
stock trades recommended in real-time to our newsletter subscribers
since 2001. Fighting the crowd to buy low and sell high is very
profitable, as all these trades averaged stellar annualized realized
gains of +19.3%!
The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, before undervalued gold stocks
soar much higher. An easy way to keep abreast is through our
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contrarians!
The
bottom line is gold stocks just suffered a brutal capitulation
selloff. These extreme anomalies are very rare and inherently
unpredictable. Epic record gold-futures short selling pushed gold
low enough to unleash cascading forced stop-loss selling in the gold
stocks, pummeling them to deep lows. But these resulting gold-stock
prices are radically-oversold and wildly-undervalued, certainly not
justified fundamentally.
While very challenging psychologically, the aftermath of
capitulations is exceedingly bullish. They suck in all available
near-term selling, leaving nothing but buyers to propel sharp
mean-reversion rebounds. The technicals and sentiment spawned by
capitulations are so extreme they usually birth massive uplegs and
entire bull markets. Contrarians willing to deploy capital when few
others will can earn fortunes out of such lows. | 
