The
gold miners’ stocks have huge upside potential in 2018, likely the
best among stock-market sectors. They really lagged gold last year,
so a major mean-reversion catch-up rally is coming. The gold miners
are universally ignored and deeply undervalued relative to the metal
which drives their profits. And gold itself is likely to power
dramatically higher this year as euphoric record-high stock markets
inevitably start to falter.
Gold
has always been the leading contrarian investment, tending to move
counter to stock markets. So not surprisingly investment demand
stalled last year as the extreme taxphoria-fueled stock surge
blasted relentlessly higher. When stock markets apparently do
nothing but rally indefinitely, investors feel no need to prudently
diversify their portfolios with the anti-stock trade gold.
So they ignored the yellow metal in 2017.
That
was certainly evident in the leading proxy for gold investment
demand, the flagship American GLD SPDR Gold Shares gold ETF. Its
physical gold bullion held in trust for shareholders merely grew
1.9% or 15.3 metric tons in 2017. That was a colossal slowdown from
2016’s massive 28.0% or 179.8t growth! Given the weak gold
investment demand last year, it’s rather impressive how well gold
managed to perform.
Big
up-years in the stock markets sometimes drive big down-years in
gold, and 2013 was a key case in point. That year
extreme Fed
easing catapulted the benchmark S&P 500 broad-market stock index
(SPX) an amazing 29.6% higher. Exuberant investors wanted nothing
to do with gold, and dumped it in droves. So the gold price
plummeted 27.9% in 2013, leaving deep psychological damage that
persists to this day.
In
2017 the SPX soared 19.4% on hopes for big tax cuts soon from
the newly-Republican-controlled US government. Extreme complacency,
greed, euphoria, and even hubris ran rampant among investors. It
was a perfect scenario to see gold crushed again on a mass exodus of
investor capital. Yet despite the stock markets enjoying their best
year since 2013, gold was still able to achieve a strong 13.2% gain
in 2017!
Nevertheless, the wildly-optimistic stock-market sentiment drowned
out everything else so psychology in precious metals remained
exceptionally weak. The leading indicators for gold sentiment are
this metal’s peripheral leveraged plays of silver and gold miners’
stocks. Both typically amplify gold’s upside by 2x to 3x.
But oddly in 2017 despite gold’s big rally, silver and the main
gold-stock index only climbed 6.4% and 5.5%.
That
index is of course the NYSE Arca Gold BUGS Index, better known by
its symbol HUI. It is closely mirrored by the dominant gold-stock
ETF, the GDX VanEck Vectors Gold Miners ETF. The composition of
these gold-stock trackers
is very similar
by necessity, as the universe of major gold miners to pick from when
building indexes is small. Without scales, it’s impossible to tell
the difference between HUI and GDX charts.
In a
13.2% gold up-year like 2017, the HUI really should’ve leveraged
that by 2x to 3x to enjoy solid annual gains of 26.4% to 39.7%. Yet
because investors weren’t interested in either gold or its miners’
stocks, the HUI languished with that miserable 5.5% gain last year.
That made for terrible 0.4x leverage to gold, which is wildly
unacceptable. Gold miners must generate greater returns than
gold to be viable investments.
Owning gold miners is much riskier than simply owning gold itself.
On top of all the price risks that gold faces, the miners heap many
additional operational, geological, and geopolitical challenges.
They must compensate investors for these considerable added risks
relative to owning gold outright, or there is truly no point in
owning them at all. 2017 was a rare anomaly where they dramatically
lagged gold’s solid rally.
That’s very unlikely to persist into 2018, as we’re already seeing.
Since the Fed’s
5th rate hike of this cycle in mid-December, gold and the HUI
have rallied 5.5% and 12.8% as of the middle of this week. That
makes for solid 2.3x upside leverage, already a vast improvement
over last year’s 0.4x. Thus investors are already returning to gold
stocks in a meaningful way, and this young trend should accelerate.
The
gold miners’ stocks are radically undervalued fundamentally
after so horribly underperforming gold last year. Gold mining is a
simple business from a profits standpoint. Miners painstakingly
wrest gold from the bowels of the Earth, then sell it at prevailing
market prices. So their earnings are the differences between
current gold prices and mining costs. Gold-mining profitability was
actually fairly strong in 2017.
Right after quarterly earnings seasons, I dig into the newest
reports from the world’s top gold miners included in that leading
GDX gold-stock ETF. In their
latest-reported
quarter of Q3’17, the top 34 GDX component gold miners averaged
all-in sustaining costs of $868 per ounce. AISCs are this
industry’s main profitability measure, accounting for not only
mining but maintaining production by replenishing reserves.
One
of the primary attributes that makes gold stocks so attractive to
investors is the fact these costs don’t change much
regardless of prevailing gold prices. Over the past 7 quarters
ending in Q3’17, GDX’s top-34 gold miners reported average AISC of
$833, $886, $855, $875, $878, $867, and $868. That makes for a
tight variance, despite gold trading as low as $1074 and as high as
$1365 during this same span.
These quarterly major-gold-miner average AISCs within this gold bull
have their own mean of $866, so let’s assume this industry can
operate at $865 all-in sustaining costs. In 2017 gold averaged
$1258 per ounce, so the major gold miners were collectively earning
profits of $393 per ounce. That equates to hefty 31% profit
margins, levels most industries would die for. Yet gold-mining
stocks certainly didn’t reflect this!
The
HUI averaged just 196.0 in 2017, incredibly-low levels. This
leading gold-stock index first hit 196 in September 2003 when gold
was only trading near $375. Back then the major gold miners were
far less profitable in both absolute and percentage terms. In 2004
the HUI averaged 212.2, considerably better than 2017 levels despite
gold’s super-low average price of $409 that year. Today’s
gold-stock prices are absurd!
In
2010 the gold price averaged $1228, a bit below 2017’s $1258. Yet
the HUI averaged 471.5, or a whopping 141% higher than last year’s
ridiculous levels. The gold miners’ stocks are now priced as if
this industry was operating at massive cashflow losses with its very
future viability called into question. Yet obviously that isn’t the
case, as the gold miners are generating big positive cashflows and
profits today.
The
only explanation for this epic fundamental anomaly is extreme
sentiment, which never lasts for long. Because the stock
markets soared in taxphoria last year, investors shunned gold and
everything related to it. Thus the gold stocks fell deeply out of
favor, universally ignored if not scorned. When that weird
psychology inevitably shifts, the beaten-down gold stocks are going
to stage a massive catch-up upleg.
There’s plenty of precedent for that. Back in early 2016 when the
general stock markets suffered their last correction,
gold investment
demand exploded for prudently diversifying stock-heavy
portfolios. The SPX only fell 13.3% over 3.3 months, but even that
minor correction was enough to rekindle big gold buying. That
catapulted gold 29.9% higher in 6.7 months, birthing its first
new bull market since 2011!
Like
today, gold stocks were neglected and anomalously-cheap before that
last stock-selloff-driven gold upleg. Then in roughly that same
first-half-of-2016 span, the HUI skyrocketed 182.2% higher in just
6.5 months! That made for amazing 6.1x upside leverage to gold.
When gold stocks have underperformed their metal, their catch-up
rallies are huge and greatly amplify gold’s gains. 2018’s action
should echo 2016’s.
Gold
stocks certainly have the potential today to see similar fast gains
this year to their near-triple in a half-year on gold powering less
than a third higher a couple years ago! The lead-in to 2018 was
very similar to that lead-in to 2016, with gold stocks deeply out of
favor and thus languishing at
fundamentally-absurd price levels relative to their profits.
But the vast majority of traders haven’t figured this out yet.
Investment is all about buying low then selling high, and
that requires buying when assets are unpopular and thus
underpriced. Unfortunately most investors ultimately perform poorly
because they reverse this. They instead wait to buy until assets
are adored, which forces them to buy really high. Then once those
assets inevitably mean revert to much-lower levels, investors
succumb to popular fear and sell low for big losses.
In
late 2015 just like in late 2017, the contrarian gold-stock sector
was despised. Few investors were even aware of it, and most of
those didn’t want to touch it with a ten-foot pole. Yet in 2016,
the gold stocks were the best-performing stock-market
sector. The HUI rocketed 64.0% higher that year on a mere 8.5% gold
rally, trouncing the SPX’s 9.5% gain! Fighting the crowd to buy low
really multiplies wealth.
There’s a high probability the gold miners’ stocks will once again
prove the best-performing stock-market sector in 2018. There’s
virtually nothing else deeply out of favor and radically undervalued
in these entire taxphoria-inflated stock markets! Everything else
has already been bid dramatically higher, and thus is susceptible to
suffering sharp selloffs as the stock markets roll over. Gold
stocks are the only bargains left.
Since prevailing gold prices directly drive gold-mining
profitability and hence ultimately stock prices, the HUI/Gold Ratio
is a great valuation proxy for this sector. It simply divides the
daily HUI close by the daily gold close. When charted over time,
this core fundamental relationship reveals when gold stocks are
overvalued or undervalued relative to gold. And there’s no
doubt the latter is true in spades heading into 2018.
Despite the gold miners’ nice post-FOMC-meeting rally in recent
weeks, they left 2017 trading at an HGR of just 0.148x. In other
words, the HUI was trading at just under 15% of the gold price.
This ratio means nothing in isolation, but years of history shows
when gold stocks are high or low compared to gold. And they almost
couldn’t be lower today, or more undervalued. Essentially only 2015
saw worse gold-stock prices.
That
happened to be the climaxing stretch of a major gold bear
that ran 6.1 years leading into the Fed’s first rate hike
of this cycle
in December 2015. The HGR slumped to all-time lows near 0.09x late
that year, extreme and unsustainable. And indeed the gold stocks
rallied sharply out of that anomaly, again nearly tripling in a
half-year. Gold-stock prices remain super-low, overdue to mean
revert dramatically higher.
This
long-term HGR chart encompasses a 15-year secular span that included
every conceivable market condition for gold and its miners’ stocks.
The HGR averaged 0.341x through all of it, or fully 2.3x
higher than today’s extreme lows. That means the gold stocks as
measured by the HUI ought to be trading at least 127% higher than
today’s levels! And that’s assuming gold just stalls out instead of
rallying further.
Instead 2018 is almost certain to see gold surge dramatically higher
in its next major bull-market upleg. That leaves the gold
stocks with early-2016-like potential to skyrocket again, greatly
outperforming gold until their stock prices catch up or more likely
overshoot to the upside. The driver will once again be these
euphoric stock markets rolling over into their next correction or
more likely the long-overdue bear market.
Despite the extreme stock euphoria as 2018 dawns, today’s stock
markets are
hyper-risky. They have powered higher for years now on extreme
central-bank easing before the recent taxphoria. But that has
forced them to exceedingly-dangerous bubble valuations. The
SPX left 2017 with its elite component stocks sporting an average
trailing-twelve-month price-to-earnings ratio of 30.7x, above the
28x bubble threshold!
The
SPX has now gone 1.9 years without a 10%+ correction, and such
selloffs tend to happen at least once a year in healthy bull
markets. Now that the highly-anticipated Republican corporate tax
cuts have indeed come to pass, 2017’s taxphoria will naturally
fade. The more-optimistic Wall Street estimates are for those tax
cuts to boost corporate earnings by 10% in 2018, which still
won’t justify today’s lofty stock prices.
If
this year sees SPX earnings indeed grow 10%, that still leaves its
components’ average P/E ratio way up at a near-bubble 27.6x! Stock
valuations are so extreme after an extraordinary 8.8-year 301.0% SPX
bull market that the biggest US corporate tax cuts ever will barely
put a dent in bubble valuations. That leaves stock markets at risk
for their first correction-grade selloff since early 2016, which is
great news for gold.
But
the real coup de grâce to these euphoric record stock markets will
be this year’s enormous central-bank tightening radically
unprecedented in history. The Fed’s new quantitative-tightening
campaign is ramping up in 2018, starting to unwind years of epic
quantitative easing. And the European Central Bank is sharply
tapering its own QE bond buying by slashing it in half. Together
this will strangle this stock bull.
There is nothing more important to the global markets this year than
this unparalleled tightening by both the Fed and ECB. I wrote a
whole essay
analyzing it in depth back in late October, which every
investor needs to understand! Compared to 2017, 2018 and 2019
will respectively see $950b and $1450b more tightening and less
easing from the Fed and ECB! Nothing remotely like this has ever
before been witnessed.
When
these central-bank-easing-inflated record stock markets face the
biggest central-bank tightening in world history, while trading at
bubble valuations no less, the only possible outcome is a serious
selloff. At best it will be a major correction approaching 20%
in the SPX, but far more likely a new bear market. Those tend to
run near 50% losses over a couple years, annihilating wealth of
investors who get trapped in them.
Just
like in early 2016, the long-overdue next major stock-market selloff
will quickly rekindle major gold investment demand. Investors will
remember gold when their stock-heavy portfolios start tanking, and
rush to diversify into it. The reason gold rallied 29.9% in roughly
the first half of 2016 is investors flooded back into gold
following the last SPX correction. That was led by American
investors heavily buying GLD shares.
This
dominant global gold ETF saw its holdings skyrocket 55.7% or 351.1t
over that same short span! That was just after a 13.3% SPX
correction. Imagine the gold investment demand if we approach 20%
or go beyond into the inevitable next bear. The differential
GLD-share buying forcing stock-market capital into physical gold
bullion could very well be unprecedented. That’s exceedingly
bullish for gold stocks!
When
this gold-demand-killing stock euphoria inescapably breaks, gold
could easily power another 30% higher in 2018. But let’s be
conservative and look for a 20% upleg, which would leave gold near
$1563. That’s still well below gold’s all-time high of $1894 in
August 2011, not extreme by any measure. Gold was above $1550
almost continuously for 1.8 years between July 2011 to April 2013,
we’ve seen it before.
At
$1565 gold and those top-34 GDX gold miners’ average all-in
sustaining costs of $865 during this gold bull, their profits would
soar to $700 per ounce! That’s 78% above 2017 levels. There’s
nowhere else in all the stock markets where such huge earnings
growth is even possible, let alone probable. Such a big surge in
profits coupled with excessively-low gold-stock prices would lead to
huge fundamentally-driven gains.
At
$1565 gold and that 15-year-average 0.341x HGR, that implies the HUI
fair value is around 534. That is 170% above this week’s gold-stock
levels. Thus much like early 2016, the gold stocks truly have the
potential to nearly triple again in 2018 on higher gold
prices! Even better, after being excessively low the gold stocks
tend to not just mean revert but overshoot to overvaluations. So
their upside potential is huge.
The
gold stocks are really
a coiled spring
today, ready to explode higher in 2018 and trounce everything else.
They are deeply out of favor, incredibly undervalued, and one of the
only sectors that can rally sharply when general stock markets sell
off. If you want to multiply your wealth this year by fighting the
crowd to buy low then sell high, this small and forgotten contrarian
sector is the place to be. Nothing else rivals it.
While investors
and speculators alike can certainly play gold stocks’ coming
powerful upleg 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 gold 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 Q3, this has resulted in 967 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 +19.9%!
The key to this
success is staying informed and being contrarian. That means
buying low before others figure it out, before undervalued gold
stocks soar much higher. An easy way to keep abreast is through our
acclaimed weekly
and monthly
newsletters. They draw on my vast experience, knowledge, wisdom,
and ongoing research to explain what’s going on in the markets, why,
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The
bottom line is gold-stock upside potential is huge in 2018. The
gold miners really lagged gold last year due to the extreme stock
euphoria gutting gold sentiment. That left gold stocks deeply out
of favor and exceedingly cheap relative to the metal which drives
their profits. This extreme anomaly won’t last for long, as
investors will flood back into these fundamental bargains as gold
starts powering higher again.
Gold
investment demand is set to surge again when these euphoric stock
markets inevitably roll over into their next major selloff. The
likely trigger will be massive central-bank tightening at
wildly-unprecedented levels. The last time stock markets corrected,
gold shot up almost a third while gold stocks nearly tripled in
merely a half-year! 2018 is perfectly set up for a similar
scenario, portending massive gold-stock gains. |