Gold stocks have been pummeled mercilessly this
month, their price action looking almost apocalyptic. The psychological
stress spawned by such extreme weakness is intense,
breaking the wills of this sector’s few remaining bulls. This week
their selling cascaded into a full-blown capitulation, a mass surrender by
weary investors. While exceedingly miserable, these events flag major
long-term bottoms.
Over the course of gold’s powerful secular
bull, the gold stocks have been a sentiment roller coaster. Early on their
gains were enormous, gold stocks even rocketed higher while the general stock
markets plunged in a brutal cyclical bear. Though they were nearly obliterated in 2008’s
once-in-a-lifetime stock panic, as expected
they soon soared in a massive recovery. Last autumn they hit new all-time
highs.
But since the flagship gold-stock index (HUI) peaked
in September, this sector has really fallen out of favor. Selling begets more
selling, technical levels are broken, sentiment
waxes increasingly bearish, so gold stocks are driven ever lower. In the
first couple weeks of May alone, the HUI plunged 15.2%! Relentless selling
leading to abysmal new lows eventually shakes out all but a bull’s true
believers.
Even though the HUI was already hyper-oversold by
its own bull-to-date standards, it plunged another 8.6% over 3 trading days
ending this past Tuesday. Such massive selloffs from already-deep lows are a
hallmark of capitulation. The
frenzied exit of traders throwing in the towel in great frustration leads to
selling exhaustion. Everyone susceptible to being scared into selling anytime
soon is squeezed out.
But this leaves only buyers, so the nearly total
absence of sellers after a capitulation ignites a big surge. This major
reversal usually matures into a strong upleg. Thus
capitulations, the wholesale abandonment of a sector by traders pushed to
their emotional limits, are one of the greatest buy signals. And this
week’s intense technical weakness and extreme sentimental distress in
gold stocks sure looked like one.
While capitulations are psychological events,
collective emotions can’t be measured. But the miserable impact of
excessive fear and disgust is readily apparent in price action. So the mass
surrender of capitulation is easily identifiable on charts. And the recent
cascading selloff from already-low gold-stock levels is perhaps most vividly
illustrated across multiple gold-stock measures in indexed terms.
The first is the HUI, long the leading gold-stock
index closely followed by investors and speculators. Officially known as the
NYSE Arca Gold BUGS (Basket of Unhedged
Gold Stocks) Index, it currently includes 16 elite major gold miners. But in
this increasingly ETF-dominated world, the GDX gold-stock ETF is
vying for the HUI’s throne. This Market Vectors Gold Miners ETF was
launched in May 2006.
Today GDX has 31 component stocks, but despite its
broader reach it still trades very similarly to the HUI due to the way each
metric’s major components are similarly weighted. For a variety of
reasons beyond the scope of this essay, I suspect GDX will eventually replace
the HUI as this sector’s measuring rod of choice. Its little brother,
the GDXJ junior-gold-stock ETF,
offers the best view of the latest capitulation.
This Market Vectors Junior Gold Miners ETF was
launched by Van Eck Global just like GDX, but quite a bit later in November
2009. While GDX focuses on major gold miners, GDXJ offers a valuable window
into the volatile world of much-smaller producers and explorers. It currently
has a whopping 86 components, dominated by small market-cap companies.
Juniors were ground zero for this capitulation.
And of course no look at gold stocks would be
properly framed without considering gold. This metal’s price naturally
drives the long-term profitability and hence ultimately the stock prices of
the companies that produce it. The fact that gold stocks plunged so
dramatically relative to gold remaining high and strong greatly enhances the
odds for success in this post-capitulation gold-stock buying opportunity.
With 4 data series on 4 different scales, the only
way to parse them all at once is by indexing them. This makes them perfectly
comparable in percentage terms. I set each individual index to 100 as of the
HUI’s recent all-time high in early September 2011. From there a 10%
move higher or lower takes any index to 110 or 90 respectively. This first
chart establishes some strategic context for identifying capitulations.
![](http://www.24hgold.com/24hpmdata/articles/2012/05/img/20120519CLA07551.gif)
Because gold’s fortunes are gold stocks’
only real long-term fundamental driver, I zeroed the vertical axis so this
latest capitulation can be understood relative to gold. Gold has had a rough
time lately, no doubt. A relentless parade of economic fears out of Europe,
Asia, and the US, as well as traders realizing the Fed isn’t going to launch a third round of inflationary quantitative easing
anytime soon, really hit gold.
Since its latest interim high in late February, gold
was down 13.9% as of this week. While that isn’t a trivial selloff,
gold was still only dragged back to a 10-month low. Even though gold fell
under $1550 and spooked excitable traders, you have to remember that before a
year ago such levels had never even
been seen before! Technically gold has merely been consolidating high
after getting very overbought last August.
But the gold-stock investors and speculators have
wildly overreacted to this relatively minor gold selloff in the grand scheme.
Over this same short 11-week span, the HUI was pounded 31.5% lower. To give
you an idea of how disproportionate this was compared to gold, the HUI hit
27-month lows this week! There is a huge disconnect between gold slumping to
10m lows and its miners being pummeled to 27m ones.
And it gets even worse. This week’s
capitulation beat the flagship HUI gold-stock index back down near 375. The
first time the HUI exceeded 375 in this secular gold bull was way back in
September 2007. Where was gold then? It had just approached $720 for the first
time in this bull! So this week, gold stocks were trading as if gold was at
$720 when this metal was really 2.1x higher near
$1540! Crazy.
As you can see above, the indexed blue HUI line and
white GDX line are virtually identical. But the red GDXJ performance is
radically different. This premier junior ETF was obliterated this week,
falling to the lowest levels it’s ever seen since its birth in November
2009. The highly-speculative juniors are a great weathervane for gold-stock
psychology in general, and they were wildly
out of favor this week.
Gold juniors have long been our specialty at Zeal,
and we own plenty of them thanks to gold stocks languishing at stock-panic levels relative to gold in
recent months. During this week’s capitulation, even though many of
these stocks were already near major multi-year lows, some plummeted by 10%
to 20% on a single trading day with no news! Extreme selling from lows, for
no reason, is a capitulation.
And the jaw-dropping magnitude of the recent
gold-stock selloff is crystal-clear on this zeroed indexed chart. The gold
stocks, big and especially small, have just cascaded lower in a waterfall
decline. The psychological angst, pain, and pressure such a brutal selling event
spawns are nearly impossible to resist for all but the most battled-hardened
contrarians. Gold stocks have just fallen off a cliff lately.
Such immense selling has only been seen one other
time before in recent history, during 2008’s epic stock panic. Gold
stocks plummeted then, again dramatically outpacing gold’s own decline.
They ended up at absurdly-oversold levels that I pointed out at the time
were a once-in-a-lifetime buying opportunity. And indeed
this sector soon started surging, the HUI more
than quadrupling in the next 3 years!
The stock-panic plunge leading into that amazing
time to fight the scared herd and buy aggressively is provocatively the only
other recent event remotely comparable to this latest gold-stock
capitulation. Extreme weakness, shaking out every last trader who can’t
withstand the intense pressure of fundamentally-sound positions plunging for
emotional reasons, paves the way for enormous rallies.
Could the HUI actually quadruple again in the coming
3 years? Absolutely. As I’ve discussed in many essays since the stock
panic, this index had an average ratio to gold of 0.511x in the 5 years before 2008’s stock panic. This
week the HUI/Gold Ratio plunged to 0.244x, levels
only briefly seen during the
panic’s dark heart. If gold merely stays flat near its recent lows, the
HUI would have to more than double
just to regain its pre-panic HGR!
But given gold’s bullish fundamentals
globally, this metal certainly isn’t likely to languish near lows in
the coming years. With mine supply growth
still heavily constrained and investors including central banks still
seriously under-allocated to this unique asset, gold’s
secular bull ought to have years left to run yet. And by the time we
see that popular-mania parabolic gold-bull climax, the HUI will likely easily more than quadruple.
This next chart zooms in to highlight this latest
gold-stock capitulation. The selling in the gold stocks, especially the
high-potential juniors, was wildly disproportionate relative to what has
happened in gold. Once again the HUI, GDX, GDXJ, and gold are all indexed to
100 as of the day the HUI’s all-time high was achieved last September.
The sheer carnage driven by this irrational gold-stock capitulation is unreal.
![](http://www.24hgold.com/24hpmdata/articles/2012/05/img/20120519CLA07552.gif)
Since their latest highs, the HUI and GDX plunged by
40.8% and 41.0% as of this week. This is ridiculous given gold was only down
18.8% from its own all-time high a little earlier. But the selling in the
major gold miners was dwarfed by the apocalyptic plunge in the juniors. From
its latest interim high last April, GDXJ was down a stomach-churning 57.8% as
of this week! Juniors are getting obliterated!
These highly-speculative stocks are tasked with the
critical mission of discovering and starting to mine new gold deposits to
feed the world’s voracious investment demand for this yellow metal. And
just like larger miners, the price of gold determines the profitability of
these hard labors. And universally in the stock markets, any company’s
long-term profits ultimately drive its long-term stock-price levels.
When GDXJ peaked in early April 2011, gold had just
hit $1475 for the first time in history. And given this ETF’s ascent
into that interim high mirroring but only modestly outperforming the HUI,
that valuation of gold-stock prices relative to gold was certainly
conservative. But fast-forward to this week, and this basket of elite gold
juniors was 58% lower while gold itself actually rose 4% over this same span!
Why is the entire gold industry valued between 40% to 60% less
when gold is gradually inching higher even at its recent lows? You
have to agree this makes no sense at all fundamentally,
it is incredibly illogical and irrational. We continue to do extensive
research into gold juniors at Zeal, and they continue to find excellent new
deposits and bring great new mines online just like they always have.
In fact besides the lack of investor interest (which
makes it very difficult to raise the capital needed to explore and mine),
juniors as a whole have no new industry-wide operational problems or
impairments. The entire junior-gold rout culminating in this latest
capitulation is purely emotional, it
has absolutely nothing to do with fundamentals. Gold-stock investors and
speculators are simply scared, end of story.
The same is true in the major gold miners, where
we’ve done extensive research on
their profit margins. In both gross-margin and absolute terms, gold-mining
profits continue to rise dramatically thanks to these sustained high gold
prices. Late last August heading into the HUI’s all-time high, its
components had a market-capitalization weighted-average price-to-earnings
ratio of 23.3x earnings. By the end of April, it had plunged to just 13.2x!
So it’s not like gold miners aren’t
earning money anymore with gold near $1500 instead of $1800. They are
actually earning profits hand over fist, and are seriously cheap even by
general-stock-market standards. 2011 was gold miners’ most profitable
year ever by far, when gold averaged $1573 on close. So far this year,
despite all the bearish gold hysteria, gold has averaged $1672! This is 6%
higher.
Regardless of which angle you choose to view gold
stocks from, their steep selloff culminating in this week’s
capitulation climax makes zero sense
fundamentally. The hard truth is gold stocks have been sold wildly
disproportionately to gold’s own weakness merely because investors and
speculators succumbed to their own unjustified fears. Capitulations are
always irrational, emotional events.
The extreme fear and disgust generated by these
exceptional selling climaxes force out every last trader that lacks emotional
discipline. Sadly all many investors and speculators can think about is the
last couple weeks’ technical action. They can’t be bothered with
researching gold-stock fundamentals, or with learning the essential
contrarian discipline of keeping their own emotions in check. So they
surrender.
The capitulation event itself forces all the weak
hands to exit at once, they sell low in their rush
to realize huge losses. But once they are gone, the buyers regain control.
And with everyone too scared shaken out, sentiment quickly swings back away
from extreme fear and disgust. So capitulations nearly always spawn huge
rallies and uplegs, major advances are born out of
the deck-clearing throes of despair.
And indeed one appears to be starting. As I pen the
draft of this essay on Thursday, gold and the gold stocks are surging
dramatically out of Tuesday’s and Wednesday’s hyper-oversold
lows. Even weak general stock markets weren’t enough to retard
early-day gold and HUI rallies on the order of 2.5% and 6.0%! The sharp
bounce after a brutal cascading selloff offers confirmation the capitulation
is over.
At Zeal we’ve been actively trading gold
stocks for over a decade, earning a fortune through every kind of extreme
sentiment condition you can imagine. This week’s capitulation certainly
isn’t the first time gold stocks have been loathed. Like every other
sector, they gradually oscillate from in favor to out of favor and back
again. If you can steel yourself to fight the crowd, be brave when others are
afraid, you can buy them at incredible bargains occasionally. And today looks
like just such a rare opportunity.
Since the vast majority of selloffs don’t
climax in full-blown capitulations, such events are inherently unpredictable.
So we did plenty of buying earlier in this gold-stock selloff. But all our
positions are deeply-researched elite high-potential gold stocks with
outstanding fundamentals. You can learn about them in our popular fundamental reports. Our latest on
gold juniors are full of awesome companies trading
at irresistible bargains. Buy your reports today, learn about
these elite juniors, and buy cheap!
We also publish acclaimed weekly and monthly subscription
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The bottom line is gold stocks appear to have just
suffered a full-blown capitulation. For no fundamental reason whatsoever,
they cascaded sharply lower from major lows. Traders simply let their own
fear and anxiety overpower their reason, so all the weak hands rushed for the
exits to end the pain. While miserable to suffer through, these rare extreme
selling climaxes mark major long-term bottoms.
So if you can keep long-term fundamentals in focus
and tame your fear, capitulations are the worst-possible time to sell and an
amazing time to buy. Though they feel like hopeless death spirals, this very
despair quickly burns itself out. And with buyers greatly outnumbering
sellers, prices soon rocket higher to undo the tremendous technical damage of
the capitulation. Gold
stocks are due to rebound sharply.
Adam Hamilton,
CPA
May 19, 2012
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