Earlier this week,
the US stock markets (S&P 500) fell 4.6% to their lowest close since
November 20th?s panic low. It was a very unpleasant day as latent
fears of bungled government meddling flared up again. But one
sector, the gold stocks, was able to buck this very weak tape. That
very day the HUI gold-stock index rallied 2.6%.
This action was
actually a microcosm of what we?ve seen since the stock panic?s
lows. At its very best in early January, the S&P 500 (SPX) was up
24.2% from its panic lows. That certainly wasn?t bad, but since
then those gains have been pared to 4.8%. The stock markets aren?t
plunging anymore, but they certainly aren?t recovering very
enthusiastically either.
Meanwhile, gold
stocks as measured by the HUI were up 76.0% in early January over
the very same 30-trading-day span where the SPX saw its greatest
post-panic gains to date! And provocatively, back in early January
gold was only trading in the $860s so the growing gold excitement
we?ve seen this week was not a factor behind gold stocks?
initial outsized post-panic gains.
At best from its
own panic lows (as of this week), the HUI has soared 113.8% since
late October! For investors and speculators looking for sectors
that are thriving in this challenging time, gold stocks are it. The
financial media?s oft-expressed lament that nothing is doing well in
these markets is simply untrue. Gold stocks have already rallied
strongly and odds are the majority of their surge is still yet to
come.
It may seem odd to
be very bullish on a sector that has already more than doubled in
less than 4 months, but gold stocks are not your typical sector.
Gold stocks have one major driver, the price of gold. In long-term
fundamental terms, the gold price determines their profits and hence
their ultimate stock prices. In near-term sentimental terms, the
daily gold action drives traders? desire to add capital to this tiny
sector.
And as you know if
you?ve seen any CNBC lately, the strong gold surge over the last
week or so is a big deal. Even mainstreamers are getting interested
as the psychological milestone of $1000 again looms large. With
gold soaring $89, or 9.9%, in just 6 trading days, traders are
naturally getting a lot more interested in the gold stocks that
leverage this metal.
Long ignored by
all but a few contrarians despite their epic 1331% bull run between
November 2000 and March 2008, the gold stocks are still a tiny
sector. At the end of January the total market capitalization of
all the stocks of the HUI was a trivial $123b. Meanwhile the S&P
500?s was running at $7785b, 63x larger even at today?s depressed
stock-market levels. So if even a small fraction of mainstreamers
decide they want some gold-stock exposure, this sector will fly.
But interestingly,
the bullish case for gold stocks goes far beyond the new interest
$1k gold is generating. Like most sectors, gold stocks were sold
off far too aggressively in the midst of the stock panic. They have
yet to even reflect the low-$700s gold seen in the panic, let alone
today?s much higher gold prices. If they simply mean-revert to
their years-old historical relationship with gold, they will rally
mightily.
Two charts will
make this case crystal-clear. The first simply shows the price of
gold (red) and the HUI gold-stock index level (blue) over the past
year. Both vertical axes are zeroed so raw percentage changes are
easier to compare visually. While gold really held up pretty well
during the stock panic, gold-stock traders did not. They let
their intense fears cloud their logic and judgment leading them to
sell like mad.
Last summer the
HUI was drifting lower in a typical modest downtrend often seen
during the summer
doldrums. But in late July, the HUI plunged below support.
This was when the GSEs, Fannie Mae and Freddie Mac, were imploding
which greatly exacerbated the credit crunch. Owners of the
ubiquitous GSE debt, which is backed by American residential
mortgages, started dumping their bonds and parking capital in vastly
safer US Treasuries.
Of course
foreigners first had to buy US dollars before they could buy
Treasuries, so the US dollar surged in one of its
strongest rallies
ever witnessed. This led to a sharp $127 (13.9%) gold plunge in the
first half of August. Not surprisingly the gold stocks, which are
driven by gold, plummeted in sympathy. The chain of events from
this bond panic ignited by the GSE implosion kicked off the HUI?s
brutal 67.7% plunge.
With gold weak,
gold-stock traders? psychology was already shaken before the stock
panic. And gold actually recovered by mid-September, blasting $160
(21.5%) higher in just 7 trading days. The HUI rallied sharply on
gold?s strength, hitting 354 in late September. It probably would
have continued rallying from there, but then the psychological
maelstrom of the
Great Stock Panic of 2008 slammed into the markets. Gold stocks
did not escape.
A panic is a
bubble in fear,
investors and speculators rush to sell anything and everything
in order to raise cash fast. In just 5 weeks, gold-stock traders
sold so aggressively that they drove the HUI 57.2% lower! The HUI
has never seen anything like this before and probably won?t again in
our lifetimes, since true stock panics are once-in-a-century types
of events. This was catastrophic for gold-stock sentiment.
But the great
irony of all this is gold only fell 18.9% over that 5-week
stock-panic span. Throughout history, even
during stock
bears, the gold stocks tend to follow gold on balance, not the
stock markets. Sure, extreme fear in general stocks can
temporarily spill into gold stocks from time to time. But
strategically they always ultimately march to the beat of the gold
drummer. Since gold governs their future profits and current
psychology, it rules them with an iron fist. So this huge
disconnect was very strange.
Even if gold had
done nothing since, even if it had lingered in the low $700s, it was
crystal clear during the panic that gold stocks were radically
oversold. We were buying aggressively in late October and early
November, as the best time to go long is when everyone else is
terrified so the bargains are the greatest. A pair of new
gold-stock and silver-stock investments I recommended to our
newsletter subscribers near those panic depths were already up 69.2%
and 105.8% as of this week.
I was buying when
everyone else was selling because the longstanding relationship
between gold stocks and the price of gold was all out of whack. In
the 5 years before the stock panic, the HUI/Gold Ratio (HGR)
had usually traded in a tight range between 0.46x and 0.56x. It
averaged 0.511x over this secular time frame. In other words, the
HUI index generally traded around half the price of gold.
You can see a long-term chart of this
HGR relationship
in an essay I wrote just after the stock panic.
This narrower span
over the past year offers higher resolution on the HGR developments
during the stock panic. When the HGR is rising, it means the HUI is
outperforming gold. Conversely when the HGR is falling, it means
gold is outperforming the HUI. Often in this latter case, as the
blue HGR line below shows, gold?s outperformance means gold is
simply not falling as fast as the HUI in a correction.
During the panic,
the HGR plummeted to its lowest levels since April 2001 when gold
traded in the $250s! Initially the huge US dollar spike ignited by
the bond panic, and then the tsunami of fear unleashed by the stock
panic, conspired to batter gold stocks to ridiculously unreasonable
levels relative to the price of gold. On October 27th, the HGR
bottomed at the unthinkable level of 0.207x. The next day in our
popular Zeal
Speculator alert service, I bought and recommended the GDX
gold-stock ETF.
Here?s what I
wrote to ZS subscribers on October 28th, the day after the HUI
closed at its panic low of 152. ?And how about gold? We are
witnessing the biggest inflationary event in US history, and that is
saying a lot. All of this bailout capital will eventually flood
into the real economy and drive incredible inflation. I?ve been
long gold since the $250s (early 2001) continuously and I?ve never
felt more bullish than I do today after this nasty financial panic
and its resulting bailout mess. Gold?s fundamentals are stellar.?
?Yet the HUI
closed near 152 yesterday, which is end-of-the-world levels as far
as I am concerned. This index hasn?t been this low since mid-2003!
Where was gold trading back then? In the $350s! Is this madness or
what? We have a gold price over twice as high yet stock prices are
apparently discounting mid-2003 gold levels. This is clearly not
rational and reflects the sentimental nature of this stock selloff.?
Today this seems
like an easy call in hindsight, but it was very contrarian at
the time. Even long-time gold-stock fans were capitulating, with
widespread predictions for gold falling to the $600s even in the
traditional gold-bull community. Dig up your favorite commentators?
newsletters or essays published the last week in October 2008
and see what they were writing about gold?s and gold stocks?
potential back then. Most were extremely bearish, with very very
few bulls out there at the panic depths.
But being brave
when everyone else is afraid is the essence of contrarianism, and I
have never seen blood flowing in the gold-stock streets like I did
in late October and early November. It was HGR analysis, that gold
stocks were way too cheap even relative to then-prevailing gold
levels, that provided the fundamental reasoning for fighting popular
sentiment. And this same HGR analysis is still why the gold stocks
are so bullish today.
The blue line
above is the HGR while the red one is the raw HUI. But I added a
yellow one too, a hypothetical HUI based on the 5-year secular
average HGR of 0.511x. The yellow line is where the HUI should
have traded since July if it had tightly followed its historical
average relative to gold. While just a thought exercise, it really
helps place the HUI?s great potential then and now in proper
perspective.
On October 27th
when the HUI bottomed, it closed just under 152. But at 0.511x the
gold price where it usually oscillates around, it should have closed
at 374! That day the HUI was trading at about 41% of where the gold
price implied it should be! Talk about the mother of all gold-stock
anomalies. I really think we?ll never see another one anywhere near
this magnitude in our lifetimes, stock panics are so rare.
Back in July
before this whole mess started, the actual HUI was trading at 95% of
the hypothetical HUI based on the previous 5 years? average HGR. By
mid-August, this gap had grown to 83%. And from there it just kept
expanding until it mushroomed to the massive 41% levels seen at the
depths of the panic. Maybe 80% is somewhat understandable in a
scary time, but 40% of where the HUI ought to be trading? No way.
It was ridiculously silly.
Since those panic
lows, the gap between the real HUI and HGR-implied HUI has
narrowed. By late December after the HUI had doubled out of
its panic lows it was still trading at just 67% of where the hypo
HUI ran. And as of this week, the HUI had actually lost some ground
relative to gold at 64%. Note above that the blue HGR line has been
stalled in a tight, flatlined wedge since mid-December.
Such low HGR
levels have never persisted for this entire 8+ year gold-stock
bull. And I doubt they will be able to persist today, especially
with gold?s powerful performance starting to put the neglected
gold-stock sector on more mainstream investors? radars. Sooner or
later it is highly likely the HUI will return to its longstanding
historical relationship with the price of gold. Interestingly, as I
wrote a couple weeks ago
silver is very
bullish today for the same gold-normalization reasons.
At $1000 gold, a
0.511x HGR implies a HUI level of 511. This is 58% higher than
today?s HUI levels! And this bullish case for gold stocks right
now is understated in a couple key ways. First,
gold?s
fundamentals are spectacularly bullish today partially due to
the enormous
monetary inflation Washington has baked into the pipelines. If
gold continues powering higher as it ought to, the HUI?s case gets
even more bullish.
Second, after
major extremes in one direction the financial markets often tend to
overshoot in the opposite direction. If gold drives mainstream
interest in the tiny gold-stock sector, gold stocks could rocket up
so far and fast that they exceed the HGR?s 0.511x average. At the
tops of previous gold-stock uplegs when traders got excited, the HGR
exceeded 0.60x
on multiple occasions. Take 0.60x and apply it to $1000 or
higher gold and gold stocks look like the best buys on the planet
today.
But what if gold
retreats? This panic drove home the point that anything is possible
in the markets, they don?t have to act rational over the short
term. Amazingly the HUI was so oversold during the panic that this
shouldn?t really matter. At $950, $900, and $850 gold, the HUI at
its 5-year-average HGR ratio would still run 485, 460, and 435.
These numbers are still 35% to 50% higher than today?s HUI levels.
It is mind-blowing just how cheap gold stocks got relative to gold
during the madness of the panic.
I?ve been a
speculator all my life, I bought my first stock (IBM) with my own
money (earned from mowing lawns and fishing golf balls out of water
traps) when I was 12. After decades actively in this game, I know
exactly how hard the psychological component is. Dealing with the
greed and fear smothering our own hearts is incredibly challenging.
It is hard to deploy capital when everything looks terrible and you
are scared.
Yet this is when
the big money is made. You could wait and buy gold stocks after the
SPX and US economy start recovering and the markets start looking
normal again. But by that time the lion?s share of the gains will
have already been won. It didn?t feel comfortable buying in the
depths of the panic. Even though I knew prices were
irrational, I couldn?t tell if the panic was over yet in late
October and early November. But I bought and recommended gold
stocks then anyway, ignoring my own emotions.
And it doesn?t
feel comfortable buying now when gold stocks have lagged gold?s
surge. Look around the Web and you can find countless reasons, and
logical rationalizations, why gold and gold stocks should plunge.
Fear and bearishness and pessimism is rampant, not a great deal
better today than at the panic lows. Most traders are waiting for
lower prices later, until they?re ?comfortable?, but they?ll
probably miss the boat playing that game.
Gold stocks may
indeed go lower, anything can happen. But there is no doubt they
are far too cheap relative to gold today. At Zeal we spent
the panic months deeply researching the fundamentals of
virtually all of the world?s publicly-traded gold producers. We
knew the buying opportunities were tremendous, but we needed to
narrow down the field fundamentally to find the best stocks. In
mid-December we finished our research and published a 36-page
comprehensive report
on our 12 favorite gold producers.
Since this report
was published, the general stock markets have fallen 12.8%.
Meanwhile the HUI was up 11.0%. But as of this week the average
absolute gain of the 12 stocks we profiled is 16.1%, exceeding the
HUI?s performance by nearly 1.5x. With the HGR still trying to
recover from the panic anomaly, the buying opportunities still
remain fantastic today. But like any bargains these gold-stock
prices won?t last forever. Buy our awesome
new gold-stock report
today, get off the sidelines, and start making some money.
We have also been
adding positions in elite gold and silver stocks in our acclaimed
monthly Zeal
Intelligence newsletter. If you want to really understand what
is going on in the markets, to steel yourself from succumbing to the
thundering herd?s mood swings, to see what (and when and why) we are
trading ourselves,
subscribe today. After a panic is the greatest time to get
active, get learning, and get trading. Carpe diem!
The bottom line is
gold stocks have surged mightily since their panic lows. But they
were so radically oversold then that their surge remains young.
Almost no matter what gold does, the gold stocks need to rally
greatly to reclaim their long historical relationship with the price
of gold. Today?s gold-stock bargains aren?t as epic as they were in
the depths of the panic, but they are still among the best of this
entire bull.
And boy, if you
add the growing excitement around $1000 gold and the tiny size of
the gold-stock sector into this whole HGR-anomaly mix, the bullish
gold-stock case gets wildly more compelling. Investors everywhere
are tired of hiding in cash yielding nothing, they are looking for a
strong bull market to deploy their idle capital in. Once they
discover gold stocks are it, the sky is the limit for this
gold-stock surge.
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