The gold miners’ stocks are still grinding sideways after last month’s Fed-rate-hike scare. This technical basing is laying the foundation for this interrupted gold-stock upleg to rebound. Today’s low gold-stock prices relative to the metal they mine will amplify that coming upside. The leading gold-stock index was just slammed back down to the support of its secular valuation uptrend, portending a big mean reversion higher.
The gold stocks were consolidating high, digesting sharp young-upleg gains, just a month ago. Then the latest FOMC meeting spawned a sharp gold plummeting, which the gold stocks leveraged like usual. The Fed didn’t do anything, keeping its hyper-easy zero-interest-rate policy and $120b of monthly quantitative-easing money printing in place indefinitely. There were no hints at all of rate hikes or tapering QE bond buying.
But top Fed officials’ individual projections of future federal-funds-rate levels, which the Fed chair himself warned to ignore, were slightly more hawkish than expected. Just a third of these guys thought the Fed might need two quarter-point rate hikes way out into year-end 2023. Who cares, right? That may as well be an eternity away in financial-market terms. Yet it still scared gold-futures speculators into selling hard.
In just three trading days after that nothingburger FOMC decision, gold plummeted 5.2%! In the week including that hawkish Fed dot plot, specs dumped an enormous 24.0k gold-futures long contracts while adding 4.9k new short ones. That made for the equivalent of 89.7 metric tons of gold selling, far too much too fast to absorb. So the leading GDX VanEck Vectors Gold Miners ETF collapsed 9.2% in that same span.
That whole episode was a crazy anomaly, that Fed gold-futures purge wasn’t sustainable given specs’ positioning leading into it. Their panicked exodus quickly exhausted itself as expected, leaving gold’s near-term outlook far more bullish with the vast majority of potential gold-futures selling spent. But that gold drop had an ugly impact on gold-stock psychology, unleashing widespread bearishness still festering.
Traders fretting or fleeing don’t realize how unusual this gold-stock walloping was. This chart is updated from my latest gold-summer-doldrums essay of a couple weeks ago. It individually indexes the gold stocks’ summer performances during all modern gold-bull-market years to May’s final close, rendering them all in perfectly-comparable percentage terms. Gold stocks’ hawkish-Fed-dots swoon was super-anomalous.
Solely because gold-futures speculators feared distant-future rate hikes, GDX suffered its worst June of all modern gold-bull years with a brutal 13.8% thrashing! That’s why sector psychology has cratered, and traders have either abandoned the gold miners or remain too wary or scared to move more capital in. But such a severe deviation from early-summer norms portends an imminent big mean-reversion rebound.
Gold stocks only plummeted in sharper early-June selloffs in 2006 and 2009. But both those happened in necessary corrections right after massive uplegs. GDX was only born in mid-May 2006, which is why we have to use the older HUI gold-stock index for this longer-term seasonality analysis. Both the HUI and GDX are dominated by the same major gold miners. In 6.6 months into May 2006, the HUI had soared 82.5%!
A few years later in spring 2009, GDX was increasingly usurping the HUI’s role to become this sector’s most-widely-followed benchmark. In 7.2 months leading into early June that year, this dominant gold-stock ETF skyrocketed a staggering 172.1%! So extremely-weak early-summer gold-stock performance isn’t just rare, it usually only happens after huge uplegs roll over into healthy corrections to rebalance sentiment.
There was definitely no need for that this summer before that hawkish-Fed-dots scare. The major gold stocks had recently finished a big 30.5% correction in GDX terms that bottomed in early March. That paved the way for the next bull-market upleg, but that only climbed 28.4% at best over 2.5 months by mid-May. Gold stocks consolidated high after that, digesting their gains. There was no need for a correction.
Last month’s ridiculous Fed-gold-futures purge hammering gold stocks was incredibly anomalous, actually without precedent in modern gold-bull years. That means the gold miners’ stock prices are way too low, needing to normalize by mean reverting sharply higher. This phenomenon even happens with totally-righteous corrections. By early July 2006, the indexed HUI was already back to 105 or 5% over May’s close.
Even though 2009’s pre-summer upleg was radically more extreme necessitating a proportionally-large correction, from early July to early August that year the indexed HUI rebounded back from 79 to 94. As the major gold stocks mean reverted sharply higher out of massive early-summer losses even in serious corrections, they are even more likely to do that again today. That FOMC-spawned plummeting wasn’t justified.
In last week’s essay I wrote about the technical aspect of this imminent mean reversion, about the gold stocks coiling post-Fed. GDX has just been pummeled to oversold levels relative to its 200-day moving average, implying a big rebound higher is imminent. And this leading gold-stock benchmark hadn’t been anywhere near overbought before that distant-future-rate-hikes scare, buttressing the mean-reversion case.
Another strong argument for gold stocks bouncing sharply higher to resume their interrupted upleg comes from the fundamental side. It looks at gold-stock price levels compared to those of their dominant primary driver, gold prices. The gold stocks are ultimately just leveraged plays on gold, as their earnings really amplify material sustained gold-price moves. I’ve written about this extensively for decades now in many essays.
This core fundamental relationship is readily evident in the top 25 GDX gold miners’ results from the last four reported quarters ending in Q1’21. A great proxy for their sector-profitability trends comes from their average per-ounce earnings. Those are calculated by subtracting their average all-in sustaining costs in a quarter from its average gold price. The year-over-year changes in both reveals gold miners’ profits leverage.
From Q2’20 to Q1’21, gold’s average quarterly prices soared by 30.9%, 29.8%, 26.5%, and 13.4% YoY. During those same quarters, the GDX-top-25 gold miners’ average unit profits rocketed up 66.2%, 49.7%, 50.3%, and 25.3% YoY! That made for implied sector profitability amplifying gold by 2.1x, 1.7x, 1.9x, and 1.9x over this past year of finished earnings seasons. But amassing all that data is very labor-intensive.
I’ve done this challenging analysis for 20 quarters in a row now for the GDX-top-25 gold miners! I’m looking forward to the next round after this imminent Q2’21 earnings season wraps up in mid-August. A far-easier way to visualize the relationship of gold-stock prices to gold’s is found in a simple ratio. It just divides the daily GDX closes by those of the leading and dominant GLD SPDR Gold Shares gold ETF.
This GDX/GLD Ratio or GGR is a powerful tool revealing valuation trends in the major gold stocks. And thanks to June’s brutal hawkish-Fed-dots scare, gold-stock prices were bludgeoned back down to major multi-year support compared to gold prices. This chart superimposes this GGR indicator in blue over the raw GDX itself in red. There is a powerful fundamental case for gold stocks to mean revert sharply higher soon.
During secular gold bulls, gold-stock price levels gradually march up faster than gold prices. The more years gold powers higher on balance, the more comfortable traders become with deploying capital in this high-potential gold-leveraging sector. This current secular uptrend in gold-stock valuations per this GDX/GLD Ratio proxy was born in September 2018. The upsloping GGR range since has proven well-defined.
Gold-stock valuations have meandered higher in recent years, carving distinctive zones of lower support and upper resistance. The only serious deviation came during the extreme stock-panic anomaly of March 2020, when markets cratered on governments’ COVID-19 lockdowns. But the GGR’s deep sub-support time was short-lived like usual, with a massive and sharp mean reversion higher in gold-stock valuations.
That ultimately skyrocketed into an enormous 134.1% GDX upleg over just 4.8 months into early August 2020! Those huge gold-stock gains far outpacing gold’s own ultimately pushed the GGR up to 0.241x. A share of the GDX gold-stock ETF was trading at 24.1% the price of a share of the GLD gold ETF. That was a 4.0-year high in this valuation proxy, elevated by recent-years precedent but certainly not extreme.
Gold stocks’ leverage to gold is a double-edged sword, with that amplification working during both gold uplegs and corrections. By early March 2021, GDX’s 30.5% correction had outpaced gold’s own enough to drag the GGR back down to 0.191x. The subsequent young upleg interrupted by that hawkish-Fed-dots scare in mid-June boosted the GGR to 0.227x at best. That wasn’t high at all, far from upleg-slaying levels.
The minority Fed-officials’ opinion that a couple rate hikes might be necessary over a couple years into the future slammed gold and thus gold stocks. Again gold and GDX plummeted 5.2% and 9.2% during the several trading days following that hawkish dot plot. The major gold stocks were leveraging gold’s downside by 1.8x, pretty mild in light of the normal 2x-to-3x range of GDX price moves compared to gold’s.
But gold-stock psychology was so badly damaged by that extreme early-summer anomaly that the miners kept grinding lower even after gold bottomed and started recovering. Gold’s post-Fed low was essentially hit the Friday after that Wednesday FOMC decision. That was retested in late June, before gold’s fairly-strong rebound. By early July, gold had bounced 2.4% recovering about 3/7ths of its rate-hike-scare losses.
But gold-stock traders continued to worry, pummeling GDX 2.5% lower on July 8th as gold drifted flatlined after regaining $1,800. Fear and apathy spawned by that Fed-gold-futures purge continued to plague the gold stocks. That pushed the GDX/GLD Ratio way down to 0.200x, a share of GDX was worth 20% of a share of GLD. As you can see in this chart, gold-stock prices were right back down to secular valuation support.
The major gold stocks’ valuations being bludgeoned to the bottom of their multi-year uptrend is a strong fundamental argument for an imminent mean reversion higher. Gold-stock prices are too low relative to prevailing gold prices to be sustainable for long. Thus their interrupted upleg should soon resume, with gold-stock gains well outpacing gold’s own. This implies some major near-term upside for GDX gold stocks!
The reason contrarian speculators and investors tolerate gold stocks’ wild volatility is their gains during gold uplegs grow utterly massive. GDX has averaged huge 99.2% gains over 7.6 months in this bull’s previous four uplegs! Those big-and-fast moves leave gold stocks really-overbought relative to their 200-day moving averages and really-overvalued compared to gold. Uplegs usually crest with the GGR above resistance.
This key valuation ratio’s secular-resistance line is running around 0.240x today, and will likely climb closer to 0.250x as this interrupted gold-stock upleg matures in coming months. And gold-stock uplegs depend on gold uplegs, so gold prices need to head higher too for the gold miners to amplify their metal’s gains. So we can make some conservative assumptions on gold stocks’ probable upside in this coming rebound.
Today’s secular gold bull was born in mid-December 2015, interestingly right as the FOMC kicked off its last rate-hike cycle. Gold has enjoyed four major bull uplegs since averaging hefty 33.3% gains each. This current one is likely to grow larger, as the Fed’s money printing has been staggering. Since that March 2020 stock panic, the Fed has ballooned its balance sheet by 87.8% or $3,786b in just 15.9 months!
The US-dollar supply nearly doubling in that short span explains the increasingly-raging inflation since. This is the perfect environment for gold investment to soar, catapulting gold prices sharply higher. But let’s just make a cautious assumption gold powers 25% higher in its current interrupted fifth upleg of this bull. That would take the metal itself to $2,100, just a little over the last upleg’s peak of $2,062 in August 2020.
In GLD terms, that translates to about $197 per share for this dominant gold ETF. Assuming gold-stock gains outpace gold’s enough to fully mean revert that GDX/GLD Ratio back up to coming resistance near 0.250x, that implies a GDX share price near $49.25. That would make for a smaller gold-stock upleg with just 59% gains, but is still another 42% above this week’s depressed levels! That’s a nice mean reversion.
Of course with more-aggressive assumptions on gold levels and gold-stock outperformance, this upleg’s gold-stock-topping projections can get much higher. But the important point today is gold stocks are too cheap relative to gold and need to mean revert much higher. As gold itself recovers, traders will migrate back into the major gold stocks of GDX really accelerating their gains. Fundamentals totally support this!
In last week’s essay I outlined a preview of this soon-to-be-reported Q2’21 earnings season. Despite that goofy Fed-gold-futures purge last month, gold’s average price still climbed 1.2% sequentially in Q2 to $1,814. Meanwhile the GDX-top-25 gold miners’ all-in sustaining costs are likely to retreat about 5% from Q1 to around $1,014 per ounce. The gold miners tend to enjoy strong 5%ish output boosts from Q1s to Q2s.
I explained why last week, and higher production lowers costs proportionally. Thus the major gold miners could very well earn fat unit profits averaging $800 per ounce in Q2! That would make for a sharp 10.1% sequential jump from Q1’s already-high levels. While we won’t know for sure until the quarterly reporting is ending, it wouldn’t surprise me to see good-to-great results from gold miners helping to attract back traders.
So it’s not just oversold technicals arguing for an imminent mean-reversion bounce in the gold stocks, but strong fundamentals. That hawkish-Fed-dots scare hammered gold-stock prices to undervalued levels compared to the metal they mine. In GDX/GLD Ratio terms, the gold stocks were dragged back down to major secular support. They’ve surged sharply higher after past approaches in recent years, excluding the panic.
So traders should be taking advantage of these anomalously-low gold-stock prices to get deployed in this high-potential sector. And GDX’s likely upside as this interrupted upleg resumes is easily trumped by that of the fundamentally-superior mid-tier and junior gold miners. So we’ve been redeploying in them in our newsletter trading books after stoppings spawned by that hawkish-Fed-dots scare. This is a prime buy-low time!
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The bottom line is this interrupted gold-stock upleg needs to rebound higher in a major mean reversion. Last month’s Fed-gold-futures purge crushing gold stocks left them both really oversold technically and really undervalued compared to prevailing gold prices. The large gold stocks of GDX were driven right back down to their major secular-uptrend support. This considerable anomaly won’t be sustainable for long.
As gold investors return on the Fed’s extreme money printing increasingly manifesting itself as dangerous inflation, gold-stock traders will also start flocking back. Their buying should push gold-stock prices sharply higher in coming months. Given their incredibly-bullish backdrop, the fifth gold and gold-stock uplegs of this bull have real potential to grow much larger than average before they eventually give up their ghosts.
Adam Hamilton, CPA
July 16, 2021
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