The left-for-dead
gold stocks have rallied dramatically this past week, surging to a
major breakout. This pivotal technical event reveals the
hyper-bearish psychology plaguing this sector in recent months is
dissipating, paving the way for investment capital to return. And
given the fundamentally-absurd price levels in this battered sector,
this new gold-stock buying is likely just the initial vanguard of a
massive new upleg.
Even among
contrarians, the overwhelming consensus view is that gold miners?
stocks are doomed to grind lower indefinitely. Pretty much everyone
even aware of this obscure sector totally despises it, the
inevitable result of recent years? dismal price action. The
flagship gold-stock index, the NYSE Arca Gold BUGS Index better
known by its symbol HUI, certainly reflects the unbelievable misery
in this business.
Over 4.0 years
between September 2011 and September 2015, the HUI plunged 83.5% in
a bear market of apocalyptic magnitude! This incredibly-large bear
excelled in annihilating all interest in this sector. Almost
everyone capitulated, scared away by the brutal mauling. Adding
insult to injury, the benchmark S&P 500 general-stock-market index
soared 63.5% over this same span. Gold stocks have been dreadful.
But as long as
these companies can profitably mine gold, their stocks aren?t going
to zero. And since markets are forever cyclical, at some
point gold stocks are absolutely going to reverse from secular bear
back to secular bull again. And there?s a good chance this past
week?s amazing technical events marked that transition. If this
indeed proves to be true, the coming gains to be won in this sector
will be legendary.
The gold miners
are an exceptionally-volatile sector that not only suffers big
bears, but enjoys enormous bulls. In the 10.8 years between
November 2000 and September 2011, the HUI skyrocketed an utterly
astounding 1664.4% higher! Multiplying your wealth by nearly 18x
in a single decade is a life-changing legacy-creating event. And
during that span, mainstream investors endured a 14.2% loss in the
S&P 500.
So if the
long-overdue next gold-stock secular bull market is indeed getting
underway, the opportunity for early contrarians to earn fortunes is
vast beyond belief. While it is gold stocks? ludicrously-cheap
fundamentals resulting from epically bearish sentiment that make
them so compelling, this past week?s major breakout is the
potential new-bull confirmation signal. So let?s look at
technicals first, then fundamentals.
While the HUI is
the premier gold-stock index, this sector?s dominant trading vehicle
watched by investors and speculators is the GDX Market Vectors Gold
Miners ETF. While it?s only been around since May 2006, GDX is a
fine sector benchmark that
nearly perfectly
mirrors the HUI. So let?s consider this past week?s phenomenal
price action in GDX terms before we dive into the fundamentals of
why it?s justified.
This chart looks
at the gold-stock price action over the past year or so, and the
majority wasn?t bearish. From November to May, the gold
stocks were actually rallying on balance. Their latest woes didn?t
begin until June, when these stocks suffered an anomalous breakdown
relative to gold. The dominant driver of gold-mining profits is the
price of gold, so gold-stock prices usually amplify gold?s moves in
lockstep.
And gold did
weaken in June, retreating 1.5%. Since the stocks of the major gold
miners that dominate the weightings in both GDX and the HUI tend to
leverage gold by 2x or so, that should have pushed these benchmarks
down about 3.0%. But with investors and speculators irrationally
scared and fed up with this sector, GDX lost a
wildly-disproportionate 9.3% that month! That inflamed
already-bearish psychology.
But interestingly,
the entire gold-driven precious-metals complex has always tended to
be weak during the market summer of June, July, and August. This is
the weakest time of the year
seasonally for
gold, with no outsized demand spikes coming from global
income-cycle and cultural drivers. That has created the
PM summer doldrums,
where gold, silver, and the stocks of their miners usually drift
sideways to lower.
That typical
seasonal weakness and associated bearish psychology was greatly
amplified this year as gold stocks? important 7-month-old uptrend
support line decisively failed. So most traders capitulated and
fled, a decision that surprisingly proved wise. July would witness
the most extreme gold-futures shorting attack on record, a
concerted effort by a large speculator to run long-side stops by
crushing gold at an odd hour.
That event is
exceedingly important to understand. It proves that gold?s recent
new lows were totally artificial, they had nothing at all to
do with normal supply and demand. In a nutshell, late on a lazy
Sunday evening in July a speculator sold short a jaw-dropping
24k gold-futures contracts in a single minute! The only
purpose of such a huge, instant short sale outside of normal trading
hours is outright price manipulation.
Gold plummeted $48
in that minute to $1086 on this selling, a major new 5.3-year
secular low. And that sparked the extreme gold-stock plummet to
fundamentally-absurd lows in July. Back in early August I wrote
a whole essay
detailing this extreme gold-futures shorting attack. You can?t
understand why gold stocks are so low, and such an epic buying
opportunity, if you don?t understand what triggered these lows.
During the two
trading days straddling this gold attack, the metal plunged 4.1%.
But with sentiment in the ravaged gold miners already so miserable,
traders again rushed to exit. GDX plummeted 14.7% over that span,
again wildly disproportionate to gold?s own losses! A super-bearish
technical pattern in gold-stock prices was forming known as a
descending triangle, which is highlighted in this chart in blue.
Gold stocks were
merely able to bounce back up to a rapidly-dropping upper resistance
line before they were forcefully repelled lower again. No matter
how strong the gold-stock buying, including early August?s sharp
surge, this descending triangle?s resistance proved a graveyard in
the sky. The fact that GDX?s key 50-day moving average paralleled
this resistance really bolstered it. Gold stocks were hopelessly
trapped.
But in order to
carve a descending triangle, prices also have to hold near a
horizontal lower support line. And that?s exactly what happened in
recent months. While GDX couldn?t break out to the upside, it also
didn?t fail to the downside. This leading gold-stock ETF?s
all-time record low in early August essentially held strong.
This confounded the legions of bears calling for gold stocks to keep
on plunging deeper.
The gold stocks?
descending triangle was coiling prices tighter and tighter. And
this price formation is very bearish, as the
highest-probability outcome by far is indeed a steep break to the
downside once the triangle?s right-side apex is hit. Read any
textbook on technical analysis, and it will say that descending
triangles are warning signs of imminent major downside. This led to
exploding gold-stock short selling.
But looking at
technical price action in isolation without considering sentiment
and fundamentals isn?t prudent. Obviously gold-stock bearishness
was extreme beyond belief as prices were crushed lower and lower in
recent months. And sentiment extremes are finite and inherently
self-limiting. Once all the traders who want to sell low have
already sold, that leaves only buyers which portends a sharp rebound
rally.
Though GDX?s
history only extends to its birth in May 2006, the HUI index?s goes
back a decade earlier to March 1996. So the all-time low in GDX
terms in early August was accompanied by a 13.0-year low in HUI
terms. The last time the gold stocks had traded at those extreme
prices was way back in July 2002. The crazy part was gold
was meandering around just $305 then, and had yet to exceed $329 in
its young bull!
To see gold stocks
priced as if gold was around $300 when it was actually near
$1100 was ludicrous, it had to be an extreme anomaly spawned by
extreme and unsustainable fear. So I took the lonely contrarian
side on gold-stock prices in recent months. Rather than seeing the
typical high-odds descending-triangle break to the downside, I
advised our newsletter subscribers to game a major upside
breakout.
Provocatively the
bears tried to rely on a fundamental argument to bolster their
keep-on-shorting-super-low-gold-stocks case. They claimed over and
over again that the costs for mining gold in this industry centered
around $1200. Therefore with gold well under $1200, this sector
couldn?t generate positive cashflows or profits. Soon nearly
everyone believed them, that sub-$1200 gold simply wasn?t
survivable.
But after
intensively studying and actively trading gold stocks for over 15
years, that number didn?t make any sense to me. It didn?t jibe with
any of the deep fundamental research we do. So in mid-August as
gold-stocks-to-zero calls drowned out all rational discourse, I
analyzed the costs that all the leading gold miners in both the GDX
and GDXJ ETFs reported in Q2?15. The former are the majors, the
latter the juniors.
And it turned out
that $1200 industry breakeven number was a total pile of bear crap,
false propaganda!
GDX?s elite gold
majors had average cash and all-in sustaining costs in Q2
of just $635 and $895. This meant the long-term viability level for
this industry is under $900, far below the prevailing $1100+
levels of August. And
GDXJ?s juniors
looked better, with average cash and AISC of just $613 and $858 in
Q2.
So the fact that
gold miners were priced as if gold was around $300 and they?d never
earn a profit again, yet they were still earning on the order of
$200 per ounce as an industry, was fundamentally ludicrous. It made
zero sense. So we fought the extreme herd fear to aggressively buy
elite gold and silver stocks in August and September. I?ve never
seen a greater fundamental disconnect of stock prices anywhere.
The inevitable
reversal out of this extreme stealthily began on the final trading
day in September. That day the HUI enjoyed a super-bullish
outside reversal. After falling on open to what would?ve been a
new 13.2-year closing low, the HUI surged sharply to a nice 3.1%
gain. That day saw an intraday low below the previous day?s, an
intraday high above the previous day?s, and a close right at that
high.
Outside reversals
often signal major trend changes. And just a couple days
later on last Friday October 2nd, gold surged 2.2% after that total
disaster on the US September jobs report. This unleashed frantic
short covering in gold stocks, catapulting GDX 8.1% higher that
day. Those sharp gains continued with 4.3% and 3.6% rallies Monday
and Tuesday. The HUI?s 3-day gains ran an even bigger 8.3%, 5.2%,
and 4.3%!
The result of this
flurry of gold-stock buying is the very-decisive major breakout
shown above. Just as the fundamentals argued, gold stocks?
descending triangle yielded to a rare upside breakout rather than
the common downside one. And with both this formation?s strong
overhead resistance and GDX?s oppressing 50dma overcome, this
flashed a major buy signal to speculators and investors waiting on
the sidelines.
While gold stocks?
major breakout is very exciting, the reason it is so incredibly
bullish for this sector is far more fundamental than
technical. Remember all stock prices are ultimately a function of
underlying corporate profits. And gold-mining earnings are driven
almost exclusively by the price of gold. Higher gold prices lead to
profits that grow far faster than gold is rallying. This profits
leverage is critical to understand.
If a gold miner is
producing its metal for $900, and gold is at $1100, it earns $200
per ounce. But if gold rallies 9% to $1200, this miner?s costs,
which are largely fixed on its mine build, remain at $900. So all
of a sudden it is earning $300 per ounce, a gigantic 50% increase in
profits. As gold rallies, the profits for mining it literally
explode! And gold?s new mean reversion higher means gold stocks
are even more undervalued.
This last chart
looks at the HUI/Gold Ratio, a construct that quantifies gold
miners? stock prices relative to the gold price which drives their
profits. And gold stocks have never been cheaper compared to
gold?s prevailing price levels than in the past couple months. This
extreme anomaly all but ensures a major new gold-stock upleg is
already underway or due imminently. This gold-stock rally
is barely just beginning!
In late September,
this HGR fundamental measure of gold-stock price levels hit an
all-time low of just 0.093x! In other words, the HUI index was
trading at just 9.3% the price of gold. This means nothing alone,
but when considered within the context of HGR history it is an
absurdly-extreme low. And extreme lows are never sustainable in
forever-cyclical markets, they inevitably lead to big mean
reversions higher.
This chart covers
nearly 13 years of gold and gold-stock price history, a long secular
span that witnessed virtually every kind of market condition
imaginable. This ranged from mighty gold-stock bulls to a
once-in-a-century general-stock-market panic. And throughout all of
that, good times and bad alike, the gold stocks were always
priced much higher relative to the metal that drives their
profits and hence ultimately stock prices.
Between the
middles of 2003 and 2008, the last time the markets were actually
normal before that crazy stock panic in late 2008, the HGR averaged
0.511x. For a variety of reasons beyond the scope of this essay, I
suspect that is normal territory for the fundamental relationship
between gold prices and gold-mining profitability. Even at today?s
measly $1150 gold, that historical 0.511x HGR would yield a HUI at
588.
That?s a whopping
366% above current levels, and shows how extremely
undervalued the gold miners? stocks are today fundamentally! But
you certainly don?t have to expect gold stocks? relationship to gold
to return to pre-panic levels to be bullish today. During the most
extreme fear event of our lifetimes by far, 2008?s stock panic, the
worst level the HGR saw was 0.207x. At $1150 gold, even that
implies a 238 HUI.
Even those
peak-despair levels are 89% above today?s ridiculous ones! And the
last time the HUI got so low relative to gold in late October 2008,
it would more than quadruple over the next several years with
a 319.0% gain. This trounced the S&P 500?s mere 39.7% rally over
the same span. It hasn?t been all that long since undervalued gold
stocks earned fortunes for brave contrarians strong enough to buy
them low.
But it?s way too
pessimistic to consider stock-panic lows to be normal, as the
definitive VIX fear gauge soared way up above 80 then. A much more
reasonable span to evaluate righteous gold-stock price levels in
fundamental terms relative to gold came in the post-stock-panic span
between 2009 and 2012. That was after 2008?s extreme panic, but
before 2013?s
extreme market distortions from the Fed?s QE3.
During that
secular span, the HGR averaged 0.346x. Given this metric?s history,
it?s hard for anyone to argue that those levels are fundamentally
unreasonable. At $1150 gold, this post-panic average HGR pegs the
HUI?s righteous level today at 398. That?s 215% above this week?s
dismal gold-stock price levels! So even being very conservative,
gold stocks at least need to quadruple out of their recent
extreme lows.
With the exception
of the sharp mean reversion higher after 2008?s stock panic, gold
stocks have been falling faster than gold almost continuously
since April 2006. This is also an extreme span, defying normal
history where gold stocks outperform and then underperform gold
cyclically. Nothing in the markets moves in one direction
forever, so after 9.5 years gold stocks are way overdue to
outperform gold again.
That means they
will rally faster than gold and drive the HGR higher again, mean
reverting it back up to a reasonable norm instead of these extreme
unsustainable lows. And gold stocks? gains will be really amplified
by gold?s own mean reversion higher. Since this metal?s deep
early-August secular lows after that extreme gold-futures shorting
attack in July, gold has been slowly carving a new mean-reversion
uptrend.
And the higher
gold climbs, the more the gold-stock upside price targets rise
thanks to these miners? inherent profits leverage to gold. At that
conservative post-panic normal-year average HGR of 0.346x from 2009
to 2012, $1300, $1400, and $1500 gold yield HUI price targets of
450, 484, and 519. And believe it or not, even $1500 gold isn?t
particularly high. Gold averaged $1669 in 2012 before the Fed?s
QE3.
That
wildly-unprecedented open-ended debt-monetization campaign is
the sole reason gold and the gold stocks have suffered so much in
recent years. As the Fed?s QE3 bond buying and associated jawboning
about more money printing levitated the stock markets,
capital fled alternative investments led by gold. The resulting
radical gold
underinvestment will reverse as the Fed-inflated
stock markets roll
over.
As gold mean
reverts higher in the coming years, the gold stocks are going to
just soar out of their recent extreme lows that are totally
unjustified fundamentally. And the Fed?s coming rate hikes are
no threat to gold, contrary to popular belief. Gold has
actually rallied
strongly in past Fed-rate-hike cycles that began when gold
prices weren?t near secular highs. Rate hikes have actually proven
very bullish for gold!
So if you?re not
deployed in these dirt-cheap gold stocks yet, you better get moving
before this window of extraordinary buy-low opportunity closes.
This is a very small sector compared to the broader stock markets,
so once speculators and investors start returning the gains will
really accelerate. And gold stocks? major breakout this past week
signals that this shift of capital back into this battered sector
has already begun.
When everyone else
was warning to flee gold stocks and sell low in August and
September, at Zeal we were buying low with reckless abandon. While
this sector?s sharp August rally whipsawed everyone, we still have a
whopping 28 new gold-stock and silver-stock positions on our trading
books that were purchased in August and September! While these have
already surged up to 47%, it?s not too late to buy low.
We?ve long
published acclaimed
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draw on our decades of exceptional market experience, knowledge, and
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Unlike most, we really do walk the walk in buying low and selling
high. Since 2001, all 700 stock trades recommended in our
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Subscribe today,
enjoy our 20%-off sale, and get deployed in elite gold and
silver stocks before they really start moving!
The bottom line is
gold stocks? major breakout this past week likely signaled the
long-overdue major trend change. After being crushed to
fundamentally-absurd prices by that extreme gold-futures shorting
attack, gold stocks refused to fall any lower despite epic
bearishness. And then they defied the odds to stage a powerful
upside breakout from a bearish descending-triangle technical
formation. Buyers are returning.
And while this
technical green light is exciting, the real reason gold stocks are
so incredibly bullish is their extreme undervaluation relative to
the metal that drives their profits. Gold stocks recently hit
all-time lows relative to gold, trading as if gold was around $300.
As gold stocks more than quadrupling after 2008?s stock panic
proved, such extreme sentiment-driven anomalies can?t persist. So
don?t delay, buy low now!
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