The gold miners’ stocks remain deeply out of favor, largely shunned by traders. Since this sector just spent the better part of a year grinding sideways, such bearish sentiment isn’t surprising. But with a giant technical formation nearing a major inflection point, things look to be coming to a head in gold-stock land. A big breakout is nearing, and gold stocks’ deep undervaluation relative to gold argues it will be to the upside.
From Adam Hamilton, Zeal:
Every investor’s portfolio should always include a core position in gold bullion. As a rare asset that tends to move counter to stock markets, gold acts like insurance. It rallies strongly when stocks and bonds are falling in serious corrections or bear markets, mitigating overall portfolio losses. Gold certainly has risks of its own, but they pale in comparison to the additional layers of risk heaped on by gold-mining stocks.
Gold miners face major financing, operational, geological, and geopolitical risks that gold doesn’t. Even when gold is thriving on strong investment demand, individual gold miners’ stocks greatly underperform if their mines suffer troubles. Thus gold-mining stocks must offer ultimate returns well beyond gold’s own, to compensate investors for bearing these miners’ big additional risks stacked on top of gold’s own risks.
Miners’ gains do amplify gold’s underlying gains during gold bulls, as evidenced in the flagship HUI gold-stock index. Gold stocks’ last secular bull ran for 10.8 years between November 2000 to September 2011. During that span the HUI skyrocketed 1664.4% higher, driven by gold’s own parallel 602.9% bull market! That made for 2.8x upside leverage for gold stocks relative to gold, right in line with historical ranges.
The major gold stocks that dominate the HUI and the leading GDX VanEck Vectors Gold Miners ETF will generally enjoy 2x to 3x upside leverage to gold in bull markets. With the big gold stocks tending to see ultimate gains doubling or tripling gold’s, investors are often willing to shoulder their additional risks. And among the smaller mid-tier and junior gold miners, their collective upside leverage to gold runs even greater!
The reason investors are so down on gold stocks today is their year-to-date leverage to gold has been horrendous. Despite the Trumphoria-fueled record-high stock markets, gold has still surged 11.9% since 2017 dawned. Incidentally that has handily bested the S&P 500’s 8.7% YTD gain. But despite gold shining, the gold stocks as measured by the HUI were only up 11.1% YTD as of the middle of this week.
And that was even after Tuesday’s surge, where the HUI blasted 6.1% higher on gold challenging $1300 again! The gold miners’ stocks, despite their big additional risks, are actually lagging gold so far this year with terrible leverage of 0.9x. That’s why bearishness on this sector is so extreme today. Truly the risky gold stocks aren’t worth owning if they fail to generate much-greater gains than gold. Upside leverage is critical.
While this year-to-date snapshot is pretty damning, it’s a myopic perspective. Like everything else in the markets, gold stocks’ leverage to gold flows and ebbs in cycles. We are likely at trough leverage now, as it’s hard to imagine this sector’s psychology becoming much worse. After exceptional underperformance relative to gold, the gold stocks’ gains tend to surge and outperform to gradually restore that 2x to 3x average.
Given the sometimes-extreme cyclicality of gold stocks’ upside leverage to gold, they were actually due for a period of underperformance. In January 2016, a new gold-stock bull was born out of fundamentally-absurd 13.5-year secular lows in HUI terms. Over the next 6.5 months, the gold stocks soared 182.2% higher on a new and small 25.2% gold bull. That was extreme 7.2x upside leverage, far too great to be sustainable.
I warned about gold stocks’ excessive early-bull gains last July, that a mid-bull correction was necessary and inevitable to rebalance sentiment. Due to a series of anomalous events slamming gold itself in the second half of last year, that healthy gold-stock correction grew far more extreme than anyone expected. But after such huge outsized gains relative to gold in 2016’s first half, a leverage mean reversion is righteous.
So the gold stocks have far-underperformed gold for the better part of a year now, fully bleeding off the excessive greed their early-2016 outperformance fueled. And now the relative-performance pendulum is once again set to swing back the other way. This chart looks at the major gold miners’ technicals since early 2016 as represented by the HUI. A major triangle consolidation chart pattern is nearing the end of the line.
That overdue gold-stock correction last summer was fast and furious in August, with the HUI plunging a blistering 22.0% in less than a month! That was totally normal. The gold stocks then spent September consolidating and bottoming, typical staging for their next upleg. But then out of the blue they got walloped by an extreme event. Gold futures suffered a mass stopping as key gold support near $1300 failed to hold.
Gold’s resulting extreme 3.3% down day in early October sucked in the gold stocks, which saw their own stop-loss-triggered cascading selling. The HUI plummeted 10.1% in a single trading day, spawning incredibly-bearish psychology! But that September consolidation before the early-October plunge would start forming the upper resistance line of the giant triangle consolidation pattern finally nearing maturity today.
After that extreme anomaly, the gold stocks soon started grinding higher again along the HUI’s key 200-day moving average. 200dmas are usually the strongest support lines in ongoing bull markets. Then unbelievably gold suffered another extreme anomaly. After Trump’s surprise election win, stock investors started jettisoning gold-ETF shares like crazy on the sharp Trumphoria stock-market rally. Gold plunged again.
And naturally the HUI followed, as gold miners’ profits and hence ultimately stock prices are leveraged to underlying moves in gold prices. After that the gold stocks started consolidating again in November, until they were hit by a mind-boggling third anomalous event after just suffering two in two months. The gold stocks dropped with gold in mid-December on 2017 Fed-rate-hike projections being more hawkish than expected.
That rare gold-futures mass stopping, the never-before-witnessed Trumphoria stock-market surge that was contrary to all pre-election expectations if Trump actually won, and the hawkish Fed ballooned that healthy gold-stock correction to a freakishly-large 42.5% in 4.4 months! But as soon as those extreme gold-selling anomalies stopped materializing, gold stocks were quick to bottom decisively in December.
They briefly consolidated low, starting to form the lower support line of that triangle consolidation chart pattern of such great interest today. After being beaten to such super-low levels relative to prevailing gold prices, the HUI took off like a rocket in a major new upleg. By early February, the gold stocks had surged 35.5% in just 7 weeks on a mere 10.0% gold rally. That was strong 3.6x upside leverage to gold!
But that initial upleg surge stopped cold at the HUI’s 200dma. When bull markets suffer unusually-large corrections thanks to anomalous events, technically-oriented traders’ perceptions can shift from seeing 200dmas as strong bull-market support to major overhead resistance. Bulls aren’t believed to be back on track until decisive re-breakouts above 200dmas occur. That actually happened with gold itself in mid-April!
So the HUI was repelled at its 200dma in mid-February, solidifying the upper resistance line of this triangle consolidation chart pattern. Then gold stocks retreated from mid-February to mid-March, as Fed-rate-hike fears flared again among gold-futures speculators. These guys dominate short-term gold price action, and are irrationally scared of Fed-rate-hike cycles even though gold has thrived during them historically.
On the very day the Fed indeed hiked again as expected in mid-March, gold and therefore gold stocks surged dramatically. The FOMC members controlling monetary policy didn’t up their collective forecast for three total rate hikes in 2017, which was considered dovish. So the HUI soared 7.8% higher in the afternoon after that third rate hike of the Fed’s newest cycle. That solidified this triangle’s support line.
Gold rallied strongly from there into mid-April, breaking decisively back above its 200dma again on rising geopolitical fears. That was after Trump lobbed cruise missiles into Syria, sent a carrier battle group to North Korea, and struck Afghanistan with the biggest conventional bomb ever used in combat all within a single week! But gold-stock sentiment remained damaged, and the HUI again failed to overcome its 200dma.
Gold and especially gold stocks faded again into early May, with new record highs in US stock markets retarding gold investment demand. Then a big stock-market down day rekindled gold’s uptrend, but the beaten-down gold stocks only edged feebly higher really lagging their dominant fundamental driver. That recent action further reinforced this symmetrical-triangle consolidation pattern that’s crystal-clear in this chart.
Since September now, the gold stocks as measured by the HUI have seen lower highs and later higher lows. Their upper resistance line is pushing lower right along the HUI’s 200dma. Just this week, that big 6.1% HUI surge on Tuesday blasted it right back to its 200dma again for the third time in five months. Meanwhile the HUI’s lower support line keeps rising, compressing this 9-month-old triangle consolidation pattern.
As you can see in this chart, this symmetrical-triangle formation has nearly closed. In a matter of weeks, the gold stocks’ resistance and support lines will converge. That will force gold stocks into an imminent technical breakout one way or the other. This drifting sector has reached a major inflection point. And the resulting move could be big, as symmetrical-triangle breakouts often fuel big momentum buying or selling.
While a breakdown is possible, the odds favor a major upside breakout soon for gold stocks. In my line of work, I hear from plenty of fund managers. They understand the gold miners’ underlying fundamentals are strong, as evidenced by the recently-reported first-quarter results of the GDX components. They also know gold stocks are unloved and undervalued relative to gold, with big upside potential when sentiment shifts.
But since fund managers have to report their performance on a quarterly basis, many are wary of shifting capital back into gold stocks early. They don’t want to be stuck reporting owning the very-unpopular gold stocks at quarter-ends before this sector starts moving again. So multiple fund managers have told me they are waiting for a decisive 200dma breakout of the HUI or GDX. That’s their green light to start buying.
That will yield hard technical confirmation that gold stocks remain in bull-market mode. And since this giant symmetrical triangle’s upper resistance is paralleling the HUI’s 200dma, a 200dma breakout will also be an upside consolidation breakout. Concurrent upside breakouts of multiple major resistance lines should unleash serious buying momentum. A decisive breakout is 1%+ above any resistance line.
Interestingly these festering fears that a gold-stock bull might not be in force anymore are kind of silly. As of the middle of this week, the HUI was still up 101.1% bull-to-date since January 2016 compared to an 18.5% gold gain over the same span. And gold stocks are only down 28.7% from their bull-to-date peak seen in early August. That’s not much in a sector as volatile as this considering all the late-2016 anomalies!
The greatest argument for gold stocks’ imminent upside breakout from their long symmetrical-triangle consolidation is actually fundamental, not technical. The gold miners’ stocks remain greatly undervalued relative to prevailing gold prices. In Q1’17, the major gold miners included in that leading GDX ETF reported average all-in sustaining costs of just $878 per ounce. That’s $409 below today’s gold price!
The gold miners are very profitable today, yet their stocks are priced as if they not only can’t earn any money now but probably never will! That’s a ridiculous anomaly driven by excessively-bearish sentiment, and such extremes never last for long. A great proxy for the strong fundamental relationship of gold-mining profits and therefore gold-stock prices to gold levels is found in the venerable HUI/Gold Ratio, or HGR.
It simply divides the daily HUI close by the daily gold close, so the resulting ratio can be charted over time. As I discussed in depth in an essay on gold-stock-bull upside targets in mid-April, the average HGR in the last normal market years between 2009 to 2012 was 0.346x. The gold stocks need to at least mean revert back up to those levels to return to some semblance of fundamental normalcy relative to gold.
This last chart looks at the HGR since early 2016, this new gold-stock bull market’s entire lifespan. It is rendered in blue along with key moving averages. The actual HUI gold-stock index level is shown in red. But a second hypothetical HUI is included in yellow, showing where gold stocks should be trading at that post-panic-normal-year HGR average of 0.346x. That’s more than double where this sector is drifting now!
If the gold stocks were popular and loved today, trading at historically-high levels relative to gold, I would be very bearish on this symmetrical triangle failing to the downside. But the exact opposite is true! This week the HUI/Gold Ratio was trading at only 0.157x. That’s still super-low historically, not too far above the all-time low of 0.093x last seen in January 2016 when this strong new gold-stock bull was stealthily born.
And even when gold stocks peaked in their young bull’s first upleg in early August, they remained way under normal levels relative to gold by all historical standards. The HGR only hit 0.209x at best, still far below that 2009-to-2012 normal-year average of 0.346x. Realize that for their entire young bull market, gold stocks have yet to trade anywhere near even normal price levels let alone high ones warranting caution.
Interestingly the HGR itself is in a similar giant technical pattern to the gold stocks, a descending triangle. Since early last November, the HGR has found strong support just under 0.15x. Like the gold stocks, the HGR is getting squeezed into an ever-tighter trading range. So an HGR breakout is also imminent. And like gold stocks, the odds favor that being to the upside. These extreme-low HGR levels are very rare historically.
If the gold stocks would simply mean revert back up to their 0.346x average HGR, the HUI would trade at over 445 at this week’s gold prices! That’s a whopping 120% higher than today’s levels. When a sector is radically undervalued fundamentally relative to the driver of its profits, upside potential is vastly greater than downside risk. Gold stocks’ mean-reversion upside from here is huge, arguing for a major upside breakout.
With gold stocks so darned cheap relative to gold, the odds heavily favor the nearing inflection point of this symmetrical triangle turning sharply north. And interestingly, a potential big buying catalyst for both gold and gold stocks is coming next week. The FOMC is meeting to make a monetary-policy decision which is widely expected to result in the fourth rate hike of this cycle. And future rates will be forecast.
Despite gold-futures speculators’ paranoia of Fed rate hikes, both gold and gold stocks surged sharply after each of the three previous rate hikes in this cycle. Why should the fourth prove any different? It’s also quite likely the FOMC members’ collective view on more rate hikes in 2017 proves either stable or more dovish than expected. After Q1’s very-weak GDP and May’s huge US jobs miss, the Fed can’t be hawkish.
The Fed only forecasts future rates at every other FOMC meeting, or once a quarter, in the so-called dot plot. That showed three total rate hikes in 2017 in mid-March, when the US economic data looked much stronger. Traders had expected that to be lifted to four, but it wasn’t. That’s why gold and gold stocks surged sharply that very afternoon. If that rate-hike forecast stays at three next week, gold should rally again.
But between the sharp deterioration of US economic data in the past quarter, along with the Fed’s desire to soon start shrinking its grotesque balance sheet ballooned by years of QE, the FOMC may very well lower its 2017 rate-hike outlook. It doesn’t even have to fall to two, signaling this year’s rate hikes are likely over. If the collective forecast even sheds a quarter point, gold-futures speculators should flood into gold.
Remember mid-March’s less-hawkish-than-expected dot plot drove gold 1.9% higher the afternoon it was published. That resulted in a major 7.8% HUI surge that very day, along with nearly a month of follow-on rallying after that! If gold and therefore gold stocks catch a bid on next week’s FOMC decision, this sector’s symmetrical triangle will conclude with an upside breakout that could unleash big buying momentum.
With gold stocks nearing such a major technical inflection highly likely to be resolved to the upside, you need to be closely following this sector. It wouldn’t surprise me one bit to see the HUI’s ultimate 2017 gains approach or even exceed its big 64% surge last year. The earlier you get informed and deploy in great gold stocks cheap, the greater your gains will be. Buy low before most others, as fortune favors the bold!
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The bottom line is a major technical inflection point nears in gold stocks. A giant symmetrical-triangle consolidation pattern formed over the past 9 months has nearly fully converged, which will soon force a major breakout. Odds are it will prove to be to the upside given this sector’s strong fundamentals and severe undervaluation relative to gold. The major gold miners are very profitable at today’s gold prices.
The most-visible near-term breakout catalyst is next week’s FOMC meeting. Gold and gold stocks have rallied sharply after each of the past three Fed rate hikes. So if gold-futures speculators see anything the Fed releases as less hawkish than expected next week, they will pile back into gold which will once again catapult gold stocks higher. And given all the weak economic data lately, it’s hard to imagine a hawkish Fed.
Adam Hamilton, CPA