Cheap Gold Stocks Basing / Commodities / Gold and Silver Stocks 2018

The small contrariangold-mining sector remains deeply out of favor, universally ignored.  Thus the gold stocks are largely driftinglistlessly, totally devoid of excitement. But that’s the best time to buy low, when few others care.  The gold stocks continue to form strongtechnical bases, paving the way for massive mean-reversion uplegs.  And they remain exceedingly cheap relative togold prices, which drive their profits.

Being a gold-stockinvestor feels pretty miserable and hopeless these days.  The gold stocks have been consolidating lowfor 14.2 months now, stuck in a seemingly-endless sideways grind.  There are still gains to be won, but they aremostly within that low-trading-range context. We haven’t seen one of the huge uplegs gold stocks are famous for sincethe first half of 2016.  So most tradershave given up and moved on.

That’s understandablepsychologically, but unfortunate for multiplying wealth.  Sometimes it takes a while for gold stocks tocatch a bid, but once they get moving theyoften soar.  This sector is so smallrelative to broader stock markets that even minor shifts in capital flows candrive enormous gains.  While it’s hardwaiting for gold stocks to return to favor, the vast upside when they do is wellworth the buying-low pain.

The leading gold-stockmeasure and trading vehicle is the GDX VanEck Vectors Gold Miners ETF.  It was the original gold-stock ETF launchedin May 2006, and still maintains a commanding advantage in popularity.  This week, GDX’s net assets of $7.7b were24.0x larger than its next-biggest 1x-long major-gold-stock-ETFcompetitor!  GDX is as big as all the othergold-stock ETFs trading in the US combined.

GDX’s price action showswhy gold stocks are such compelling investments when everyone hates them.  After gold stocks were universally despisedin mid-January 2016, GDX soared 151.2% higher in just 6.4 months!  After the previous time sentiment turned sooverwhelmingly against gold stocks in October 2008, GDX rocketed 307.0% higherover the next 2.9 years.  Buying gold stocks low has proven very lucrative.

That quadrupling of GDXafter 2008’s first-in-a-century stock panic was actually the tail end of avastly-larger secular gold-stock bull. Many years before GDX was even a twinkle in its creators’ eyes, thatgold-stock bull started stealthily marching higher out of total despair.  It can’t be measured by GDX since that ETF startedtoo late, but the classic HUI NYSE Arca Gold BUGS Index reveals the magnitudeof that bull run.

Over 10.8 years betweenNovember 2000 and September 2011, the gold stocks as measured by the HUIskyrocketed an astounding 1664.4% higher! And that was during a long bear-market span in the general stockmarkets, where the flagship S&P 500 drifted 14.2% lower.  The gains in gold miners’ stocks as they meanrevert from out of favor to popular are so epically enormous that they faroutweigh any time lost waiting.

Gold stocks are evenmore attractive today given the exceedingly-overvalued anddangerous US stock markets, which are on the verge of a long-overdue major bear. Market valuations remain deep in literal bubble territory despite early-February’s correction.  The simple-average trailing-twelve-monthprice-to-earnings ratio of the elite S&P 500 stocks was still 31.5x at theend of last month, above the 28x bubble threshold!

The market-darlingstocks investors love today are crazy-expensive, portending huge downside inthe next bear.  The most-popular stockamong professional and individual investors alike is Amazon.com, a greatcompany.  Yet AMZN stock is now tradingat a ludicrous 252.5x earnings!  That means if profits held steady it wouldtake new investors today a quarter millennium just to recoup their stockpurchase price.

Meanwhile the world’slargest gold miner in 2017-production terms, Barrick Gold, is now trading at aTTM P/E of 9.5x.  That’s dirt-cheap byany standards!  And ABX’s profits-growthpotential is greater than AMZN’s.  Lastyear Barrick mined 5.32m ounces of gold at all-in sustaining costs of $750 perounce.  That was $508 under gold’saverage price of $1258 last year, fueling fat full-year profits over $1.5b on$8.4b in sales.

Every 10% increase inprevailing gold prices boosts Barrick’s earnings by 25%.  And the average gold price so far in 2018 isalready up 5.7%, so gold miners’ profits aregrowing fast.  I’m not a Barrick Goldinvestor, and am just using this leading major gold miner as an example.  There are plenty of smaller mid-tier goldminers with far more upside profits leverage to gold prices.  Gold stocks are darned attractive!

They are one of thelast bargain sectors remaining in these overheated stock markets.  They are one of the only sectors that can rally in major bear markets, becausethey follow gold which drives their profits. Gold investment demand surgesin weak stock markets, which brings investors back to gold stocks.  At some point, investors are going to figureout how compelling gold stocks are today and stampede back in.

Despite the apatheticsentiment plaguing them, the gold stocks are still looking fine technically andeven better fundamentally.  This firstchart looks at gold-stock technicals as rendered by their dominant GDXETF.  Given how bearish traders havewaxed on gold miners, you’d think they are spiraling relentlessly lower.  But they are actually consolidating nicely, establishing a strong base from which tolaunch their next upleg.

After plunging to fundamentally-absurd all-time lows in mid-January 2016, GDX soared into a major new bullmarket.  While its 151.2% surge in just6.4 months was undoubtedly extreme, that emerged out of even-more-extremelows.  And it merely catapulted GDX to a3.3-year high in early-August 2016, nowhere close to secular toppinglevels.  But the gold stocks were veryoverbought then, and soon corrected hard.

GDX’s enormous 39.4%correction in 4.4 months after that initial bull peak was also extreme, theresult of a couple major anomalies. First gold-futuresstops were run on major gold support failing, which ignited parallelcascading stop-loss selling in the gold miners’ stocks.  Then investors fled gold in thewake of Trump’s surprise election victory, which led stock markets to soar onwidespread hopes for big tax cuts soon.

Gold-stock sellingfinally exhausted itself in mid-December 2016, the day after the Fed’s 2nd rate hike ofthis cycle.  Just a couple weeks later,GDX entered its now-14.2-month-old trading range that persists to thisday.  It is a basing consolidation trendrunning from $21 support to $25resistance, which makes for a 19.0% trading range.  This has held rock solid ever since, whichhas made gold-stock trading fairly easy.

My strategy has beensimple.  Given the extremeundervaluations in gold stocks that I’ll discuss shortly, a massive new upleg is likely to ignite anytime.  So I want a full trading book to reap thoseenormous gains when they inevitably arrive. Thus every time GDX slumped down into the lower quarter of itsconsolidation range, between $21 to $22, I’ve been adding positions in greatmid-tier gold miners with superior fundamentals.

All this is shared inreal-time with our newsletter subscribers, who graciously support our researchwork.  Buying low in the context of thisvexing gold-stock consolidation has driven some great trades despite lacklusteroverall action.  One example is KirklandLake Gold, an elite mid-tier miner.  Iadded a new position in our popular weekly newsletter in December2016.  A year later I sold it for a hefty 184% realized gain!

So while thisgold-stock trading range has sure felt dull, it has still created plenty oftrading opportunities.  And over the pastmonth or so since that sharp stock-market correction, GDX has largely meanderedin that lower quarter of its range near support again.  That means it’s an excellent time to deploycapital in the unloved and cheap gold miners’ stocks today.  Another surge higher is due, and it could bea big one.

While GDX $21 supporthas proven strong since the end of 2016, so has GDX $25 resistance.  The gold stocks have tried and failed tobreak out above $25 four separate times since early 2017.  A couple of the attempts were close, butweren’t sustainable as gold retreated. Once that $25 breakout finally comes to pass, investors will realizesomething different is happening and rush to chase gold stocks’ upsidemomentum.

Before early February’ssharp stock-market plunge that changed everything, I was looking to the releaseof gold miners’ Q4’17 operating and financial results as a potential catalyst to fuel that $25 breakout.  That didn’t happen though, as gold andespecially gold stocks were sucked into the fear surrounding the unprecedentedstock-market volatilityshock a month ago.  That dragged GDXback down near support, which held.

This recent supportapproach is probably a blessing in disguise, offering another chance forinvestors to deploy capital in cheap gold stocks before they really startmoving again.  The great and sad paradoxof the markets is investors are least willing to buy when stocks are low andout of favor, which is the exact time they should be buying before laterselling high.  Gold-stock prices can’tand won’t stay this low forever.

With stock-marketvolatility back, the highly-likely catalyst to ignite that GDX $25 breakout isgold rallying on resurgentinvestment demand.  Gold is largelyignored when stock markets are high and investors are euphoric, as they feel noneed to prudently diversify their portfolios. But once stock markets sell off for long enough to spook investors, theystart shifting capital back into gold which often moves counter to stocks.

With the US stockmarkets still trading deep into bubble territory in late February, and euphoria remaining rampant as evidencedby the blistering bounce rally following that early-month plunge, there’s noway the stock-market selling is over yet. It will have to resume sooner or later with a vengeance to actuallystart rebalancing away greedy sentiment. When that happens, gold and gold stocks will soon catch major bids.

The fact gold stockshave held strong in their consolidation trading range for well over a year nowis a glass-half-full kind of thing.  Ittestifies to relatively-strong investment demand given the terribly-bearishsentiment pervasive in this sector.  Thelonger prices base during bull markets, the greater the upside potential intheir next upleg.  It likely won’t takemuch of a gold rally to blast GDX back up through $25 again.

This strong technicalpicture and an inevitable sentiment mean reversion are reason enough for goldstocks to surge dramatically higher.  Butsupercharging that is the dirt-cheap state of gold stocks today in fundamentalterms.  That includes current gold-miningprofits compared to prevailing gold-stock prices, as well as near-futureearnings-growth potential as gold itself continues mean reverting much higherahead.

I’m well into my quarterly research work analyzing the Q4’17 results from themajor gold miners of GDX.  Unfortunatelydue to the complexities of preparing annual reports, the Q4 reporting season upto 90 days after quarter-ends is double the 45-day deadlines for Q1s throughQ3s.  So all the data isn’t quite in yet,but I expect to have enough to delve deeply into the major gold miners’ Q4’17results in next Friday’s essay.

In the meantime, agreat fundamental proxy for gold-stock valuations is the HUI/Gold Ratio.  This is as simple as it sounds, dividing thedaily close of that classic gold-stock index by the daily gold close andcharting the resulting ratio over time. This reveals when gold stocks are expensive or cheap relative to themetal which drives their profits.  Andthis sector has rarely been more undervalued than it is today!

This week the HGR wasway down at 0.131x, meaning the HUI index’s close was running just over 13% ofgold’s close.  That’s incredibly low historically, showingthat the gold miners’ stocks have been wildly underperforming gold.  The gold stocks are trading at levels todayimplying gold and their profits were radically lower.  This is a colossal fundamentally-absurd disconnectthat can’t last forever, it has to unwind.

GDX and the HUI wereway down at $21.57 and 173.4 in the middle of this week.  The first time the HUI ever hit this levelwas way back in August 2003, years before GDX was even born.  Back then gold was only running $357, and hadyet to trade above $380 in its entire young secular bull.  Let that sink in for a second.  Gold stocks are trading at prices today firstseen when gold was in the $350s fully14.6 years ago!

This week gold wastrading near $1325, an enormous 3.7xhigher.  That should certainly bereflected in gold miners’ stocks. Today’s super-low gold-stock levels aren’t much above the HUI’sstock-panic lows back in October 2008. There was only a week where the HUI traded lower than today at peak fearin the stock markets, and gold averaged $732 during that extreme span.  This week it was trading 81% higher!

This is incrediblyillogical, only explainable by irrational sentiment.  If any other stock-market sector was tradingat levels from a decade or more earlier despite the selling prices of itsproducts doubling to quadrupling,investors would be beating down the doors to buy.  That would rightfully be seen as a huge andunsustainable anomaly, a rare chance to buy deeply-undervalued stocks atdecade-plus-old prices.

And it’s not just goldthat’s far higher, so are the profitmargins for mining it.  With the newQ4’17 results from GDX’s major gold miners not all out yet, the latest data wehave this week is Q3’17’s.  During thatprevious quarter, the top GDX miners averaged all-in sustaining costs of just $868 per ounce.  The costs of mining gold industrywide don’tchange much, which is what creates profits’ big upside leverage to gold prices.

My still-incompleteQ4’17 analysis shows AISCs very similar to last quarter’s.  That makes sense, as the past year’s quartersending in Q3’17 had collective GDX AISCs of $875, $878, $867, and $868.  Mining gold costs similar amounts regardless of prevailing gold prices, atleast over medium-term multi-year spans too short for new gold mines to bebuilt.  So Q4’17 AISCs are likely toremain around these levels.

Assuming $868 carriesforward into Q4’17 and Q1’18, gold-mining profits are really growing.  Average gold prices surged from $1276 in Q4to $1330 quarter-to-date in Q1.  That’sup 4.2% sequentially, really strong.  Thisimplies major gold miners’ earnings are surging13.2% QoQ in our current Q1’18 from $408 to $462 per ounce!  That would make for strong 3.1x upsideprofits leverage to gold, which is impressive.

And whether the majorgold miners are collectively earning $400, or $450, or even $500 per ouncetoday, such profits alone are much greater than the $350s prevailing gold pricethe first time the HUI traded at today’s levels.  With fat profits like this heading much higher as this gold bullcontinues, it’s ridiculous for gold stocks to be priced as if gold was still inthe $350s like mid-2003 or the $730s like in 2008’s stock panic.

This extreme anomalycan’t and won’t last.  The gold stocksshould be priced for today’s prevailing gold prices around $1325.  The first time gold hit $1325 in October2010, the HUI was trading at 522.  Thatis triple today’s ludicrouslevels!  The gold stocks more thanquadrupled in the years following 2008’s stock panic, another irrational situationwhere sentiment had battered gold stocks to fundamentally-absurd levels.

Between that first-in-a-centurystock panic and extreme central-bankeasing that really hit full steam in 2013, the last quasi-normal years inthe markets were 2009 to 2012.  Duringthat post-panic span the HGR averaged 0.346x. If the HUI would merely mean revert back up to those levels relative togold, it would have to soar to 458. That’s 164% higher than this week’s levels, upside unparalleled in anyother sector.

For 5 years before thestock panic, the HGR averaged 0.511x. While gold stocks might not be able to sustain levels so high anymore,they could certainly blast up there in a temporary mean-reversionovershoot.  After extremes, prices don’tsimply migrate back to the average. Instead they overshootproportionally to the opposing extreme as sentiment is equalized.  That implies a HUI level of 677, 290% higherfrom here.

No one knows how highgold stocks can go, but there is zero doubt they are radically undervalued given today’s gold prices and the gold-miningprofits they generate.  Whether youexpect this battered sector to quadruple again like after the stock panic, ormerely double, that dwarfs the potential of the rest of the stock markets.  Especially with the S&P 500 trading atbubble valuations after a long central-bank-goosed bull.

The gold stocks are truly a coiled spring today,ready to explode higher soon and trounce everything else.  They are deeply out of favor, incrediblyundervalued, and one of the only sectors that can rally sharply when generalstock markets sell off.  If you want tomultiply your wealth this year by fighting the crowd to buy low then sell high,this small and forgotten contrarian sector is the place to be.  Nothing else rivals it.

While investors and speculators alike cancertainly play gold stocks’ coming powerful upleg with the major ETFs like GDX,the best gains by far will be won in individual gold stocks with superiorfundamentals.  Their upside will farexceed the ETFs, which are burdened by over-diversification and underperforminggold stocks.  A carefully-handpickedportfolio of elite gold and silver miners will generate much-greater wealthcreation.

At Zeal we’ve literally spent tens of thousands of hours researchingindividual gold stocks and markets, so we can better decide what to trade andwhen.  As of the end of Q4, this hasresulted in 983 stock trades recommended in real-time to our newslettersubscribers since 2001.  Fighting thecrowd to buy low and sell high is very profitable, as all these trades averagedstellar annualized realized gains of +20.2%!

The key to this success is staying informed and beingcontrarian.  That means buying low beforeothers figure it out, before undervalued gold stocks soar much higher.  An easy way to keep abreast is through ouracclaimed weekly and monthly newsletters.  They draw on my vast experience, knowledge,wisdom, and ongoing research to explain what’s going on in the markets, why,and how to trade them with specific stocks. For only $12 per issue, you can learn to think, trade, and thrive likecontrarians.  Subscribe today, and getdeployed in the great gold and silver stocks in our full trading books!

The bottom line is gold stocks are basingtechnically and cheap fundamentally today. While this small contrarian sector has largely been forgotten, its pastyear’s consolidation trading range continues to hold solid.  The longer the basing, the greater thepotential upleg when investors return. And despite trading at levels implying vastly-lower gold prices, themajor gold miners are actually earning fat profits today.

Those earnings will surge dramatically asgold continues powering higher in its own bull market.  It’s only a matter of time until investorssee the extreme market-leading value inherent in the gold miners’ stocks.  And with stock-market volatility roaring backafter long years of central-bank suppression, diversifying portfolios with goldwill soon return to favor.  The goldstocks will soar as investment buying drives gold higher.

Adam Hamilton, CPA

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