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Gold stocks continue to
be universally despised, plagued by extreme bearishness.This
has hammered their stock prices to epically-undervalued levels that are truly
fundamentally absurd.This whole sector is now
trading as if the gold price was less than a third of current levels!This massive disconnect
has created vast opportunities for brave contrarians who have forged the
mettle to buy low when few others will.
For literally thousands
of years around the entire planet, gold has been an indispensable asset.It has been Tolkien�’s One Ring of money, ruling over
all national currencies ever created.It has been
essential for wealth preservation and portfolio diversification, not to
mention inflation protection and capital gains.The
natural human lust for gold has dramatically reshaped world history, there is
simply nothing else like it.
With gold highly-prized
and valuable in all places and all times, the companies that painstakingly
wrest it from the bowels of the Earth have also been highly valued.Their hard efforts recover a rare, scarce, and
finite resource of great value, so investors usually flock to own these companies.Their extreme degree of out-of-favorness among investors today is far from the norm, it
is actually a wildly-unprecedented anomaly.
Such incredibly
irrational hyper-bearishness has bludgeoned gold-stock prices down to levels
so far below fundamental reality that it defies belief.Through
all the stock markets, individual stock prices are ultimately a direct
function of the profits each underlying company generates.Gold
stocks are no different.Like every other sector,
they will eventually settle at reasonable multiples of their underlying
earnings.
And obviously for the
gold-mining industry, the price of gold is the dominant driver by far
of its profitability.Building new mines is
fantastically capital-intensive, so the costs of recovering the gold from any
deposit are largely fixed when its mine is planned and constructed.Thus
any increase in the gold price translates directly into higher profits, which
grow far faster than gold rallies due to the fixed mining costs leveraging
them.
As I discussed in an
essay last week about the foolish gold-stock ostrich investors who have shut off their brains to
succumb to bearish groupthink, gold stocks are trading at
fundamentally-absurd levels.The
first time the flagship HUI gold-stock index achieved today�’s levels was fully a decade ago,
when gold and silver were near just $385 and $5.25.With the precious metals
vastly higher now, such levels make zero sense today.
The clearest way to
understand this massive fundamental disconnect is to look at gold stocks
relative to the price of gold, which drives their profits and hence
ultimately stock prices.The HUI/Gold Ratio is the
preferred metric for this, something I�’ve been writing about for many years now.Like nothing else it visually captures the
fundamental absurdity of today�’s gold-stock prices and the
resulting epic opportunities.
This first chart looks at
the HGR in blue superimposed over the raw HUI in red.Out
of the countless charts we�’ve created at Zeal, this is one of
my favorites.Successful investing demands first
buying low then later selling high, and today�’s gold-stock price levels
represent one of the greatest buy-low opportunities I�’ve ever seen.No
sector is ever cheaper than when nearly everyone expects it to continue
falling forever!
Just this week the
HUI/Gold Ratio fell to 0.166x.In other words, the flagship HUI gold-stock
index was trading at just 16.6% of the price of gold.This
was the lowest this ratio has fallen in 12.8 years, even far below the
2008 stock panic�’s extreme of 0.207x.Going back 12.8 years takes
us to January 2001, when the gold price was languishing near $265 and the secular gold bull wouldn�’t even start for a few months!
The implications of this
fact for investors are staggering.Gold stocks are
as out of favor today as they were at the end of a brutal multi-decade
secular bear.Gold stocks are as out of favor today
as they were when the HUI was just beginning its epic 1664% bull run
between November 2000 and September 2011.Gold stocks have literally never
been cheaper in almost the entirety of their wildly-profitable secular
bull!
Today prudent contrarian
investors can buy gold stocks at the same prices relative to gold last
seen in the very first months of an epic 10.8-year bull run where they
multiplied capital invested in them by nearly 18 times!Who wouldn�’t want to partake in such an opportunity?It�’s as if the extreme sentiment anomaly
plaguing gold stocks today has unwound the entire secular gold-stock bull,
totally resetting stock prices.
This epic pricing anomaly
is the result of the most extreme bearishness imaginable.Investors
have totally given up on gold stocks, they have convinced themselves gold
stocks will never rally again.This has led to a self-feeding vicious circle.Discouraged investors dump gold stocks, driving
their prices lower.This ramps popular bearishness
even higher, leading even more investors to capitulate and run for the exits.
I certainly understand
the brutal psychological pressure this year�’s extreme selling has exerted on
gold-stock investors.As of this week, the HUI is
down 50.6% year-to-date thanks to gold�’s own 22.0% loss.And
it wasn�’t like gold stocks were expensive before 2013�’s wildly-unprecedented GLD mass exodus and gold-futures forced liquidations triggered by the Fed�’s stock-market levitation arrived, they were
cheap then too.
But they got far cheaper
as this year�’s extreme capitulation selling persisted.It�’s funny, as the legions of gold-stock bears
who no longer think fundamentals apply to gold stocks use this to beat
contrarians over the head.But there is never any
shame in buying low.If you offer me a $100 bill for
$80, I will buy it immediately.If $100 bills are
then going for $50 a few months later, the bargain just gets that much more
attractive.
Extreme pricing and
sentiment anomalies never last in the financial markets, they are
naturally self-limiting.At some point everyone who
can be scared into selling has sold, and everyone weak enough to succumb to
popular groupthink has already become bearish.There
is only a finite amount of selling possible, and a finite amount of traders
who can manage to delude themselves to believe a sector will fall forever.
The best example of this
is right in the middle of the chart above, 2008�’s once-in-a-century stock panic.Gold
stocks got sucked into that epic fear superstorm
like everything else, and the HUI plummeting a gut-wrenching 71% in a matter
of months.It felt like the end of the world, so
many investors who had owned gold stocks for many years gave into their own
fears and sold right into those extreme lows in panic.
But selling when everyone
else is scared and universal bearishness dominates is always the height of folly.Just when things look like they will never get any
better is exactly when they can�’t get any worse!As I aggressively warned our subscribers at the
time, gold stocks were trading as if gold was less than half the
levels it hit at worst during 2008�’s stock panic.That
fundamental anomaly was ridiculous, it couldn�’t last.
And it didn�’t.Over several years after those extreme
hyper-bearish 2008 stock-panic lows, the flagship HUI gold-stock index more
than quadrupled.Many of the elite smaller miners we
prefer saw far bigger gains than that.Vast fortunes
were won by betting on a simple market truth.Extremes
of prices and sentiment never last, both stock levels and emotions always
mean revert.Markets
are forever cyclical.
All prices, along with
greed and fear, perpetually flow and ebb.Gold
stocks can only fall relative to gold for so long, can only fall out of
investor favor for so long, before that trend inevitably reverses.And
if you look at this HUI/Gold Ratio chart above, this out-of-favor trend has
lasted for a long time.Gold
stocks have been slipping on balance relative to gold ever since 2008�’s stock panic, which shattered
their previous trend.
In the 5-year secular
span before that event that sparked the greatest market fear we�’ll witness in our lifetimes by far, the HGR
averaged 0.511x.The HUI tended to trade at just over half the price of gold.This whole sector naturally oscillated between
periods of becoming more liked and less liked by investors.The
former sometimes drove the HGR above its 0.56x resistance, the latter
occasionally pushed it under 0.46x support.
But the stock panic
destroyed that normal secular trend.The majority of
gold-stock investors who thought they were contrarians had deceived
themselves, they were too weak psychologically to ride out a
stock-panic-grade anomaly.So they capitulated and
foolishly sold low, and then fled the gold-stock realm to never return.But even without them, the cyclical nature of the
markets still decisively reasserted itself.
New investors, real
contrarians, saw the extreme gold-stock lows and bearishness plaguing
this sector and bought low, eventually driving the HUI to more than quadruple.And
now today we find ourselves in a similar anomaly, the HUI�’s extreme plunge in the first half
of 2013 mirrors its late-2008 one during the stock panic remarkably well.The HUI is down 67% now compared to 71% then,
similar catastrophes.
This year�’s extreme bearishness hammered the
HUI to its worst level in 4.6 years in late June, not too different from
2008�’s stock
panic which blasted it to a 5.3-year low.Today,
just like back in late 2008, the HUI fell to its lowest levels relative to
gold of essentially the entire secular gold-stock bull.The
parallels are many, despite the gold-stock price and sentiment extremes being
far worse at today�’s cyclical ebb.
Today�’s smug gold-stock bears foolishly
ignore market history, they make the assumption that gold stocks (and gold
for that matter) will continue falling deeper out of investor favor forever.But this flies in the face of the indisputable
truth that markets are cyclical.The HGR has been plunging almost without respite
for over 2 years now, since early 2011.At some point this will
reverse, gold stocks will start reflecting fundamentals.
This week the HUI slumped
to 219, levels first seen way back in October 2003 a decade earlier.But
back then gold and silver were merely near $385 and $5.25.This week they were
fully 3.4x and 4.2x higher near $1305 and $22.00.Does it make any sense at
all for the gold stocks to trade as if the great majority of the secular gold
bull never happened?Of
course not!Their pricing today is truly
fundamentally absurd.
Even if gold does nothing
but drift, sooner or later gold-stock prices have to reflect the prevailing
gold prices driving their high profitability.This is going to result in one heck of
a mean-reversion rally.In the post-panic years
between 2009 and 2012, before 2013�’s extreme gold-selling anomaly, the HGR
averaged 0.346x.To merely mean revert to that low standard would lead the HUI
to more than double to 451!
But after price and
sentiment extremes inevitably burn themselves out, mean reversions almost
never end at averages.Like a released pendulum they
don�’t magically stop at the center of their arc, but they overshoot
proportionally as the momentum carries them to the opposite extreme.Thus I continue to believe there is a high
probability the HUI will at least regain its pre-panic average HGR of
0.511x in the coming few years.
This next chart reveals
the staggeringly-bullish implications of such a mean reversion for gold stocks.It looks at the HGR and HUI again in just the
post-panic years, but adds a third series in yellow.That
shows where the HUI would be trading if it regained its secular pre-panic
average HGR of 0.511x.Even at today�’s relatively-weak gold prices,
gold stocks at normal valuations would more than triple the HUI to
667!
This week and back in
late June at the HUI lows, this index was merely trading at 33% of
where it would have been at that 5-year pre-panic-average HGR of 0.511x.This
was actually far more extreme than during 2008�’s stock panic, when the lowest the HUI sunk
was 41% of this level.And if the HUI more than
quadrupled after that anomaly, why on earth won�’t it enjoy even greater
mean-reversion gains after this bigger one?
Starting way back in
April 2011, gold stocks begin to lose ground relative to gold.This
led to the brutal HGR downtrend that persists to this day, only interrupted
for several months in 2012 when gold stocks started to regain investors�’ favor again.Unfortunately that natural
market cycle was artificially derailed when the Federal Reserve�’s highly-inflationary QE3 campaign ignited an unnatural levitation
in the stock markets.
With general stocks
rallying relentlessly on traders�’ belief that the Fed wouldn�’t let them fall, alternative investments including gold fell deeply
out of favor.Gold stocks followed the yellow metal
lower and leveraged its losses, ultimately leading to the recent months�’ extremes. I�’ve been actively trading and studying gold
stocks for their entire secular bull, and I�’ve never seen them more out of favor than
today.
Being a contrarian is
never easy, you have to be brave when others are afraid to buy low and
later afraid when others are brave to sell high.Mainstream
investors who only gain comfort from running with the crowd, selling low near
bottoms and buying high near tops like everyone else, always ridicule the
black-sheep contrarians.By thinking differently,
fighting the herd, we make mainstreamers very uncomfortable.
They don�’t want to hear that a
deeply-out-of-favor sector is too cheap and on the verge of a massive upleg.They don�’t want to hear that levitating
stock markets are far too expensive and due to roll over into a new cyclical bear.The history-proven concept that
markets are cyclical, that extremes on either side never last and soon mean
revert, is heretical.So contrarian thought is
mercilessly scorned and attacked.
But who cares? Would you
rather be accepted by your friends and peers and fritter away your fortune by
selling low and buying high like everyone else does?Or would you rather fight the crowd to buy low
when few others will, then later sell high when everyone else realizes you
were right, and grow wealthy?Decades ago I made
this decision myself, being a student of the markets forced me to be a
contrarian.
Buying gold stocks low back in the early 2000s or during the 2008 stock panic when everyone thought it
was sheer lunacy wasn�’t any easier than it is today.Buying out-of-favor stocks in hyper-bearish sectors
always makes those around you deride you as a fool.But
the vast profits that come out of contrarian investing, becoming millionaires
and then multi-millionaires through stock trading, makes all well worth it.
That�’s what investing is all about,
right? Multiplying your wealth through buying low then selling high.It�’s not a popularity contest, it�’s not about feeling good or accepted.The worst investors in general feel about any
sector, the more bearish they are on it, the lower its prices and hence the
better the bargains.There is no sector in all the
stock markets today that can even remotely approach the extreme cheapness of
gold stocks!
After falling deeper and
deeper out of favor for more than a couple years now, gold stocks have
effectively never been cheaper relative to gold in this sector�’s entire secular bull.Gold stocks are
trading at just a third of their pre-panic average levels relative to
gold, with the HGR just hitting nearly-13-year lows this week.This
anomaly cannot persist, gold stocks can�’t mock their own fundamentals and
market cycles forever.
If gold does nothing and
the HGR merely returns to its post-panic average, the HUI will more than double.If gold does nothing and the HGR mean reverts to
its pre-panic average, the HUI will more than triple.And
if the HGR overshoots as is highly probable, the gains will be far larger.And if gold rallies too, as is almost a certainty
after such an extremely-anomalous selloff, the gold-stock gains will be
even greater.
And as always the elite
smaller high-potential gold stocks will enjoy ultimate gains dwarfing those
of the large gold miners of the HUI!That�’s
why we�’ve continued to diligently research gold stocks
at Zeal while the rest of the world forsakes them.We
just spent 3 hard months painstakingly whittling a universe of nearly 700
junior gold stocks down to our dozen fundamental favorites.These
elite companies are incredible!
The bottom line is gold
stocks are as deeply out of favor as they�’ve ever been in their entire secular
bull.They�’ve never been lower relative to gold, nor
suffered popular bearishness so extreme, in nearly 13 years.This
has crushed their prices to fundamentally-absurd levels even worse than the
stock panic�’s.They are trading as if the last decade
of the secular gold bull never even happened, which is crazy.
But the silver lining of
extreme anomalies in prices and sentiment is they never last.Selling
and fear are self-limiting, they eventually burn themselves out.And then the cyclical nature of the markets reasserts
itself to drive massive mean reversions, and ultimately overshoots to the
opposite extremes.Today�’s cheap gold stocks are set up for
a colossal mean-reversion rally, maybe the biggest HUI upleg
ever witnessed.
Adam Hamilton, CPA
October 11, 2013
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