If you are a
gold-stock investor, the dark cold days surrounding the winter
solstice seem exceptionally fitting this year. As the warm sunlight
has largely fled the northern hemisphere, so has bullish sentiment
largely fled the gold stocks. Thankfully as inevitably as sun
returning to the north, gold-stock sentiment too will thaw.
Today?s terrible
gold-stock sentiment is really something of a paradox. The gold
price is the primary long-term driver of gold miners? profits and
hence their stock prices. And gold is really looking good these
days. After powering over
$800 nominal
for the first time in a quarter century in early November, gold has
since casually meandered near $800 like it was born to trade here.
Over the 33
trading days since gold?s first foray over $800, it has averaged
$804 on a closing basis! Gold-stock investors and speculators ought
to be dancing in the streets, jumping for joy, as it is hard to
imagine better news for gold miners. $800 gold seemed impossibly
high for the first six years of this gold bull, but it has now
become the new reality. Nevertheless, gold-stock traders are very
discouraged.
Sentiment is so
bad that even long-time gold-stock investors are considering moving
their gold-stock capital into gold bullion. This week I saw a
professional gold-stock fund manager on CNBC saying he was
considering deploying all his capital in gold because he
thought gold stocks? profits would wane due to operating cost
increases. This is amazing to hear from a professional
gold-stock investor!
I love physical
gold investing and have always thought that it needs to be the
foundation of every investment portfolio. But while 10% to
20% of one?s portfolio should always be in gold, I think 100% is a
bit extreme. Over the course of entire commodities bulls all
throughout history, mining stocks far outperform their underlying
commodities. Gold stocks are the classic way to leverage and
multiply gold?s gains.
But although
stocks outperform commodities over entire bull cycles, despite
inflationary cost increases, their outperformance is highly
cyclical. Sometimes the underlying commodity soars, leaving the
stocks in the dust for a season. Later the stocks catch a bid and
blow past the commodity, far more than making up for lost ground.
Stocks? outperformance of commodities is certainly not a smooth
linear phenomenon.
And much like the
endless greed and fear cycles in the markets, after a long period of
one type of behavior (either stock outperformance or
underperformance) traders naturally start to extrapolate it out into
infinity. You know the thought pattern. ?Well, since gold has
outperformed stocks for so long now maybe they will never outperform
gold again. To heck with gold stocks, I am going solely with gold.?
But this is the
same type of flawed logic that gets traders in trouble at major
interim tops and bottoms. Remember the NASDAQ top in March 2000?
?Tech stocks have gone up for a decade now so they will probably
keep going up forever. We are in a New Era now.? Whenever one
condition lasts long enough for traders to assume it is permanent,
the markets tend to quickly change and crush that flawed perception.
I suspect we are
reaching a similar inflection point regarding gold and gold stocks.
Gold has outperformed for a long time now so traders assume this new
status quo is going to last forever. But in reality, relative
performance is very cyclical. Gold outperforms for a while, then
the stocks outperform for a while. After long periods of gold
outperformance is actually when the stocks are the most likely to
suddenly rocket higher.
This cyclical
nature of outperformance is readily evident in our gold-stock bull
to date. My favorite way to look at it is via the HUI/Gold Ratio.
The HGR is very simple just like it sounds. The closing price of
the flagship HUI unhedged gold-stock index is divided by the closing
price of gold on an ongoing daily basis. Then the resulting ratio
is charted over time. It creates a continuing chronicle of relative
outperformance.
Since the HUI is
in the numerator of this ratio, a rising HGR line means the gold
stocks are outperforming gold. Conversely with gold in the
denominator, a falling HGR means gold is outperforming the gold
stocks. Now please realize this doesn?t necessarily mean both are
rising. If gold is falling at a slower pace than gold stocks in a
correction, for example, gold is still ?outperforming? gold stocks
to the downside.
If today?s popular
thesis that gold is destined to outperform gold stocks forever is
correct, then the HGR will perpetually grind lower. But the reality
of this bull is quite different. Since early 2001 when gold?s
secular bottom arrived, the HGR has been meandering higher on
balance. Standard technical analysis applied to this ratio,
rendered below in blue, is very illuminating. Perhaps gold stocks
aren?t doomed to forever linger in limbo in gold?s dark shadow.
This graphical
depiction of relative outperformance drives home just how cyclical
it really is. While the HGR has risen nicely on balance, it has
been one wild ride. This chart is extremely volatile, witnessing
dazzling spikes rocketing higher followed by long periods of
sideways-to-lower grinding in between. If you can internalize the
relative outperformance trends so far in this bull, you?ll have a
much better idea of what to expect going forward.
First consider the
temporal division of outperformance. This whole chart covers 28
quarter-year periods. Within this seven-year span, there have
really only been four episodes of sharp HUI outperformance. They
are numbered in blue above. If you count the quarters over which
these massive gold-stock rallies unfolded, the number is somewhere
around 10. So gold stocks have only radically outperformed gold in
10 of 28 quarters since 2001. This works out to 36% of the time,
not much more than a third.
So everything else
being equal, based on this bull so far we should expect gold stocks
to not be radically outperforming gold almost 2/3rds of the
time. In reality gold-stock traders are far less patient. If gold
rises in a single trading day, but gold stocks don?t dutifully
leverage this gain instantly, traders get worried and start spinning
bearish theories. This is very irrational from a long-term
perspective though.
The 1/3rd of the
time when gold stocks radically outperform gold is cyclical in
nature and readily apparent in the HUI/Gold Ratio. This ratio tends
to surge up to major interim highs on gold-stock outperformance.
This happens when the HUI is powering higher in
massive uplegs.
(For reference, the raw HUI is charted above in red off the left
axis.) But after these huge HUI uplegs, the HGR drifts sideways for
a season. These drifts are just as important as the surges.
Whenever gold
stocks rocket to new bull highs, traders get uncomfortable. They
wonder if the bull is over and if such lofty prices are
sustainable. So gold stocks enter high consolidations after massive
HUI uplegs. This trading sideways not only bleeds off the excess
greed rampant at the preceding upleg top, but it gives traders time
to acclimate to new high prices. Drifts build the technical base
off of which the next surge eventually launches.
This surge-drift
pattern drives the HGR higher in fits and starts. The ratio surges
higher on relative HUI outperformance, but then it drifts sideways
for a long period of time to acclimatize. Often these sideways
drifts angle lower too, which shows relative gold outperformance.
Since these drifts last longer than the surges, relative gold
outperformance is the norm rather than the exception.
Nevertheless, the relative outperformance is highly cyclical and
eventually the next HGR surge will come despite the naysayers.
As this chart
shows, over time this surge-drift pattern has created a secular
uptrend in the HUI/Gold Ratio. With the exception of an impressive
surge above this uptrend in late 2003/early 2004, the HGR has been
very comfortable within this secular support and resistance channel
for six years now. This rock-solid uptrend has huge implications
for gold-stock investors and speculators today.
Since early 2006
at the apex of the last major HUI upleg, the HGR has been drifting
sideways to lower. On balance, gold has been outperforming the gold
stocks which is increasingly discouraging traders. But this typical
post-upleg drift has accomplished a great deal technically. Where
the HGR was way up near its resistance after the early 2006 surge,
today it is down near support thanks to the subsequent long drift.
Over the last six
years, there have only been five major support approaches including
today?s. It is provocative that the first four couldn?t remain near
support for long. Whenever sentiment got bad enough to drive the
HGR to such dismal lows, soon after the HUI blasted higher. Some
support approaches, like 1 and 4 labeled in yellow above, simply
resulted in sharp and fast HUI rallies.
But other support
approaches, 2 and 3 above, resulted in some of the biggest massive
uplegs seen in this entire gold-stock bull! They occurred right at
the very beginnings of huge surges higher in the HGR driven by
extreme gold-stock outperformance. So worst case a support approach
calls for a sharp and fast HUI rally, but best case it can portend a
new and highly profitable massive upleg in the gold stocks. And we
are right at this ultra-bullish long-term support line again now!
Such a new massive
upleg today would carry the HGR up to its upper resistance. Since
these take a couple quarters to unfold, HGR resistance would
probably be near 0.70 by the time this happened. Where would the
gold price climb to drive such a massive gold-stock upleg? Probably
at least to $900 to $1000. At $900 gold, a 0.70 HGR yields a HUI
target of 630. At $1000 this jumps to 700. Incidentally these
HGR-HUI targets are right in line with the
HUI upleg cycle
targets of 580 to 700 for the HUI in this upleg.
So just because
the HGR has been drifting for some time now doesn?t mean it is
permanent. HGR drifts are more common than surges, but the surges
always erupt late in the drifts when most traders have largely given
up hope. In both time and technical terms, we are now overdue for a
surge where gold stocks radically outperform gold for a couple
quarters and the HUI surges to incredible new highs.
Before we move on,
I want to address one more aspect of this long-term HGR chart. The
HGR hit its bull high in late 2003, and wasn?t able to exceed it in
early 2006. So measured from a top basis, the case can be made that
gold stocks haven?t outperformed gold since late 2003. While
technically true, this is misleading. As I discussed last week in
reference to euro
gold, extreme outlying highs are not the optimal measure from
which to consider a bull?s progress.
At highs, euphoria
reigns supreme. Unbelievable greed can drive mind-blowing prices,
but they just aren?t sustainable. As soon as the greed abates,
prices plunge. So over the long term, interim lows far better
reflect sustainable fundamental realities than interim highs. At
major interim lows, euphoria is nonexistent. Most traders have
abandoned a sector temporarily, and the remaining ones are quite
discouraged. So interim lows offer a superior fundamental picture
(not greed-tainted) of true sustainable price levels.
Much like
euro gold?s support
was rising on balance for years yet traders ignored it in favor of a
few outlying highs, the HUI/Gold Ratio?s support has also been
rising for years. This means that even at the worst of times
sentimentally, fundamentals supported a rising HGR. On balance gold
stocks have outperformed gold for years. This is confirmed by the
HGR?s rising-on-balance 200-day moving average. And if you drew a
mathematical best-fit line into this chart, it would rise at a
strong slope to the right.
So I wouldn?t get
hung up on the late 2003 HGR high. No it hasn?t been exceeded yet,
but it was an extreme extra-trend outlier. I strongly suspect that
either in this gold-stock upleg or the next the HGR will climb over
0.65, achieve new bull highs, and hit its rising resistance. Due to
the nature of secular gold bulls, I am almost certain that we will
see higher HGR levels to come. It is only a matter of time.
This next chart
zooms in a bit to focus on our current HGR drift since early 2006.
While this tactical perspective isn?t as important as the strategic
perspective above, it still offers some additional insights. Once
again the raw HUI is rendered in red behind the blue HGR for easy
comparison.
As the
down-sloping initial drift resistance shows, gold was really
outperforming the HUI on balance for most of this drift. This trend
started to change back in July, when the HGR made an upside breakout
above this drift resistance line. Since then, the HGR has showed a
lot more strength indicating that this drift is maturing. It is the
worst possible time for traders to extrapolate gold outperformance
out into infinity.
The HGR?s drift
support line was also trending lower, but only slightly. Almost
like clockwork, every two or three months in this drift the HGR
would hit this support line and bounce. But several times,
including today, the HGR suddenly knifed under its drift support.
These sub-support episodes were very short-lived though. Whenever
they happened, a sharp HUI rally soon ensued to yank the HGR back up
into more normal territory.
With sharp HUI
rallies occurring in both June 2006 and August 2007 after the last
deep sub-support HGR episodes, I suspect we can reasonably expect
another sharp HUI rally today out of our latest sub-support
episode. And as late as we are in this drift, as irrational as fear
and pessimism surrounding gold stocks have become, a massive upleg
is just as likely as a simple rally. We are sure overdue for one!
The sharp HUI run
starting in mid-August out of the last sub-support HGR episode is
also interesting to consider. While the HUI itself soared to easily
break out of its long consolidation, the HGR did not. Before the
HUI rally even got halfway to its early November interim high, the
HGR stalled. After that the HUI was merely pacing gold, not
outperforming it. While this discouraged a lot of traders, I think
its interpretation is actually bullish.
In these giant HGR
surge-drift cycles, the surges are solely defined by massive
outperformance of gold by the gold stocks. Clearly this didn?t
happen between mid-August and early November per the HGR. This
means that the sharp HUI rally we saw recently was not the one
that this mature HGR drift is calling for! In pure HGR terms, this
recent rally was irrelevant. The expected massive surge upleg is
still entirely yet to come.
Now I know there
are legions of bearish theories surrounding gold stocks today, as
there always are prior to massive uplegs when traders are
discouraged from the preceding long consolidations. Many of these
theories focus on problems gold miners are having mining gold.
While gold mining is indeed
very challenging,
it is important to realize that near-term profits growth is not the
only driver of gold-stock prices.
Like every other
price on the planet, gold-stock prices are set by supply and
demand. If traders want to buy more shares than are offered for
sale over any given span of time, a stock price has to rise.
The rising price retards demand and entices out more supply to
create a new market-clearing price where all traders who want to
trade are able to do so. While profits help drive long-term stock
demand, they are irrelevant over this pure short-term share
supply/demand perspective.
A couple weeks ago
I did a study on the
GDX Gold Miners ETF.
Its 34 component companies represent the lion?s share of the entire
gold-stock world in market-capitalization terms. Back in early
December, prior to this week?s HUI carnage, all 34 GDX component
companies added together only had a market capitalization of
$163b. This compared to $220b for Google alone and $13,369b for the
S&P 500. Gold stocks remain an exceedingly small sector. There
aren?t many shares available to meet demand surges.
So as gold travels
higher as it ought to due to
the US dollar
woes and endless
fiat-paper
creation by the central banks, will mainstream stock investors
get interested? Will $900 or $1000 gold get their attention? I bet
it will. Like all investors, mainstreamers want to chase momentum.
Some will buy GLD,
the gold bullion ETF, for exposure. But I am sure the more
speculative-bent will look to leverage gold?s gains through gold
stocks, just as we contrarians have done for over six years now.
With today?s
entire tiny gold-stock sector probably in the neighborhood of
$175b in market capitalization, it won?t take a lot of bidding to
drive stock prices up fast. This is just a trivial amount of
capital in general stock-market terms. New mainstreamers flooding
in won?t be worried about long-term profits growth, but short-term
stock-price gains. If they are willing to own GOOG at 55x earnings,
they aren?t going to be the least bit worried about gold-stock P/E
ratios.
So despite rising
operating costs and profit pressures on gold miners, the
speculators who will rush in to drive a surge in gold stocks
won?t care one bit. They will be looking for short-term capital
gains and have zero interest in the long-term viability of gold
miners. Massive HUI uplegs have always been far more sentimental
than fundamental in nature. It is greed, not underlying stock
profits growth, that drives them.
At Zeal we have
been battered and bruised since early November like the rest of the
gold-stock traders. Nevertheless, we focus on the long-term picture
and don?t believe the fear-drenched status quo will last forever.
So we have been buying
elite gold stocks in our
subscription
newsletters lately and preparing for the next upleg. It is
never easy buying when sentiment is rotten, yet this is when the
most favorable buying prices arrive.
Join us today to
ride this coming massive surge upleg!
The bottom line is
gold has been outperforming the HUI since early 2006. But
contrary to trader fears, this isn?t going to last forever.
Relative outperformance is highly cyclical. Gold outperforms about
2/3rds of the time during HUI/Gold Ratio drifts. But when the HUI
outperforms the other 1/3rd of the time during surges, watch out!
Truly legendary gains can be won during these massive gold-stock
uplegs.
The longer that
any given market condition has persisted, the harder it is to
believe that it could actually change. Yet change always happens.
The markets abhor all extremes and they are never sustainable.
Based on market history, there is almost zero chance that we have
entered a New Era where suddenly gold is going to outperform gold
stocks forever. Gold stocks will have their day in the sun again.
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