Commodity Trade Mantra

Gold Investment Demand Will Drive Gold Stocks Higher

Gold Investment Demand Will Drive Gold Stocks Higher

Gold Investment Demand Will Drive Gold Stocks Higher

Gold-mining stocks surged higher this past week after breaking free from their high consolidation.  This newest upleg catapulted gold stocks to a doubling in less than 3 months, a remarkable world-leading performance.  But despite its quick doubling, this red-hot sector still has another easy doubling left to come from here.  Gold mining stocks still remain greatly undervalued relative to prevailing gold prices.

Gold stocks’ whipsawing journey so far this year has been nothing short of incredible.  Back on January 19th, less than 3 months ago, the flagship HUI gold-stock index plunged to 100.7.  Those levels were utterly astounding, as that was the HUI’s lowest close since July 2002.  Back then gold was trading near $305, and had yet to exceed $329 in its young secular bull.  Revisiting those levels felt like a gold-stock apocalypse.

But as I argued in an essay that very week, that 13.5-year secular gold-stock low was fundamentally-absurd.  The very day gold stocks collapsed to their nadir, gold closed at $1087 which was 3.6x higher.  How on earth could anyone think it was rational for gold stocks to trade as if they could only sell their product for 3/11ths of its actual selling price?  The upside potential out of that extreme anomaly was vast.

Right then as traders had totally abandoned this left-for-dead sector, I wrote “Gold-stock prices are so low that they need to quadruple merely to reflect gold today!”  I put my money where my mouth was too, recommending 6 new gold-stock and silver-stock trades in our weekly Zeal Speculator newsletter on that very dark day the HUI bottomed.  That bet is paying off, with average unrealized gains of +118% as of this Tuesday.

The day before, the HUI had surged 6.2% to hit 206.1.  This 200+ close was a major psychological and technical milestone.  Seeing the HUI languish in the 100s since October 2014 destroyed investors’ confidence in this high-potential contrarian sector.  While the 200s is still low, at least it no longer looks and feels like the gold miners have one foot in the grave.  A 200+ HUI on balance will greatly improve sentiment.

200+ also took the HUI into doubling territory since those extreme mid-January lows.  As of this Tuesday, the HUI had skyrocketed 105.7% higher in less than 3 months!  That’s a clean doubling, one half of the coming quadrupling I was banging the table on in late January.  So gold stocks have not only doubled in short order, but they have another easy doubling coming from here.  They remain way too cheap.

That might sound like a tough argument to make in the wake of such enormous and fast gains.  But as always in the financial markets, perspective is everything.  Though gold stocks have indeed rocketed higher, their prices still remain very low compared to longer-term precedent.  All their blistering new bull has accomplished so far is erasing last year’s terrible losses that were never fundamentally righteous.

These charts help illuminate that essential broader context.  This first one focuses on the technical side, while the second shifts to fundamentals.  Gold stocks’ technicals as illustrated by the HUI are really pretty simple.  Here the HUI, its key 50-day and 200-day moving averages, and Bollinger Bands based off 2.5 standard deviations from its 50dma are rendered.  Gold stocks have merely unwound 2015’s plunge.

Gold Investment Demand Will Drive Gold Stocks Higher

Before this week, the HUI hadn’t seen 200 since peeking above it briefly in January and February 2015.  Back then the gold stocks were in a solidifying uptrend, and those levels were around the top resistance of its trading range.  The bottom was the pre-breakdown support line shown here, which held strong for fully 7 months.  The gold stocks suffered an anomalous breakdown below that support early last June.

That was odd because gold, the dominant driver of gold-mining profitability and hence ultimately gold-stock price levels, was stable.  Gold actually rallied 1.0% into mid-June 2015, yet the HUI still dropped by 4.2%.  During that entire month, the HUI plummeted 10.2% to gold’s modest 1.5% loss!  Normally gold stocks’ leverage to gold runs 2x to 3x, even on the downside.  Last June witnessed a very extreme 7.0x.

This unexplained and unjustified technical breakdown of gold stocks fed on itself, spawning cascading selling as stop losses were triggered.  Not helping matters was the fact that summers are the weakest time of the year seasonally for gold, thus a time when gold stocks usually languish in the doldrums.  So the battered gold stocks kept sliding lower into July, when they were beset by gold-induced panic selling.

Late one lazy Sunday evening, a giant gold futures trader attempted to run gold stops with an extreme blatantly-manipulative shorting order.  It dumped nearly 24k gold-futures contracts controlling $2.7b worth of gold in just one minute.  That was so extreme that 20-second trading halts were triggered twice within that single minute!  Gold was crushed $48 lower to $1086 in that minute, shattering support as intended.

This extreme gold futures shorting attack was perfectly executed to unleash panic among other gold futures speculators holding leveraged long positions.  They had to exit instantly as prices slammed into their stops or risk catastrophic losses.  This artificially-manipulated failure of major multi-year gold support really freaked out gold-stock traders.  The following day, the HUI plummeted 12.0% to gold’s 3.2% loss!

This panic selling ultimately climaxed a couple weeks later in early August at 104.9 on the HUI.  That was a 13.0-year secular low, gold stocks were trading at fundamentally-absurd levels as I wrote at the time.  Those gold stock prices were so ludicrously low that it was hard to imagine any traders susceptible to being scared into selling low still left in them.  And indeed HUI 105 soon formed critical secular-low support.

Despite gold drifting sideways to lower over the subsequent months on totally unfounded Fed-rate-hike fears, the gold stocks refused to fall much under those 105 panic lows.  Until mid-January, when a bizarre plunge on no catalyst dragged the HUI to that new 13.5-year secular low.  But that was short-lived, as the HUI spent just a single day under that 105 support.  That selloff really reeked of a final capitulation.

It was breathtakingly illogical, the product of extreme and unjustifiable fear.  As of the day it bottomed in mid-January, the HUI had fallen 9.4% month-to-date despite gold rallying 2.5%!  So gold-mining stocks were plunging as their profits were rising.  Such a divergence couldn’t last for long, especially coming at extreme decade-plus secular lows.  And indeed ever since, the gold stocks have been off to the races.

Less than 2 weeks later, the HUI had rebounded 23.7% to decisively enter a new bull market on the first trading day of February.  Gold was surging on massive investment buying, the biggest capital inflows it had seen in 7 years.  And the gold stocks naturally followed it higher, amplifying gold’s gains on their profits’ high leverage to the yellow metal.  As gold stocks powered higher, their technicals greatly improved.

In late February the HUI flashed the fabled Golden Cross buy signal, one of the strongest indicators of a young new bull market in all of technical analysis.  When a price’s 50dma crosses back over its 200dma after a major secular low, it almost always signals a new multi-year bull market just getting underway.  That was followed by the HUI’s 200dma turning north in early March for the first time since mid-2014.

By early March the HUI had skyrocketed 72.1% higher in just 6 weeks, leaving it very overbought on a short-term basis.  So a correction wouldn’t have been out of order at all.  But instead the gold stocks spent March largely consolidating high on balance, a major show of technical and sentimental strength.  The traders flocking to this red-hot sector were so convinced its run wasn’t over that they refused to sell.

And that’s where the crucial technical perspective necessary to understand why the gold stocks are going to double again starts coming in.  During March’s high consolidation, the HUI was actually just under its original pre-breakdown support that ran from late 2014 to mid-2015.  All the gold stocks had done by that point was simply unwind their ridiculous losses from last summer’s anomalous breakdown.

The newest upleg in gold stocks started erupting in April just last week.  As gold began climbing out of its own high consolidation in defiance of the powerful bear-market rally in the stock markets, capital started to chase the gold miners’ stocks once again.  This rapid upside breakout drove the HUI to 207.1 this past Tuesday.  But as you can see above, that certainly isn’t a high and risky level in the grand scheme.

This leading gold-stock benchmark merely hit a 14.7-month high after more than doubling in less than 3 months in 2016.  If gold stocks were charging to a 15-year high there’d be serious reason to be very wary, but a 15-month high?  Despite all their sound and fury so far this year, all the gold stocks have done is claw their way back up to break-even since early 2015.  That’s definitely far from being a major secular peak.

While I’m thrilled with this blistering new gold-stock bull so far this year, HUI 200 is truly nothing.  Gold stocks remain greatly undervalued relative to the metal that drives their profits and hence ultimately stock prices.  The HUI first closed above 200 in September 2003, when gold was just cresting $375 for the first time in its young secular bull.  In 2004 when the HUI averaged 212, gold’s average price was just $409.

This week when the HUI regained 207, gold was trading at $1255.  The idea that gold-stock price levels today are fundamentally righteous with gold over three times higher is as ridiculous now as it was back in mid-January at those secular lows.  Despite just doubling in a matter of months, gold stocks still need to double again to even approach some semblance of fundamental normalcy relative to the price of gold.

While gold mining is a tough industry, its earnings fundamentals are quite basic.  These companies mine their metal to sell at prevailing prices.  Those less costs yield profits.  These costs for gold mines are largely fixed in the mine-planning stages when specific ore bodies are targeted and recovery methods defined.  So increases in gold prices usually flow directly through to the bottom line, in an outsized way.

In Q4’15, the elite gold miners of the leading GDX Market Vectors Gold Miners ETF reported average all-in sustaining costs of $836 per ounce.  That’s how much it cost them to produce gold including all the expenses necessary to replenish and sustain current production levels.  That quarter saw gold suffer its worst average price since Q4’09, just $1105.   That still yields industry profits on the order of $269 per ounce.

At $1250, gold is up 13.1% from those dismal average Q4’15 levels.  But since gold-mining costs are largely fixed and don’t change with higher gold prices, their impact on profits is far greater.  At $1250 gold and $836 costs, the industry profits surge to $414 per ounce.  That’s a hefty 53.9% boost on a mere 13.1% gold rally!  Gold-mining fundamentals radically improve as gold powers higher in bull markets.

A great proxy for gold stocks’ ironclad fundamental relationship with gold is the HUI/Gold Ratio.  Looking at trends in the HUI’s daily close divided by gold’s daily close over time reveals whether gold stocks are overvalued or undervalued relative to the dominant driver of their profits.  And this fundamental analysis is what essentially proves gold stocks are due to more than double again despite already doubling in 2016.

Gold Investment Demand Will Drive Gold Stocks Higher

This has long been my favorite chart, highlighting the epic contrarian opportunities for life-changing wealth multiplication in radically-undervalued gold stocks.  And I’m glad I could include it since today’s essay happens to be my 700th.  Despite gold stocks’ blistering early-year bull market, they still remain not far off all-time lows relative to the price of the metal that drives their profits.  They are still greatly undervalued.

Late last September the HGR slumped to an all-time low of 0.093x, which was revisited in mid-January at the HUI’s 13.5-year secular low.  Gold stocks had never been cheaper compared to gold!  And since all the markets are forever cyclical, gold stocks simply can’t underperform gold forever.  The HGR shows that gold stocks underperforming gold is exactly what happened on balance for 8 long years now since late 2007.

Before 2008’s once-in-a-lifetime stock panic sucked gold stocks into its mind-boggling maelstrom of fear, the HGR spent a long 5-year secular span averaging 0.511x.  The HUI generally oscillated around trading near half the price of gold.  But this post-panic world has been very different thanks to central banks’ extreme manipulations leading to gross market distortions.  This is especially true since early 2013.

That’s when the Fed’s wildly-unprecedented open-ended third quantitative-easing campaign ramped up to full steam.  Every time the stock markets threatened to retreat materially, Fed officials were quick to jawbone about being ready to expand QE3 if necessary.  That led stock traders to believe the Fed would not tolerate lower stock markets.  They used this perceived Fed Put as an excuse to keep on buying stocks.

So the stock markets seemingly magically levitated between 2013 to 2015, devoid of the normal selloffs necessary to rebalance sentiment and keep bull markets healthy.  This incredible performance sucked away capital from all other assets, including gold.  So it wilted during that recent several-year span where Fed-goosed stock markets were universally adored leading to all other asset classes being shunned.

All the recent gold and gold-stock woes stem from that surreal 2013-to-2015 Fed-stock-market-levitation period.  In 2012 before the Fed artificially extended a long-in-the-tooth cyclical bull market in stocks, gold and the HUI averaged $1669 and 465.   So 2009 to 2012 was the last normal period for the gold stocks, sandwiched between 2008’s once-in-a-century stock panic and the Fed’s unprecedented stock levitation.

During that last secular yardstick for some semblance of normalcy, the HGR averaged 0.346x.  There is no doubt gold stocks will mean revert back up to that normal pre-QE3 range of pricing relative to gold.  And that’s where the next doubling will come in.  As of this Tuesday, the HGR has only climbed back up to 0.165x.  Despite that being up 78.0% since mid-January as gold stocks far outperformed gold, it is still super-low.

To merely mean revert to its post-panic normal average levels seen between 2009 to 2012, the HGR will have to blast another 109.7% higher.  And unless gold somehow materially falls, that means we’re in for an at-least 110% rally in the HUI from Tuesday’s latest peak!  This inevitable HGR mean reversion is why I predicted the HUI quadrupling off its mid-January lows at the time, and so far we’ve only seen a doubling.

And amazingly, this is actually a very-conservative outlook.  Mean reversions out of sentiment-driven extremes almost never conveniently stop at their averages.  In order to maintain the mean, extremes in one direction are usually followed by proportional overshoots in the opposite direction.  So the HGR has a great chance of blasting far higher than 0.346x, with the potential to shoot as far above as it had been below.

That would briefly yield an HGR topping of 0.599x, levels not seen since gold stocks were last in favor with investors in spring 2006.  That kind of normal overshoot as the extremely fearful sentiment seen in late 2015 reverses into universal euphoria would catapult the HUI 270% higher from here.  And that’s at prevailing gold-price levels.  Naturally at higher gold prices, the projected HUI gains balloon accordingly.

And considering gold’s massive new investment buying and defiance of stock markets’ powerful bear rally since mid-February, there’s no doubt gold is in a young new bull market.  It’s likely to run for years given investors’extreme underinvestment in portfolio-diversifying gold.  A new bear market in general stocks will fuel outsized investment demand for a couple years, as gold tends to move counter to stock markets.

Gold stocks’ mean reversion back up to and through normal price levels relative to prevailing gold prices will extend over that gold-bull span.  So I expect to see this gold-stock bull continue powering higher on balance over the next couple years or so.  While the next doubling won’t happen as rapidly as the low-hanging fruits of the first one, a doubling over a year or two is still an awesome gain trouncing all other sectors.

If you want to multiply your wealth in this long-overdue gold-stock mean reversion higher, be sure to take advantage of the inevitable selloffs in this volatile sector to deploy capital.  Buy that leading GDX gold-stock ETF, or better yet the best of the individual gold-mining stocks that will enjoy big upside well exceeding their sector peers’.  Nothing can compare to an expertly-handpicked portfolio of the best gold miners!

The bottom line is despite gold stocks already doubling in 2016, they are almost certain to double again from their recent highs.  Gold stocks remain greatly undervalued relative to gold, which overwhelmingly drives their profits and hence ultimately stock prices.  All this new bull market has accomplished so far is reversing 2015’s anomalous losses gold stocks suffered.  They are merely back to breakeven from last year.

The gold stocks still have a long ways to rally just to mean revert to average levels relative to gold, let alone overshoot to the upside as usual following last year’s record-low extremes.  These coming huge gold-stock gains will be fueled by gold’s own mean reversion higher in its young bull market.  Gold’s investment demand will continue growing as the Fed-levitated stock markets roll over, driving gold stocks higher.

 

 

 

Courtesy: Adam Hamilton

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