Commodity Trade Mantra

With Gold Prices Poised to Rally Higher, Upside Potential in Gold Stocks is Huge

With Gold Prices Poised to Rally Higher, Upside Potential in Gold Stocks is Huge

The Upside Potential in Gold Stocks is Huge

The gold stocks are off to the races again, with big gains mounting.  They just staged major breakouts, shattering a vexing consolidation that had trapped them for an entire year.  Such momentum early in gold’s strong season is a very-bullish portent.  As higher prices improve both technicals and sentiment, buying begets more buying.  With gold stock prices still quite low in secular terms, their upside remains huge.

Gold stocks are a small contrarian sector without a wide following.  So their latest surge has surprised many investors and speculators.  But it shouldn’t have.  In the markets knowledge is profits, so staying informed about gold stocks’ fundamentals, technicals, and sentiment is crucial.  The traders who did their homework this summer and bought in low when few others were willing are now sitting on fat unrealized gains.

Nearly every summer like clockwork, gold stocks slump to a summer-doldrums low.  Gold miners’ profits and hence ultimately stock prices are driven by prevailing gold prices.  And gold investment demand has always tended to slump seasonally in summers.  On July 7th, the flagship HUI NYSE Arca Gold BUGS Index, which is closely mirrored by the leading GDX VanEck Vectors Gold Miners ETF, hit a demoralizing low of 178.9.

The gold-stock sector was down 1.9% YTD in a year where gold had rallied 5.4% over that span.  That very day, I published an essay titled Gold Stocks’ Summer Bottom.  I explained why summer gold-stock weakness is a great buying opportunity, concluding “So smart contrarians willing to fight the herd to deploy when it’s unpopular are subsequently richly rewarded when gold stocks’ seasonal rallies march much higher.”

From that typical summer-doldrums low, the HUI has already surged 21.7% higher as of this week!  But sadly not many traders rode that whole rally, as most people hate buying low.  In early August when just a third of gold stocks’ recent rally had happened, I wrote another essay explaining gold stocks’ bullish autumn seasonals.  This sector has always tended to rally sharply with gold from summer lows into late September.

A week later when less than half of gold stocks’ latest surge was accomplished, I dug into their technicals to illustrate why this sector was a coiled spring.  The gold stocks had just peeked their heads above their key 200-day moving average, and major breakouts were imminent.  Now a month later they have indeed come to pass just as expected.  These big breakouts were highly probable, leading to big profits for the informed.

Now it’s important for all investors and speculators to understand these major breakouts’ significance and implications going forward.  Such events are very bullish, happening early in major new uplegs.  This first chart looks at HUI technicals since early 2016, when a new bull market in gold stocks was birthed out of extreme secular lows.  Today’s breakouts are the biggest and most important since February 2016, super-bullish.

Back in mid-January 2016, the gold stocks were universally despised and bearishness was off the charts.  They were battered to fundamentally-absurd 13.5-year secular lows, trading at levels last seen when gold was near $305.  Yet it was actually 3.6x higher at $1087!  Gold-stock prices couldn’t stay radically disconnected from their underlying earnings fundamentals forever, thus that incredible anomaly couldn’t last.

So gold stocks reversed hard and took off like rockets, blasting the HUI 182.2% higher in just 6.5 months!  That certainly left them very overbought last summer, which I warned about at the time.  So they started correcting, which is perfectly normal in all bull markets.  But that healthy correction snowballed to truly monstrous proportions thanks to another epic anomaly.  Trump’s surprise election victory indirectly crushed gold.

Gold investment is so important in all portfolios because gold tends to move counter to stock markets, which is rare.  Gold is effectively the anti-stock trade, the ultimate portfolio diversifier.  So the incredible Trumphoriastock-market surge in the election’s wake decimated gold investment demand.  That dragged the gold stocks far lower than they deserved to be fundamentally.  The HUI plunged 42.5% in 4.4 months.

That left this small sector seriously out of favor as 2016 wrapped up, which was ridiculous.  Despite an ugly Q4, the HUI still blasted 64.0% higher last year!  Gold stocks were the best-performing sector in all the stock markets, yet traders foolishly shunned them.  That irrational hyper-bearish sentiment in the wake of the post-election gold rout bled into 2017.  That trapped the gold stocks in a vexing consolidation.

It is readily evident in this chart, the triangle pattern running for an entire year until recent weeks.  The gold stocks enjoyed some big rallies with gold, but they sequentially failed at lower highs.  That really spooked technically-oriented traders.  But the action wasn’t wholesale bearish, as the gold stocks per the HUI were generally carving higher lows as well.  The result was this massive triangle consolidation pattern.

Unfortunately there wasn’t much hope of a breakout during the summer.  Gold’s summer doldrums lead to parallel sideways action in gold stocks in most summers.  For gold-stock investors, summers are just something to be endured.  They usually end up being barren sentiment wastelands where traders give up on this sector entirely.  So material gold-stock gains in summers are rare, they can’t be expected in any year.

The HUI drifted 3.5% lower in June, really damaging sentiment.  This was much weaker than normal in early summers, as the HUI saw average gains of 1.2% in Junes in the modern bull-market years of 2001 to 2012 and 2016.  Even the HUI’s 5.6% rebound in July, far better than its 0.7% average losses, wasn’t enough to restore sentiment.  So the gold stocks generally drifted lower this summer within that same triangle.

Interestingly the upper resistance line of that big chart pattern closely paralleled the HUI’s important 200-day moving average.  Chart patterns like this triangle consolidation are subjective, they can be drawn in different ways.  So while the general resistance line was evident to all technically-oriented traders, the timing on a breakout wouldn’t be universally recognized.  But 200dmas are hard mathematical constructs.

200dmas are the most-important and widely-followed technical lines in all the markets.  They smooth out the daily volatility to highlight long-term trends.  Prices below their 200dmas are often considered to be in bear markets, leaving traders expecting further weakness.  But once prices forge decisively above their 200dmas, traders assume they are reentering bulls.  That generates bullish psychology which fuels buying.

The HUI first started flirting with its 200dma again in late July.  But it wasn’t until mid-August when it started to break out decisively, closing more than 1% above that key level.  And those gains weren’t solidified until late August, when traders started to realize this 200dma breakout was the real deal and not a head fake.  That 200dma breakout in recent weeks is the most important of the new major gold-stock breakouts.

But because the upper resistance line of that vexing triangle consolidation paralleled the HUI’s 200dma, a simultaneous breakout from that chart pattern happened.  Gold stocks have not rocketed above their bull-bear-psychology-dividing 200dma, or broken a major downtrend resistance line like this, since February 2016.  And that was early in a monster upleg where this sector would nearly triple in just over a half-year!

Major breakouts are so darned bullish because they soon become self-feeding.  The great majority of investors and speculators aren’t contrarians, they lack the discipline and toughness to fight popular fear and buy low.  Instead most prefer chasing momentum, buying where gains are already happening.  So breakouts quickly shift sentiment to bullish which drives a lot more buying.  And that buying expands the breakouts.

In all markets, buying begets buying.  The faster prices rise, the more traders want to buy in to ride the momentum.  The more traders buy in, the faster prices rise.  Major breakouts kindle this virtuous circle of buying, leading to big and growing capital inflows.  Everyone loves winners, and these major gold-stock breakouts are leading to the best gains in the entire stock markets.  Traders are increasingly taking notice.

All this gold-stock buying in recent weeks is just now triggering the most-important technical buy signal of all, the fabled Golden Cross!  Golden Crosses are one of the most-powerful and most-widely-followed signals of new bull markets.  They happen coming out of lows as a 50dma crosses back above a 200dma.  As the white and black lines in this chart show, the first Golden Cross since early 2016 is triggering right now.

That last Golden Cross in February 2016 led to months on end of big capital inflows into the beaten-down gold stocks.  This week’s second Golden Cross ought to lead to a similar outcome.  Recent weeks’ major breakouts have just flashed an irresistible major buy signal to technically-oriented traders.  Whether this is the second major upleg of last year’s bull or an entirely new bull, gold stocks are early in a major rally higher.

Their upside from here remains huge.  That short-term chart above makes it appear like gold stock prices are getting to the high side, but nothing could be farther from the truth.  This next chart zooms out to the massive gold-stock bear that started in late 2011.  The small shaded zone in the lower right is the entire area of the first chart.  After a brutal secular bear persisting for years, gold stocks’ bull remains little and young.

Between September 2011 and January 2016, the gold stocks as measured by their flagship HUI index plunged a breathtaking 84.1% in 4.4 years!  That colossal bear was driven by an extreme anomaly.  The Fed’s radically-unprecedented open-ended QE3 campaign levitated the US stock markets, slaughtering demand for alternative investments led by gold.  The gold stocks plummeted on massive gold dumping.

They finally bottomed in epic despair early last year, heralding a new bull market.  It soon staged major breakouts from two separate bear-market resistance lines, which are rendered here.  That young gold-stock bull rocketed higher, leading to that near-triple in about a half-year.  But despite those wicked-fast gains, the gold stocks merely hit a 3.2-year high.  At best they were only back to mid-2013 deep-bear levels.

Even after these major breakouts of recent weeks, the gold-stock sector is still languishing way down at late-bear levels from late 2014.  Bull markets after exceptional bears usually see prices at least revisit the previous bull’s top, which was 635.0 on the HUI in September 2011.  That implies huge upside of 196% remains from even this week’s levels.  What other sector in these overvalued stock markets has tripling potential?

But if fundamentals are strong enough after exceptional bears to support symmetrical bull markets, those tend to ultimately drive prices to new all-time record highs.  I strongly suspect gold stocks’ current bull will run for years, eventually pushing the HUI above its previous peak.  That would take a total gold stock bull of just 531% from gold stocks’ deep 13.5-year secular low in January 2016.  That’s nothing by this sector’s standards.

During gold stocks’ last secular bull from November 2000 to September 2011, the HUI skyrocketed an epic 1664% higher!  That made early contrarian investors including our subscribers rich.  We only need to see a bull a third as large to propel the HUI back to new all-time record highs.  And the gold miners’ fundamentals already support secular-bull-level gains, as evidenced by their latest quarterly results just reported.

Gold mining profitability is simply the difference between prevailing gold prices and operating costs.  In Q2’17, the elite gold miners of that leading GDX gold-stock ETF reported average all-in sustaining costs of just $867 per ounce.  That was already $391 below Q2’s average gold price, pure profit.  And at this week’s higher $1339 gold levels, those major-gold-mining profits have already ballooned to a hefty $472!

The smaller mid-tier gold miners of the related GDXJ junior-gold-stock ETF looked nearly as good in Q2, with average AISC of $879.  That implies big profitability of $460 per ounce at this week’s gold prices.  These fat margins coupled with the low gold-stock prices have left many gold miners trading at low price-to-earnings ratiostoday.  This sector is wildly undervalued fundamentally, supporting a new secular bull market.

Thus odds are the major gold-stock breakouts in recent weeks are merely the beginning of a massive new gold-stock upleg.  As gold stocks keep powering higher, more and more investors and speculators will want to buy in to chase those gains.  Their capital inflows will push this small sector higher still, widening its circle of appeal to even more traders.  Once gold stocks finally get moving, they tend to run for a long time.

Since most traders inexplicably choose to be uninformed, the bullish implications of these major gold-stock breakouts still aren’t widely known.  So it’s certainly not too late to buy in, even though big gains have already been won since summer.  Gold stocks’ strong season tends to run from now until next spring, driven by gold’s own strong season.  The gold stocks will likely be considerably higher by year-end.

This young new upleg should get supercharged as gold investment demand surges when the stock markets inevitably roll over.  With the Fed on the verge of starting to reverse its quantitative easing that levitated stock markets for years with ominous quantitative tightening, that long-overdue major stock-market selloff is likely sooner rather than later.  As gold is bid higher on weaker stocks, gold stocks will soar.

The greatest gains in this young gold-stock upleg won’t be won in the popular ETFs like GDX and GDXJ, as they are far-overdiversified and burdened with way too many under-performing gold miners.  So it’s much more prudent to deploy capital in the best individual gold miners with superior fundamentals.  Their gains will handily trounce the ETFs, further amplifying the already-huge upside potential of this sector as a whole.

The bottom line is gold stocks just enjoyed two parallel major breakouts in recent weeks.  They shattered a vexing consolidation that’s trapped them for a year, and more importantly burst back above their critical 200dma.  The resulting quickly-improving technicals are rapidly shifting sentiment back to bullish, driving more buying as traders return.  Since buying begets buying, major gold-stock uplegs soon become self-feeding.

But since this small contrarian sector is largely ignored, most investors and speculators don’t yet realize how bullish these major breakouts are.  Despite their big gains since early 2016, the gold stocks remain very low and their young bull is still little in secular context.  So it’s not too late to get deployed.  With gold itself likely to rally far higher as these lofty stock markets roll over, gold stocks’ upside potential is huge. – Adam Hamilton

 

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