Gold Stocks’ Strong New Upleg


Gold stocks are on fire this year, powering higher in market-dominating performance. This is a massive reversal from their dark fourth quarter, with 6/7ths of those losses already erased.

Gold stocks are on fire this year, powering higher in market-dominating performance. This is a massive reversal from their dark fourth quarter, with 6/7ths of those losses already erased. But this strong new upleg still remains young and small by historical standards. Gold stocks’ recent rally is only the vanguard of another major bull-market upleg. This sector’s bullish technicals reveal vast upside potential from here.

The gold miners are a small contrarian stock-market sector that isn’t widely followed. Hearing about how the gold stocks are faring in the mainstream financial media is pretty rare. So this sector generally flies under the radars of the great majority of speculators and investors. That’s rather unfortunate, because the gold stocks have enjoyed some of the greatest gains in all the stock markets in this young century.

The flagship gold-stock index is the NYSE Arca Gold BUGS Index, which trades under the symbol HUI. BUGS stands for Basket of Unhedged Gold Stocks, as major gold miners can’t be included in the HUI unless their gold production is not hedged beyond 1.5 years. Running all the way back to June 1996, and having no management fees like ETFs, the HUI offers the definitive read on gold-stock performance.

Today’s leading gold-stock trading vehicle, the GDX VanEck Vectors Gold Miners ETF, closely mirrors the HUI’s price action.  Since there aren’t that many major gold miners, GDX’s composition is similar to the HUI’s by necessity.  But because GDX charges a 0.52% annual management fee, and its managers change around its components and their weightings so much, the HUI remains the gold-stock metric of choice.

All speculators and investors should pay attention to gold stocks because their bull markets and uplegs multiply wealth like no other sector.  Their last secular bull ran between November 2000 and September 2011.  During that 10.8-year span, the HUI skyrocketed 1664% higher while the broad-market S&P 500 slipped 14% lower!  Secular bull markets in gold stocks truly create life-changing dynasty-building wealth.

Last year another major gold-stock bull market was stealthily born, that has great potential to go secular and get huge.  Despite their rotten fourth quarter, the gold stocks as measured by the HUI still blasted a market-leading 64.0% higher in 2016!  That compares to a mere 9.5% gain in the S&P 500.  So with the HUI already up 21.5% year-to-date in young 2017, speculators and investors alike really need to take notice.

All this gold-stock behavior over the past year or so has been textbook early-secular-bull stuff.  And if a new secular bull is indeed underway, the gains in gold stocks in the coming years are going to radically dwarf those seen since early 2016.  This first chart looks at this young gold-stock bull in HUI terms since last January.  This sector’s technicals have turned really favorable again following the fourth-quarter anomalies.

Just over a year ago in mid-January 2016, the gold miners’ stocks had been left for dead.  Traders had abandoned them to such an extreme degree that the HUI slumped to a fundamentally-absurd 13.5-year secular low.  Gold-stock prices had collapsed back to July 2002 levels, when gold was trading near $305 and had yet to exceed $329 in its young secular bull!  But last January gold was 3.6x higher at $1087 at worst.

Just like the rest of the stock markets, gold-mining stock prices must ultimately reflect some reasonable multiple of underlying corporate profits.  Back in Q4’15 as traders fled gold stocks, the average gold price was $1105 which was the worst quarter since Q4’09.  Yet the elite gold miners of GDX still reported average all-in sustaining costs of just $836 per ounce.  They remained very profitable even in gold’s trough quarter.

So a major new bull market was born for fundamental reasons right at the peak of extreme bearishness.  Within just 6.5 months, the HUI had rocketed 182.2% higher to a 3.2-year high!  Contrarian speculators and investors smart enough and tough enough to buy gold stocks when they were loathed nearly tripled their capital in a half-year.  Incredibly 2017 has the potential to see another similar mighty gold-stock upleg.

Gold-stock enthusiasm was getting too rampant last summer, so a major correction was inevitable.  Such selloffs are essential to keeping bull markets healthy, bleeding off excessive greed to restore balance to sentiment.  Indeed this red-hot sector fell sharply in August before starting to grind higher off a lower base in September.  The gold stocks were looking bullish again after plunging 22.0% in less than a month.

But unfortunately Q4’16 proved full of weird market anomalies.  Gold stocks were hammered even lower in three separate mass-stopping events.  These are normally very rare, so suffering a few of them in a single quarter is phenomenally unlucky.  But one hard lesson all traders must learn is how essential it is to just roll with the punches.  When markets decouple from reality on sentiment, keep your eyes on fundamentals.

In early October the HUI plunged another 13.0% in three trading days as cascading stop-loss selling was triggered by gold.  As gold slipped through major support at $1300, gold-futures speculators’ own stop losses started tripping on their hyper-leveraged positions.  The resulting mass stopping was devastating to gold-stock sentiment, as it erupted from correction lows after gold stocks had already sold off considerably.

But the oversold gold stocks soon bottomed and started rallying higher along their key 200-day-moving-average support in October.  This fast recovery proved that extreme early-October selling was just an anomaly with no fundamental justification.  The gold stocks rallied on balance along their bull-market uptrend’s support line until early November.  Then Trump’s surprise election win sparked great market upheavals.

For months leading into that election, all market indications were that stock markets would sell off while gold rallied if Trump somehow pulled off a victory in defiance of the polls.  As the early results came in on Election Day’s evening, gold rocketed 4.8% higher from that day’s close in futures trading.  The big gold stocks trading live in Australia were up 15%+!  Stock markets were plunging, with the S&P 500 down 5%.

But after Clinton apparently conceded early the next morning, big buyers started to flood into stock-index futures.  As stock markets turned around and then started to surge in their incredible Trumphoria rally, gold lost its luster.  Gold is the anti-stock trade that tends to move counter to stock markets.  So when the stock markets appear to do nothing but rally, gold investment demand all but collapses thus gold prices fall.

So a couple days after the election as euphoric stock traders dumped gold positions, the HUI plummeted another 15.2% in just two trading days!  That was another snowballing mass stopping, an anomaly driven by an exceedingly-unlikely event.  Not only did Trump the underdog win, but contrary to months leading in stock traders suddenly decided capricious Trump was fantastic for stocks.  That’s a once-in-a-lifetime surprise.

Yet again the anomalous, sentiment-driven nature of gold stocks’ plunge soon became apparent.  This sector immediately stabilized and started drifting sideways near lows despite ongoing heavy gold selling by stock investors.  The HUI ground sideways until mid-December, when a third mass stopping in Q4 was triggered by the Fed proving more hawkish than expected by predicting three more rate hikes in 2017.

That took the HUI’s total loss to an extreme 42.5% in just 4.4 months!  In Q4 alone this leading gold-stock index had plunged 21.1%.  That left speculators and investors alike super-bearish on this sector, totally deluded by groupthink sentiment and blinded to the actual fundamentals.  That was a serious mistake.  The traders smart enough to get rich in the markets know extreme fear is irrational, fleeting, and marks major bottoms.

Despite stock investors’ heavy selling of gold via GLD gold-ETF shares in Q4, gold still averaged $1218 last quarter.  Yet in the preceding Q3’16, which is the latest data available, the major gold miners of GDX averaged all-in sustaining costs of just $855 per ounce.  That meant this sector was still running hefty operating profits around $363 per ounce!  Thus it was ludicrous for gold stocks to be priced for profits collapsing.

So back in late December soon after that hawkish Fed surprise we made one of our most-aggressive gold-stock and silver-stock deployments ever.  We bought and recommended a bunch of great precious-metals miners trading at ridiculously-low prices relative to their underlying earnings.  That contrarian bet has already proven wildly profitable in the form of massive unrealized gains over the past 7 weeks or so.

While the gold miners’ Q4 operating results generally aren’t out yet, this industry’s all-in sustaining costs are likely to remain largely in line with the couple preceding quarters’ $886 and $855.  That will prove gold mining remained very profitable last quarter even while that improbable series of anomalous mass stoppings fueled hyper-bearish sentiment.  Gold stocks’ strong upleg since is absolutely fundamentally justified!

As of the middle of this week, the HUI has already surged 35.5% higher out of its deep mid-December low.  That once again trounces the S&P 500’s meager 1.4% gain over that span.  Yet all the gold stocks have done so far in their strong new upleg is reverse those anomalous post-election losses.  This sector has merely mean reverted back up to its 200-day moving average, where it was trading before Trump won.

This 200dma challenge is crucial, as an upside breakout will convince a lot of speculators and investors on the sidelines that this new upleg is the real deal.  A year ago in early February, buyers started to flood into this sector once the HUI blasted back over its 200dma.  This particular long moving average is often the most-important support line in any bull market.  A decisive 200dma breakout should ignite big upside momentum.

Even on a short-term basis only considering this past year’s young gold-stock bull, this sector has lots of room to run higher from here.  The HUI needs to rally another 28% just to regain its August 2016 high, and that was still really low in the grand scheme.  The upper resistance line of this young bull market’s uptrend is even higher, up around 305 or so.  The gold-stock technicals still look very bullish from here.

But a mere single-year perspective is myopic considering what gold stocks have been through, really failing to do justice to their vast upside potential.  This next chart zooms out to the preceding bear market between late 2011 to late 2015.  Despite already nearly tripling in the first half of last year, this battered sector’s young bull remains quite small.  Gold-stock price levels are still very low by historical precedent.

If market history proves one thing, it’s that markets are forever cyclical.  Bulls are invariably followed by bears, and they tend to be proportional.  This critical core truth has been forgotten by stock traders today, as they are all caught up in the extreme Trumphoria.  Big bulls always yield to big bears and vice versa, as nothing rises or falls forever.  The gold stocks are early-on in a new bull destined to grow to great size.

Following their last secular bull where they skyrocketed 1664% higher in a little over a decade ending in September 2011, this sector collapsed into a brutal 84.1% bear market that ran 4.4 years.  That too was an anomaly, the result of wildly-unprecedented extreme Fed easing.  Back in late 2012 the Fed ramped up its new third quantitative-easing campaign to full steam.  QE3 was a very different beast from QE1 and QE2.

Unlike its predecessors, QE3 was open-ended with no predetermined size or end date.  This worked to ignite an incredible and dangerous stock-market levitation.  Whenever the stock markets started to sell off in a healthy and overdue correction, Fed officials would rush to assure traders that they were ready to expand QE3’s bond monetizations if necessary.  This extreme dovishness quickly truncated nascent selloffs.

Thus stock traders came to believe that the Fed was effectively backstopping the stock markets.  So they abandoned prudent portfolio diversification, which counter-moving gold is the cornerstone of.  Heavy differential GLD-share selling persisted for years as investors shunned gold to move even more capital into their already-stock-dominated portfolios.  The gold stocks suffered relentless extreme selling as gold fell.

Since gold investment demand and therefore gold prices are so dependent on stock-market fortunes, gold’s performance between 2013 to 2015 was largely the mirror image of the S&P 500’s.  And the gold stocks, with earnings almost totally dependent on the gold price, leveraged gold’s losses.  But the bear market in gold stocks couldn’t last forever any more than this bull market in general stocks can, as 2016 proved.

Out of that extreme fundamentally-absurd 13.5-year secular low, gold stocks started powering higher in early 2016 as heavy gold buying returned.  That was in response to the first real stock-market corrections seen in almost 4 years thanks to the Fed actively suppressing stock-market selling through aggressive dovish jawboning.  Those falling stock markets rekindled major gold investment demand for the first time in years.

The gold stocks naturally followed gold, which overwhelmingly drives their profits, higher.  They soon broke out from a short-term resistance line and then major secular resistance.  But despite their huge upleg in the first half of 2016, the HUI still merely regained mid-2013 levels.  Those were still really low in historical context, the result of gold’s extremely-anomalous plunge as the Fed jawboned stock markets higher.

At this week’s HUI levels near 220, this leading gold-stock index remains not far from deep bear-market lows.  This sector is trading at late-2014 levels, which were super-depressed by excessive bearishness.  So the gold stocks continue to have vast upside potential as they mean revert out of an extreme bear that was fundamentally unjustified into a proportional subsequent bull.  Consider a couple of recent ranges.

Back in 2012 which was the last year before the Fed’s extreme QE3 distortions sent markets haywire all over the world, the HUI averaged 465.  In order to regain those levels, the gold stocks as a sector would have to rally another 110% from this week’s levels!  Is there any other sector in all the stock markets with easy potential to double from here given the lofty stock prices and accompanying euphoria?  Not a chance.

In 2011 when gold investment was a lot more normal, the HUI averaged 551.  That’s about 150% above current levels.  Since bear markets are usually followed by proportional bulls, this young gold-stock bull is very likely to prove secular and fully regain 2011 levels.  Of course such a huge mean reversion will require higher gold prices.  Nothing gets traders more excited about buying gold stocks than higher gold.

Gold itself has embarked on its own mean reversion higher out of its deep 6.1-year secular low of late 2015.  Today gold is poised for big new buying from its two primary drivers, American stock investors and American futures speculators.  The stock investors buy gold through GLD gold-ETF shares.  Since they dumped gold so aggressively on that Trumphoria stock-market rally, they are radically underinvested now.

So they will have to do big gold buying in the coming months and years to try and re-diversify their stock-heavy portfolios.  Provocatively that just got underway this month, with GLD shares enjoying strong differential buying pressure for the first time since the election!  That will accelerate dramatically as these overvalued, euphoric stock markets inevitably start rolling over into their long-overdue next bear market.

And the futures speculators’ long positions, their upside bets on gold, are still very low.  Thus these traders have tons of room to buy and really bid gold higher as they reestablish normal long levels.  In addition to higher gold prices, another major driver of that futures buying will be the lofty US dollar continuing to fade from its recent 14.0-year secular high.  Trump’s people will talk down the dollar to boost US exports.

As gold itself continues mean reverting higher out of recent years’ bearish extremes, the gold miners’ stocks will amplify its gains like usual.  Gold-mining profits are highly leveraged to gold prices, so higher gold prices quickly translate into much-greater earnings.  This critical fundamental underpinning of this young gold-stock bull and its strong new upleg will help the former grow to massive secular proportions.

While speculators and investors alike can certainly play gold stocks’ big coming gains with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals.  Their upside will trounce the ETFs’, which are burdened by over-diversification and underperforming gold stocks.  A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.

The bottom line is gold stocks’ strong new upleg is only just starting.  Despite enjoying market-leading 2017 performance, all this sector has done so far is reverse the anomalous extreme post-election losses.  Gold mining almost certainly remained very profitable even in dark Q4, which means the gold stocks are way undervalued fundamentally relative to their current earnings power.  And that will soar as gold rises.

Gold itself is poised to see big buying from stock investors and futures speculators returning after fleeing en masse last quarter.  Higher gold prices will lead to much-higher gold-mining profits, strengthening the fundamental foundation of gold stocks’ young new bull and upleg.  And with gold stocks remaining so low historically, this bull has excellent potential to grow to secular proportions greatly multiplying wealth.

Adam Hamilton

Adam Hamilton

Contributing Editor

Email: adam[at]zealllc.com

A lifelong student of the markets, speculator, and investor, decades of experience have forged Adam into a hardcore contrarian. He believes in buying low when others are afraid, then later selling high when others are brave. He founded the financial-market research company Zeal LLC in early 2000, when he made an epic contrarian bet on a commodities secular bull and stock secular bear. Adam continues to write acclaimed weekly and monthly subscription newsletters, which have helped countless traders all over the world deepen their understanding of the markets and multiply their fortunes. Zeal also publishes comprehensive reports on our fundamental favorite stocks in specific sectors.

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