The
gold miners’ stocks have blasted higher to a powerful upside
breakout this month. Amplifying gold’s underlying surge, they’ve
achieved major new bull-market highs. Yet despite that big
rallying, gold stocks remain undervalued relative to the metal they
mine that drives their earnings. They still need to mean revert
much higher to reflect prevailing gold prices, with momentum buying
fueling a proportional overshoot.
Markets are forever cyclical, flowing and ebbing in endless marches
of uplegs and corrections within bulls and bears. Price action is
pendulum-like, oscillating between opposing extremes. Those include
high and low technicals, overvalued and undervalued fundamentals,
and greedy and fearful sentiment. Long-term averages reflect the
bottom midpoints of pendulum arcs, mean-reversion targets for
stretched prices.
But
pendulums pulled way to either side don’t stop in the middle once
they start swinging back. Their kinetic momentum carries them well
through their midpoints in proportional overshoots to the
other side. Markets dragged to either extreme function similarly,
not just normalizing to averages but swinging right through to
opposing extremes. Gold-stock cycles are no exception, and they
recently saw an extreme anomaly.
Gold-mining profits are overwhelmingly driven by prevailing gold
prices, as mining costs only change gradually. This is readily
evident in the major gold miners included in the benchmark GDX
gold-stock ETF. Their
last-reported
quarterly results were Q1’24’s, where the top 25 GDX gold miners
averaged $1,277 all-in sustaining costs. Subtracting those from
gold’s average price yields a great sector earnings proxy.
In
Q1 gold averaged $2,072, so GDX-top-25 profits ran $795 per ounce.
A year earlier in the comparable Q1’23, gold was $1,892 while it
cost these elite majors $1,302 to produce. That made for unit
earnings of $589 per ounce. So during a year where average gold
prices rallied a nice 9.5%, the GDX-top-25 majors’ profits surged
34.9%. This latest real-world example clocked in at
excellent 3.7x upside leverage to gold!
Stock prices ultimately reflect some reasonable multiple of
underlying earnings, and gold price trends fuel the great majority
of gold miners’ profits. Thus gold stocks have always acted like
leveraged plays on the metal they mine. After painstakingly
analyzing the GDX top 25’s latest results for 32 consecutive
quarters now, I can sure tell you that takes a ton of work! But an
easy proxy decently reflects this key fundamental link.
It’s
simply the ratio between gold-stock and gold price levels.
Charted over time, this shows whether gold stocks are overvalued or
undervalued relative to the metal driving their earnings. For many
years I’ve been using the GDX/GLD ratio or GGR variant of this
metric. It divides that leading gold-stock ETF’s daily closes by
those of the mighty American GLD gold ETF, the largest
physical-bullion-backed one in the world.
The
GGR’s positioning relative to recent-year averages is analogous to
gold stocks’ valuation pendulum. That was recently pulled to an
exceedingly-anomalous extreme, with the mean reversion now well
underway. Odds highly favor that momentum buying fueling a
proportional overshoot, arguing much more gold-stock gains are
coming. In this chart the GDX/GLD ratio in blue is superimposed
over the raw GDX in red.
Flagging market extremes is important for trading since they mark
major cyclical reversals, the tops of pendulums’ arcs. The
more-extreme any extreme, the greater the likelihood it will spawn a
proportional mean reversion and overshoot. An astounding one
happened in late February, when GDX plunged to just $25.79. That
was actually marginally under early October’s $25.91 when gold’s
latest upleg was born.
Over
a 4.8-month span where gold had powered 11.7% higher in a strong
upleg, the leading gold-stock ETF somehow slipped 0.5% lower!
That was insane, as I pointed out to our newsletter subscribers at
the time. Normally major gold stocks amplify material gold moves by
2x to 3x, thus GDX should’ve been up 23% to 35%! So our newsletters
added a bunch of cheap gold-stock trades in February as this anomaly
worsened.
On
February 28th at that inexplicable GDX nadir, the GDX/GLD ratio
collapsed to just 0.137x! Though an extreme 4.0-year secular low,
that understates how anomalous this was. The GGR had only been
slightly lower at 0.133x on one single day in the dark heart
of March 2020’s pandemic-lockdown stock panic! The market fear then
was off the charts, as the flagship S&P 500 index plummeted 33.9% in
just over one month!
Everything including gold stocks was sucked into that brutal
maelstrom of panic selling, as GDX suffered a miserable 38.8%
freefall over several weeks. But that was understandable with stock
markets’ VIX fear gauge soaring to challenge 83. Gold stocks’
mean-reversion overshoot out of that wild extreme was huge, with
GDX skyrocketing 134.1% over the next 4.8 months! Super-low
GGRs are phenomenal buying ops.
But
there was zero market fear in late February 2024 as the GGR
revisited those stock-panic-grade lows, with the VIX under 14. And
if it hadn’t been for that single stock-panic day, this recent GGR
low would’ve proven gold stocks’ worst levels relative to gold in
fully 8.1 years! The sheer extremity of this latest
gold-stock-valuation anomaly can’t be overstated. This sector’s
cyclical pendulum was stretched to a breaking point.
Indeed the mean reversion since then is gathering steam, with GDX
powering 52.3% higher at best as of mid-week. Our newsletter trades
added in February while that extraordinary GGR anomaly festered
already have unrealized gains as high as +97%! But this
gold-stock pendulum is only beginning to swing the other way after
stretching to 4-to-8-year extremes. This Tuesday the GGR had merely
recovered to 0.172x.
While quite an improvement from late February’s absurd 0.137x, that
hasn’t even regained averages let alone swung through to the
other side. The last quasi-normal years for gold stocks were 2019
to 2021. In 2022 gold and thus gold stocks were crushed by heavy
gold-futures selling driven by a monster US Dollar Index rally on
the most-extreme
Fed rate hikes ever witnessed! GDX collapsed 46.5% during that.
That
horrible carnage left gold stocks deeply out of favor, and
more-normal sentiment is only starting to return. In 2019 to 2021
before all that unprecedented 2022 craziness, the GDX/GLD ratio
averaged 0.199x which is a reasonable mean baseline. GDX would have
to rally another 18% from here at mid-week gold prices to mean
revert, near $45.25. But pendulums stretched to secular extremes
demand overshoots.
Late
February’s epic anomaly was 0.062x under that 2019-to-2021 average,
revealing extraordinary gold-stock undervaluation relative to gold.
A proportional overshoot as the pendulum swings back driven by
momentum buying portends a topping GGR of 0.261x. Plug that into
mid-week GLD levels, and that yields a GDX upside target above
$59.25! That’s another 54% higher from here, a big rally
well worth riding.
Interestingly that would leave GDX’s entire upleg with massive
130.0% gains. That’s right in line with that last GGR
mean-reversion overshoot out of that pandemic-lockdown stock panic
when GDX soared 134.1%. The symmetry of similar GGR extremes
yielding similar rebound uplegs is certainly agreeable. But it
wouldn’t surprise me at all if gold stocks do even better, as their
setup this time around is uniquely-bullish.
The
major gold miners’ latest quarterly results for Q2 are imminent,
being reported from late July to mid-August. As I analyzed in a
late-June essay, the gold miners likely
achieved record
quarterly earnings. That’s mostly due to dazzling record
quarterly-average gold prices, which clocked in at $2,337! That
surged 18.2% YoY, the most since Q4’20. As I explained then,
GDX-top-25 AISCs should come in near $1,325.
That
would make for implied Q2 unit profits of $1,012 per ounce.
That’s not only the best ever by far, but would soar 69% YoY! With
the great majority of traders apathetic on gold stocks in recent
years and not paying attention, gold miners’ epic earnings should
really surprise in coming weeks. Exceedingly-strong fundamentals
ought to start attracting fund investors, resulting in big capital
inflows accelerating this upleg.
Also
buying begets buying, as speculators and investors alike love
chasing upside momentum. The longer and higher gold stocks
rally, the more traders will want to deploy more capital to ride
those gains. That will also generate more-frequent and more-bullish
financial media coverage, further expanding awareness of this
sector. This virtuous-circle dynamic is largely responsible for
gold stocks’
upside breakout in July.
The
resulting buying could persist on balance for a long time. This
chart shows gold-stock valuations have languished in a downtrend for
several years now. Not only was a major reversal all but certain
after late February’s extreme lows, the GGR has already surged back
up through that entire downtrend channel. It looks to be
breaking out now, laying the groundwork for a new secular
uptrend getting underway.
And
gold stocks’ upside potential is proportionally boosted by gold’s
underlying upleg and bull market still looking like they have a long
way to run yet. After
consolidating
high mostly between $2,300 to $2,400 in recent months, gold just
surged over mid-May’s last record close of $2,424 this week. Near
$2,465 on Tuesday, gold’s total upleg since early October has
grown to a mighty 35.5%! This run has proven remarkable.
Normally powerful gold uplegs are fueled by sequential buying
largely from gold-futures speculators and American stock investors.
The latter is evident in the combined physical-gold-bullion holdings
of the GLD and IAU gold ETFs, the world’s largest. Yet during
gold’s upleg so far, these holdings have actually fallen 4.5%
or 57.2 metric tons! American stock investors haven’t even yet
started chasing today’s gold upleg.
They
are entranced by this
AI stock bubble,
ignoring everything else. But as that inevitably decisively bursts,
the scales will fall from their eyes. They will marvel at these
record gold prices and remember the wisdom of diversifying their
tech-stock-heavy portfolios with gold. Today’s gold upleg is the
biggest by far and first to achieve new-record-high streaks
since a pair both cresting in 2020, begging to be noticed by all.
Gold
uplegs grow to monster size on
gold-record
momentum. Increasing buying drives gold higher on balance
hitting more traders’ radars. Record streaks also generate
increasing financial-media coverage which grows more bullish. The
faster gold rallies, the more traders want to buy. The more they
buy, the faster gold rallies. The resulting surging prices attract
in the financial media, spreading awareness among traders.
Again today’s mighty 35.5% gold upleg happened despite 57.2t GLD+IAU
draws. Yet that 2020 pair of uplegs soared 42.7% and 40.0%,
directly fueled by huge GLD+IAU-holdings builds of 30.4% or
314.2t and 35.3% or 460.5t! Today’s upleg has mostly been driven by
Chinese-investor and central-bank buying, who have done most of the
heavy lifting. That leaves American stock investors big room to
flood back in.
It
doesn’t matter how big gold’s upleg has already grown, it’ll get a
lot bigger on normal differential GLD-and-IAU-share buying.
American stock investors could easily swing their gold investments
from about -50t in GLD+IAU-holdings terms to +400t or more!
That portends much more gold upside ahead. And the higher gold
powers, the bigger the ultimate gold-stock gains since gold prices
directly fuel their earnings.
While the GDX majors will do great, smaller fundamentally-superior
mid-tiers and
juniors will fare much better. They are better able to
consistently grow their production from smaller bases. Their
littler stables of mines tend to have lower costs too, boosting
their profitability. Their smaller market capitalizations also make
their stocks much easier to bid higher. Our newsletter trading
books are full of great smaller miners.
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The
bottom line is gold stocks are mean reverting relative to gold and
due to proportionally overshoot. Gold-stock prices were recently
pounded to exceedingly-anomalous levels not witnessed since the very
bottom of the last stock panic. Gold stocks have enjoyed a strong
mean-reversion rebound since. But they remain well under recent
years’ average levels compared to gold, let alone overshooting to
high ones.
Gold
stocks have an exceptionally-bullish setup supporting much-bigger
gains. Gold miners are about to report their best quarterly results
and fattest profits ever, fueling institutional buying. Meanwhile
American stock investors haven’t even yet started chasing gold’s
underlying upleg. Their inevitable return once this AI stock bubble
rolls over should drive gold much higher. The undervalued gold
stocks will amplify those gains. |