One year ago this week, I wrote about the end of the gold-stock panic. As
measured by its flagship HUI gold-stock index, this sector plummeted an
unbelievable 52% in a matter of weeks
in October 2008. It was an epic
catastrophe and its aftermath is still reverberating through gold stocks to
this day. All of 2009 has been
defined by gold stocks’ recovery from this unprecedented panic anomaly.
And despite last year’s legions of naysayers wondering if the
gold-stock bull was mortally wounded, recover the gold stocks have. After hitting an unbelievable panic
nadir near 152 in late October 2008, the HUI quickly doubled to finish last
year around 302. And a couple
weeks ago the HUI closed near 511, representing an outstanding 69%
year-to-date gain in 2009. This tripled the S&P 500’s 23%,
impressive!
Still, the gold stocks continue to climb the proverbial wall of
worries. Even though a couple
weeks ago the HUI closed within 1% of its all-time high from March 2008,
investors and speculators are concerned because gold rose 22% over this same
span. Why hasn’t the HUI
kept pace with gold’s awesome rally of late? And the last couple weeks
haven’t helped either, with the HUI sharply down by 14% over a short
span of time where the general stock markets were dead flat.
Considered in isolation, some of these gold-stock developments can
certainly appear ominous. But
when they are all placed into context like the pieces of a puzzle, the resulting
picture tells an entirely different story. All of 2009’s ups and downs,
triumphs and disappointments, coalesce into a coherent whole when considered
together. And it paints the
picture of a healthy ongoing gold-stock recovery.
Gold stocks’ progress is primarily measured through their stock
prices, and the resulting abstraction known as the HUI index. And a 48% year-to-date gain as of this
week on top of and following the stunning 100% gain in the final 9 weeks of
2008 is certainly excellent progress by any standard. But perhaps a more illuminating
measure, one that offers more insights, is the HUI’s progress relative
to the price of gold.
This relationship is best distilled in the HUI/Gold Ratio, or
HGR. It is simply the daily HUI
close divided by the daily gold close, charted over time. Since the HGR is such a critical
metric for this gold-stock recovery, I’ve discussed it in most of the
gold-stock essays I’ve
written over this past year. Our
subscribers have earned huge realized and unrealized gains this year betting
on the mean reversion of the HGR.
Studying the HGR in context not only offers a critical perspective on
the gold-stock recovery far beyond the raw HUI’s, it has a calming
effect on traders’ perpetually over-excitable emotions. We’ve all seen those days in
recent months where gold rallied strongly but the gold stocks lethargically
refused to leverage its gains.
Dwelling on those days to the exclusion of the broader trend quickly discourages.
This broader post-panic HGR trend is crystal-clear in showing that the
HUI is recovering relative to gold. While there are times when gold surges
ahead of the HUI (like in November), on balance the gold stocks are regaining ground relative to
gold. This is readily evident in
this chart, which renders the HGR in blue (right axis) on top of the raw HUI
in red (left axis). The HGR’s
uptrend is critical to keep in perspective.
The whole purpose of ratio analysis is to reveal relative performance.
If the HUI had merely paced gold in 2009, had the same percentage
gains as the metal these companies mine, the HGR would be a smooth flat
line. But when the HGR is rising,
the HUI is rallying faster than gold and outperforming it. And as you can see, not only has the
HGR been rising over this past year but it has formed a well-defined uptrend.
When the HUI rockets higher much faster than gold, the most-fun times
to own gold stocks, the HGR shoots up towards the upper resistance of its
uptrend. And when gold rallies
faster than the HUI (or is more often the case falls slower than the HUI during precious-metals pullbacks), the
HGR sinks back down towards its lower support. Within the past year, there have been
no fewer than 3 resistance and 4 support approaches. These extremes precisely bound the
beautiful uptrend we see above.
Whether you’re an investor or speculator, the best times to add
new gold-stock positions are when the HGR is down low near support. Whenever the HUI is weak enough relative
to gold to drag the HGR down to the bottom of its uptrend, odds are those
conditions won’t persist.
They almost always occur after gold has fallen significantly and
sentiment in the precious-metals world feels really dejected. Buy into the fear.
And speculators can also capitalize on the opposite end of this HGR
uptrend, when HUI outperformance has lifted this ratio up near
resistance. When the HUI is
strong enough relative to gold to drive an HGR resistance approach, gold
stocks are getting overbought.
Traders are too excited about their near-term prospects so a pullback
or correction is necessary to rebalance sentiment. Sell into the greed.
Gold stocks’ strong recovery in 2009 drove the HGR into a
meandering path between these two extremes. Near resistance, traders naturally
felt pretty excited about gold stocks.
And near support, they naturally felt pretty discouraged. While it is easy to get caught up in
these emotions when they happen to be prevailing, perspective is the key to neutralizing them in your own
trading. And this perspective
shows the HUI has continued to rise relative to gold on balance since last
year’s brutal stock panic.
Consider the last few months’ gold-stock action within this
paradigm. Between its interim
highs in mid-September and early December, the HUI only rose 15%. This would be well and good, but gold
blasted 19% higher over this very span.
Since gold stocks are far more risky than owning gold itself, there is
no reason to own them if they
can’t outperform gold.
While gold only has price risk driven by its own supply and demand,
gold stocks add geopolitical risks, geological risks, operational risks, and
many others.
Gold stocks need to
ultimately leverage and multiply gold’s returns to justify their enormous
additional risks. While their
leverage to gold has varied considerably in different uplegs in this bull, a long-term line
in the sand is probably 2.0x. If
gold stocks can’t at least double the underlying gains in gold, then
investors are probably better off selling the gold stocks and using the
proceeds to add to their foundational physical-gold holdings.
Between mid-September and early December, the HUI could only manage to
leverage the awesome surge in gold by a horrendously bad 0.8x. This pathetic episode has
understandably once again called the ongoing viability of the gold-stock
recovery into question. There is
no doubt that gold stocks have been seriously lagging gold’s advance of
late, and this underperformance is unacceptable.
But considered within the context of the HGR uptrend, the seeming
urgency of today’s gold-stock problems quickly fades. We’ve seen many similar
episodes. Between the end of last
year and early March, the HGR ground lower. Gold stocks were underperforming gold
so similar fears to today’s erupted. Yet once the HGR slumped low enough to
challenge support, the gold stocks rocketed higher again. In the last few weeks of March, the
HUI soared 32%!
Following that surge, the HUI again started underperforming gold in
April and drove the HGR lower.
But once this key metric hit support, it was off to the races again
for gold stocks. In May, the HUI
shot another 33% higher! Then in
June, July, and August, the HGR drifted sideways as the HUI couldn’t
leverage gold’s gains at all.
Again this looked really ominous in isolation, like a big structural
gold-stock problem. But right
after that drift, the HUI blasted 27% higher in the first couple weeks of
September.
See the pattern here? Gold
stocks are highly-speculative and have always moved in fits and starts. There are longer periods of
consolidation or retreat relative to gold that are immediately followed by
hard and fast periods of advance.
Most of the time gold stocks don’t do much at all, but when they
start moving they move. And the net result of all this ebbing
and flowing is very clear in this chart, on balance the HUI continues to gain
ground relative to gold.
Interestingly, this latest ebbing of the HUI’s fortunes has
dragged the HGR back near support today.
If this HGR uptrend holds, this implies that we will soon be due for
another sharp gold-stock rally. I
suspect this next one will drive the HGR back up to its resistance line and a
new post-panic high. While not
quite here yet, this coming HGR support approach should prove to be a
fantastic buying opportunity.
We warned our subscribers that gold was very overbought before this latest retreat, including
selling a couple of gold-stock trades at 130% and 118% realized gains in our
weekly Zeal Speculator newsletter the very day the HUI topped in early
December. They knew a pullback
was coming, and were ready. And
today we are preparing our subscribers to once again buy gold stocks
aggressively when various buy signals including this HGR support approach are
triggered in the coming weeks. It
is an exciting time for gold-stock traders.
The HGR’s textbook-perfect uptrend that has defined this
gold-stock recovery since the panic ended is all well and good. But will it persist? Is there any reason why gold stocks
should continue to gain ground relative to gold? Actually there are a couple, an
airtight fundamental argument leading into a powerful technical case for the
HGR to continue its post-panic recovery.
In the stock markets, any stock’s long-term price is ultimately
driven by the profits earned by the underlying company. If a company can grow its profits, its
stock price will rise over the long
term. Investors buying stocks are
really purchasing fractional rights in the future profits streams of the
companies they own. The greater
those profits streams, the higher the companies’ stocks will be bid up
by investors competing to own them.
Gold miners’ long-term profits are driven almost exclusively by
the price of gold. The higher the
prevailing gold price, the greater their profit margins on their existing
operations. If a company can mine
gold at a total cost of $600 per ounce, and this metal is selling for $900,
it makes a $300 profit. But if
gold only rises 33% to $1200, this company’s profits double to $600 per ounce. The earnings leverage inherent in
producing commodities for relatively fixed prices leads to enormous profits growth in
higher-price environments. In
some cases gold-mining profits grow exponentially with the gold price!
In addition, higher prevailing gold prices make previously
uneconomical ore deposits economical to mine. So gold miners can also increase their
production at higher prices, further expanding their profits. If this secular gold bull continues,
and its fundamentals strongly argue it will, then gold mining is going
to get a lot more profitable. And
higher profits always ultimately lead to higher stock prices, this is an
immutable long-term law in the stock markets. Thus fundamentally, gold stocks have
to continue higher.
And technically, they remain way too cheap relative to gold
today. This next chart expands
the HGR to a secular time frame since 2003. Prior to the once-in-a-lifetime
discontinuity caused by the stock panic, the HGR traded in a well-defined
secular range. As I pointed out a year ago as we emerged out of the panic, there is no reason why today’s
gold-stock recovery won’t return the HGR to its pre-panic secular range.
Over the 5 years prior to
2008’s stock panic, the HGR tended to meander between 0.46x on the low
side and 0.56x on the high side.
This tight range led to an average pre-panic HGR of 0.511x (which was
not skewed by extreme outliers).
In other words, before the stock panic the HUI generally traded at
about half the prevailing gold
price. Since this persisted for 5
years, it was definitely fundamentally-undergirded.
At gold’s recent early-December interim high of $1215, this
average HGR implies a HUI around 621.
This is about 22% above the 511 actually seen that day gold peaked a
couple weeks ago. But while the
HUI was really underperforming gold compared to its bull precedent, the
recovery trend certainly remains intact.
Back during the panic, the HUI plunged to just 41% of where the
average HGR suggested it should be.
But in early December, it was back up to 82% of average HGR
levels. This shows a radical
improvement in the HUI’s fortunes relative to gold over this past
year. If you scroll back up to
the first chart, this hypothetical HUI at the average HGR is rendered in
yellow so you can compare it to the actual HUI in red. The massive gap between where the HUI
is and where history suggests it should be has been gradually closing since
the panic. The gold-stock
recovery is very real, even relative to gold.
The stock panic that drove the HUI to its lowest levels relative to
gold since this gold bull began in April 2001 was an epic anomaly. It created the gigantic discontinuity
evident in this chart. But ever
since the stock panic ended, the battered HGR has been gradually
recovering. It is actually normalizing, relentlessly
mean-reverting back towards its pre-panic average levels.
And this mean reversion is eminently logical. The fundamentals that drive gold-stock
profits and hence stock prices are no different now than they were in the 5
years before the stock panic hit.
Higher gold still leads to disproportionally-large gold-mining profits
growth, and investors chase these profits by bidding up stock prices. While the panic scared away countless
gold-stock investors, many are gradually coming back while other first-time
gold-stock investors are rising up.
Capital is returning to this sector.
So despite the inevitable periods of gold-stock underperformance like
we have witnessed in recent months, and which intensified in recent weeks,
the gold-stock recovery is very much alive and well. Gold-stock weakness is not a threat,
but an opportunity. Prudent investors and speculators live
for these times where gold stocks lag so far behind gold that we can buy in
at excellent prices and ride the next fast surge higher. Opportunities to buy low in an ongoing
bull are extremely valuable.
At Zeal, we continue to relentlessly study gold and the gold stocks as
we have for the last decade. We
are constantly analyzing these powerful bull markets from fundamental,
technical, and sentimental perspectives in order to uncover excellent
opportunities for our subscribers to profit. And it looks like another great buying
op is rapidly approaching. For
just $10 a month for our acclaimed monthly newsletter, you can share in the fruits of our hard work. Subscribe today, become an informed investor, and maximize your
gold-stock trading profits!
The bottom line is gold stocks have been steadily recovering since the
stock panic. And this is not only
in nominal terms, but relative to gold itself. While there are discouraging periods
of gold-stock underperformance like we’ve witnessed recently, they are
par for the course. Gold stocks
have always moved in fits and starts, this is nothing new. The critical observation is they are recovering on balance.
And despite their huge gains since the panic, gold stocks still remain
far below their long-term levels relative to gold. This suggests the gold-stock recovery
will continue, that HUI levels will continue to normalize relative to gold. Just as it was a year ago, this
mean-reversion trade is still one of the highest-probability-for-success bets
available in the entire commodities-stock realm. Don’t miss out on it.
Adam Hamilton, CPA
Zealllc.com
December 18, 2009
Also
by Adam Hamilton
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