Adam Hamilton: "GDX Weathers Stock Selloff"

The gold miners' stocks weathered the recent stock-market plunge really well. As evident in their leading GDX ETF, they were already beaten down before stock markets started falling. The resulting explosion of fear bled into GDX, forcing it even lower. Nevertheless, no major technical damage was done. GDX remained well within its consolidation trend channel and is still within striking distance of a major $25 breakout.

Gold stocks' behavior during stock-market selloffs can seem capricious. This small contrarian sector generally amplifies the price action in gold, which drives its collective profitability. Gold tends to surge in the wake of major stock-market selloffs, which erode investors' confidence in stocks' near-term outlook. That greatly boosts gold investment demand as investors soon rush to wisely diversify their stock-heavy portfolios.

This drives gold prices higher after material stock-market weakness. So naturally the gold stocks mirror and amplify gold's gains which really improve their fundamentals. But this broader strengthening trend is interrupted by a lot of chaotic noise. The collective greed and fear generated by the stock markets' daily action heavily influences gold-stock traders, especially when the stock markets are exceptionally volatile.

The gold miners' stocks are just that, stocks. So it's not uncommon for them to get sucked into serious down days in the general stock markets, which fuel widespread fear. When the flagship S&P 500 stock index (SPX) falls sharply, nearly everything else is dumped in sympathy including the gold stocks. The SPX truly is the dominant center of the global financial-market-sentiment universe, greatly affecting everything.

Unfortunately sharp SPX down days' ability to heavily influence GDX wreaks havoc on sentiment in the gold-stock sector. Traders read historical studies proving the precious-metals realm is the best place to deploy capital in and after weakening stock markets. So they rightfully expect gold-stock prices to rally on balance. But when GDX plunges on a big SPX down day, their fear soars and they abandon gold stocks.

Human psychology always tends to overweight the importance of recent and traumatic events, with our minds wanting to extrapolate short-term turmoil out into infinity. Thus when gold stocks get sucked into a sharp general-stock selloff, traders assume they can't thrive in weak stock markets. They lose the trend forest for the daily trees! This fearful herd sentiment scares them into panicking and selling gold stocks low.

Weakening stock markets are like springtime for gold and its miners' stocks due to higher investment demand. Just as daily temperatures gradually warm over time during spring, gold stocks rally on balance after material stock-market weakness. But spring weather also includes periodic cold snaps that can feel winter-like. They are just temporary counter trend aberrations though, like gold-stock drops on big SPX down days.

This first chart looks at gold stocks' recent price action through the lens of GDX, the VanEck Vectors Gold Miners ETF. Since its birth in May 2006, GDX has grown into the leading and dominant gold-stock ETF. As of this week GDX's $7.6b in assets under management ran a whopping 22.0x larger than its next-biggest 1x-long major-gold-stock-ETF competitor! GDX actually weathered the stock plunge really well.

The sharp stock-market selloff in the past couple weeks has been extraordinary, largely unprecedented on multiple key fronts. The S&P 500 was wildly overvalued and overbought in late January, deep in its longest span ever witnessed without a mere 5% pullback. Volatility was trading near record lows, which catapulted complacency off the charts. Last week I explored all this in an essay analyzing stock selling unleashed.

The first real day of serious SPX selling was Friday February 2nd. The gold stocks certainly weren't high leading into that, as GDX had closed the day before at $23.70. That was merely on the high-middle side of gold stocks' consolidation trading range. Really since late 2016, GDX has largely meandered between $21 support and $25 resistance. It had neared a major $25 breakout in late January, but couldn't punch through.

On Friday the 2nd the SPX plunged 2.1% after rising wages on the US monthly jobs report stoked fears of inflation. 10-year Treasury yields continued their sharp surge since the latest Fed rate hike in mid-December. That SPX down day was the worst since September 2016, before Trump won the election and the resulting extreme taxphoria rally. It generated some real fear which spilled over into the gold stocks.

But that stock-fear bleed-in sure wasn't the only reason GDX fell 3.3% that day to revisit its technically-important 200-day moving average. With inflation fears mounting, futures traders figured the Fed might have to increase the tempo of this rate-hike cycle. So the US Dollar Index surged a sharp 0.7% higher, which led gold-futures speculators to hammer gold 1.4% lower. GDX's initial stock-selloff loss was reasonable.

The major gold stocks tend to amplify gold's underlying price action by 2x to 3x. And GDX's downside leverage to gold that day ran 2.4x, right in line. Most of the time gold stocks still follow gold, even when stock markets are weaker. But on exceptional SPX down days when fear really flares, that overshadows gold as traders are infected by prevailing herd sentiment. That really started to happen on Monday the 5th.

The SPX selloff greatly intensified as it plunged 4.1%, its worst daily drop since way back in mid-August 2011! That was extreme, as stock markets usually don't plummet so rapidly from record highs. Because it had been so long since the SPX plunged, fear skyrocketed as evidenced by the VIX implied-volatility index. Foolish traders who had aggressively shorted volatility near record lows scrambled to unwind their bets.

Gold caught a modest bid that day, rallying 0.6% despite the US Dollar Index climbing another 0.4% on safe-haven buying. On days when the SPX plunges yet gold climbs, traders are torn about what to follow so the gold stocks generally split the difference. Indeed that day GDX slid another 0.9%, far milder than the sharp SPX plunge but still worse than gold. That left GDX at $22.71, sliding farther under its key 200dma.

After plunging even deeper early on Tuesday the 6th, the SPX reversed sharply to a 1.7% gain on close as the extreme VIX-futures long buying abated. Gold suffered a 1.1% loss on the stronger stock markets as well as a major 1.4% draw in its leading GLD gold ETF's holdings. Investors likely dumped GLD shares for a source of capital. Since gold is much stronger than general stocks in SPX selloffs, GLD is easy to sell.

With gold falling sharply GDX dropped another 2.6% on that third day of the SPX selloff. Once again that made for 2.4x downside leverage to gold, which is perfectly normal. Although that decisively broke GDX below its 200dma, at $22.11 it remained well within its long-established consolidation trend channel. With trend support at $21, gold stocks still had a ways to go before they threatened a major technical breakdown.

The SPX selling resumed on Wednesday the 7th with a relatively-minor 0.5% loss. Gold fell by the same amount, as once again the US Dollar Index surged 0.7% on flight-capital safe-haven buying. GDX lost another 1.4% to hit $21.80 on close. That amplified gold by 2.8x, still within that normal 2x to 3x range for the major gold stocks. The gold stocks were weathering that sharp SPX selloff really well by that point.

On Thursday the 8th the stock markets started sliding again on no news, and the SPX fell relentlessly all day long. By the time the dust settled, it had collapsed another 3.8%! Two huge 4%ish down days out of just four trading days was very serious, generating the most fear traders have experienced for at least a couple years. Gold eked out a 0.1% gain with the US dollar flat, and the gold stocks split the difference as usual.

GDX only retreated 0.6% that day the SPX formally plunged into correction territory for the first time since early 2016. That was truly an impressive show of strength given the stock markets rapidly spiraling lower. At $21.68, GDX remained well above its $21 support line that has held rock solid since late 2016. It looked like the gold stocks were nearing selling exhaustion since they fell so little on such a huge SPX down day.

In just five trading days the SPX had plummeted 8.5%! That was a big drop by any standard, let alone off record highs out of near-record-low volatility. Interestingly GDX exactly mirrored that drop, falling an identical 8.5% in that same span. Relative to gold that was excessive, 3.5x the 2.4% gold lost during that same timeframe. But with GDX remaining well within its consolidation trend channel, technical damage was minor.

Last Friday the 9th once again saw the SPX slide rapidly after open before reversing sharply to a large 1.5% daily gain. Gold stocks got sucked into that early fear-spawning selling, which was exacerbated by gold itself slumping lower before a -0.2% close. GDX tested that $21 support intraday, but bounced back to a dead-flat close. This small contrarian sector had successfully weathered an exceptional SPX selloff!

This week the SPX and gold both rebounded, each rallying Monday, Tuesday, and Wednesday. Thus it wasn't surprising GDX followed suit, rallying 1.3%, 0.1%, and a monster 4.6% by the data cutoff for this essay. Thus over the entire 9-trading-day span of the recent volatility storm, GDX merely slipped 2.9%. That was again between the SPX's 4.4% loss and gold's slight gain. The gold miners' stocks are faring fine!

This Wednesday GDX was back up to $23.01, exactly in the middle of its consolidation trading range of the past year between $21 support and $25 resistance. GDX was back over its 200dma again, and still within striking range of that critical $25 breakout I discussed a month ago. If you had totally tuned out for 9 trading days and ignored the SPX-selloff action, it would've looked like gold stocks were still merely basing.

One of the greatest benefits to continuing to study the markets and staying immersed in them is you will gradually become immune to herd sentiment. After you've seen enough selloffs, they increasingly lose their ability to scare you. And you remember that sharp selloffs are short-lived, whether in the general stock markets or gold stocks. So you come to accept them as inevitable periodically, and they don't rile you up.

A great analogy is a beekeeper. Most people are scared of bees, freaking out if bees buzz too closely or land on them. I know I'm no fan of bees invading my personal space. But beekeepers have no fear of bees because they work with them all the time. They certainly respect bees and understand the risks of being around them. But all their experience with bees leads to enough knowledge to negate emotional responses.

Gold stocks have always been a volatile sector. That's actually a core reason they are so alluring, as this volatility translates into big and fast gains when they are rallying. In roughly the first half of 2016, GDX rocketed 151.2% higher on a parallel 29.9% gold upleg! Volatility is a double-edged sword, sectors that can rally fast will also fall fast. So gold-stock investors must accept periodic sharp selloffs as par for this course.

The major gold stocks as represented by GDX are doing fine. Despite some choppiness as the SPX was flailing about in recent weeks, they are continuing to base in their well-established consolidation trend. They are still on track for a major GDX $25 breakout, which will work wonders to shift sector psychology back to bullish again and spur big capital inflows. The gold miners' stocks are low technically and cheap fundamentally.

This last chart zooms out to the bigger picture, looking at GDX since 2007 which is largely its entire life. Gold stocks move in great bull-bear cycles like everything else, and they remain incredibly low today. The small highlighted square in the lower right encompasses the entire first chart. These prevailing gold-stock levels are almost as low as during 2008's epic stock panic, which is absurd based on fundamentals.

This powerful new gold-stock bull ignited in early 2016 remains young and small. Its bull-to-date peak in early August 2016 was merely a 3.3-year GDX high, still very low in secular context. After this sector was sucked into 2008's stock panic, the major gold stocks more than quadrupled out of those extreme lows. A quadruple from January 2016's all-time low birthing this bull would catapult GDX back up near $50.

That means the major gold stocks easily have the potential to more than double again from here, seeing another 117% GDX gain in the next couple years! Is there any other sector in all these wildly-overvalued stock markets that can make such a claim? No way. Like gold, the gold stocks are now deeply out of favor thanks to the extreme stock-market bull that may have just peaked in late January. Sentiment is poor.

But as gold inevitably powers higher in the wake of this newest SPX correction on strengthening demand from investors, the gold stocks will follow and amplify its gains. Fundamentally the major gold stocks are still dirt-cheap. That's readily evident in their quarterly operational and financial reports, which I closely follow and analyze for the major GDX gold miners. I can't wait for their Q4'17 results over the coming weeks.

The primary measure of industry-wide gold-mining profitability is all-in sustaining costs, what its costs to mine and replenish an ounce of gold. In Q3'17 that averaged $868 for the GDX gold miners. And these costs are pretty stable, averaging $867, $878, $875, and $855 in the four quarters before that. So odds are the major gold miners' collective all-in sustaining costs will hold near these levels in Q4'17 and Q1'18 too.

Gold averaged $1279 in Q3, leading to fat per-ounce profits of $411. Gold was essentially flat in Q4 with a $1276 average price. That means the GDX-component gold miners are likely to soon report profits of $408 per ounce. I'll dig deeply into those new Q4 quarterlies as they are released, and publish an essay on the results in mid-March. Since Q4 reporting includes full-year results, regulatory deadlines are twice as long.

The SEC requires normal quarterly reports to be filed within 40 to 45 days after quarter-ends, depending on companies' sizes. But since they have to prepare annual reports with the quarter that ends fiscal years, usually Q4, that deadline is extended to 60 to 90 days. So by mid-March most of the major gold miners' Q4'17 results will be out. I expect average all-in sustaining costs to come in flat like usual in these reports.

And that's super-bullish given what gold is doing. The yellow metal that drives its miners' profits is faring much better in Q1 than it did in Q4. It's averaging $1331 quarter-to-date, up 4.3% sequentially from Q4. So if AISCs are stable like usual, profits will surge which investors will anticipate in advance. The same $868 AISC implies Q1 GDX-major-gold-miner profitability of $463 per ounce, soaring 13.3% quarter-on-quarter!

So my month-old forecast of a GDX $25 breakout on Q4 earnings remains highly likely. When investors see how the gold miners are faring in their latest reported quarter, they are going to extrapolate mining costs into Q1. That will portend exploding profitability. GDX only needs to rally another 8.6% from its mid-week levels to hit $25. And once gold stocks break out decisively to the upside, they are off to the races.

In all the markets buying begets buying. The more a sector or asset is rallying, the more investors want to participate. And the more capital they pour in, the more those prices keep rallying. That creates and fuels a powerful virtuous circle of buying. Gold stocks have drifted sideways for so long now that they need to achieve a major upside breakout from their consolidation to catch investors' interest. That's not far away.

Despite the roller-coaster ride in gold stocks as the wild SPX volatility bullied them around in the past couple weeks, GDX is still within striking distance of that key $25 breakout. Once that happens, the gold stocks' popularity will surge again. There's still time to buy low before lots more investors start returning which will catapult this small contrarian sector sharply higher. The gold stocks look really bullish today!

While investors and speculators alike can certainly play gold stocks' powerful coming upleg with major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals. Their upside will far exceed 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.

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The bottom line is the gold stocks weathered the recent sharp stock-market selloff really well. The SPX plunged for the first time in a couple years, generating a big and sharp fear spike. As usual that spooked the gold-stock traders, who sold and fled. Yet despite the carnage GDX's major consolidation support at $21 held solid. The gold miners' stocks soon rebounded sharply back up to the middle of their basing channel.

With GDX trading near $23 this week, that critical $25 breakout to entice investors back remains within easy range. Once the collective gold-mining costs reported in the upcoming Q4 results are compared with higher Q1 prevailing gold prices, strong gold-stock buying should resume. Gold stocks have always been a volatile sector, so there's no reason for traders to fear periodic selloffs like they suffered in recent weeks.

Adam Hamilton, CPA

February 16, 2018

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