Gold Stocks GDX $25 Breakout on Earnings / Commodities / Gold and Silver Stocks 2018

The world’s leadinggold-stock ETF is nearing a major upside breakout from key technicallevels.  GDX is getting closer tochallenging and powering above $25.  Thatwould accelerate the sentiment shift in this deeply-undervalued sector back tobullish, enticing investors to return.  Goodoperating results from the major gold miners in their upcoming Q4’17 earningsseason could prove the catalyst to fuel this GDX $25 breakout.

The classic way tomeasure gold-stock-sector price action is with the HUI NYSE Arca Gold BUGSIndex.  But the HUI benchmark is beingincreasingly usurped by the GDX VanEck Vectors Gold Miners ETF as thegold-stock metric of choice.  GDX is usedfar more often than the HUI in gold-stock analyses these days, both online andon financial television.  I haven’t seenthe HUI mentioned on CNBC for years now.

GDX does have majoradvantages over the HUI.  Mostimportantly it is readily tradable asan ETF and with options.  GDX’s componentstocks and their weightings are also regularly updated by elite gold-stockanalysts, keeping it current.  The HUI israrely if ever updated to reflect company-specific changes in the ranks of theworld’s top gold miners.  GDX is dynamicwhere the HUI is effectively static and outdated.

GDX also haslimitations as a gold-stock metric though. It was only born in May 2006, so that’s the limit of its price historyavailable for analysis.  And because itsmanagers are paid 0.51% of its assets each year to maintain this ETF, GDX isnot as pure of measure of gold-stock performance as a normal index.  Over a decade that adds up to a substantial5% difference.  Nevertheless GDX’spopularity continues to grow.

This week GDX had $7.7bin assets under management, dwarfing its direct competitors.  That was 21xlarger than the next-biggest 1x-long major-gold-stock ETF!  GDX’s sister GDXJ Junior Gold Miners ETFweighed in at $4.7b, but that generally includes smaller gold miners.  GDX is the undisputed king of the gold-stockETFs.  As a contrarian speculator, Iwatch GDX’s price action in real-time all day every day.

For an entire year now,GDX has meandered in a relatively-tight trading range between $21 to $25.  As gold stocks periodically fell even deeperout of favor, this ETF slumped down near $21 lower support.  Then as they inevitably rallied back out ofthose lows, GDX climbed back up near $25 resistance.  That made for a roughly-20% gold-stock pricerange, certainly narrow by this sector’s standards and tough to trade.

This GDX chart over thepast couple years or so highlights 2017’s gold-stock consolidation.  With this unloved sector neither rallying norfalling enough to get interesting, investors mostly abandoned it over the pastyear.  So gold stocks largely driftedsideways on balance, which certainly proved vexing for the few remainingcontrarian speculators and investors.  AGDX $25 breakout would greatly improve psychology.

Last year’s gold-stockperformance per GDX was very poor.  ThisETF’s price climbed 11.1% in 2017, which is better than a kick in theteeth.  But gold’s impressive 13.2% gainlast year well outpaced the gold stocks’ performance.  Normally the major gold miners’ stocks amplify gold advances by 2x to 3x, soGDX should’ve powered 26% to 40% higher in 2017.  Gold stocks are only worthwhile if theyoutperform gold.

That’s because goldminers face many additional operational, geological, and geopolitical riskscompared to just owning gold outright. So if the gold stocks don’t outperform gold, they simply aren’t worthowning.  Seeing them lag the metal whichdrives their profits for essentially an entire year is extremely anomalous.  It’s a reflection of the entire globalmarkets proving extremely anomalous in 2017, an exceedingly-weird year.

Gold stocks normallyperform much more like 2016 than 2017.  Acouple years ago GDX rocketed 52.5% higher in one of the best major-sector-ETFperformances in all the stock markets. That greatly amplified 2016’s underlying 8.5% gold advance by 6.2x. All those gains rapidly accrued in that year’s first half, as GDXskyrocketed 151.2% higher in 6.4 months on a parallel 29.9% gold upleg!  Gold stocks can really move.

But last year asextreme record-high stock markets and the even-more-extreme bitcoinpopular speculative mania stole the spotlight from gold, gold stocks werelargely left for dead.  Speculators andinvestors alike wanted nothing to do with classic alternative investments wheneverything else proved much more exciting. Thus GDX hasn’t been able to decisively break out above its $25 upper resistance,despite trying.

GDX did power 34.6%higher in 1.8 months early last year, peaking on a closing basis at $25.57 inearly February 2017.  But that rallyfizzled with gold’s when stock markets started surging to new records on hopesfor big tax cuts soon from the newly-Republican-controlled US government.  By early March GDX had retreated back down to$21.14, right at its $21 support line. At least that held strong throughout 2017.

The gold stocks soonrebounded into another rally, but that topped at $24.57 in GDX terms inmid-April.  Again gold had stalled outamidst epic general-stock euphoria.  Goldis the key to gold-stock fortunes, as traders only think about the gold minerswhen gold itself catches their attention. GDX was repelled right at its 200-day moving average, which can proveboth major support or resistance depending on market direction.

By early May GDX wasright back down to $21.10 again, increasingly establishing the clearconsolidation trend seen in this chart. The gold stocks couldn’t rally significantly heading into theirsummer-doldrums lull, and GDX was soon right back down to $21.21 in earlyJuly.  That very day I published an essayon gold stocks’ summer bottom,predicting a new upleg once those usual weak summer seasonals passed.

And that indeedhappened, with GDX rebounding and then accelerating to power 20.2% higher to$25.49 by early September.  That wasright at its early-February peak, a critical level technically to see a majorupside breakout.  But once again golddidn’t cooperate, selling off sharply as general stock markets yet againblasted to another series of record highs on renewed hopes for big tax cutssoon.  Taxphoria was huge!

Thus the gold stocksslumped again, falling back down near GDX’s strong $21 support as this ETF hit$21.42 on close in mid-December.  Thatwas the day before the Federal Reserve’s fifth rate hike of this cycle, sogold-futures speculators were scared. They irrationally fear Fed rate hikes are bearish for gold, even thoughhistory has long proven justthe opposite.  Gold and gold stockssurged after that hike as Ipredicted.

From the day beforethat latest FOMC meeting to this week, GDX rallied 13.8% to $24.37.  Wednesday morning when I decided to pen thisessay, GDX was nearing $24.50.  So thelong-awaited decisive $25 breakout is in easy reach.  Gold stocks are a volatile sector, with 3%+daily swings in prices relatively common. So all it will take to propel GDX above its $25 resistance is a few solid-to-strongsector up days.

The upcoming Q4’17earnings season for the major gold miners in the next few weeks could prove thecatalyst to spark serious gold-stock buying. Because gold stocks are so deeply out of favor, the small fraction oftraders that even think about them assume they are strugglingoperationally.  Throughout all themarkets, traders wrongly attribute prices stretched to anomalous levels by extreme herd sentiment tofundamentals.

A month ago bitcoinskyrocketed near $20k as many traders believed such extremes were fundamentallyrighteous due to the underlying blockchain technology.  Yet it was a popular speculative mania,extreme greed sucking people in.  In early December I warned“Once this mania bitcoin bubble bursts, and it will, the odds are very highthat bitcoin will lose 50% to 75% of itsvalue within a few months on the outside!”

This week just over amonth later bitcoin has indeed been cutin half, falling to $9k intraday. Extreme prices are the result of irrational and ephemeral herdsentiment, not fundamentals.  Gold stocksare now stuck on the other end of the psychology spectrum, plagued with extremefear.  Since their prices have been soweak, traders think poor fundamentals must be the reason.  But that’s simply not true at all.

As a contrarianspeculator and market-newsletter writer for the past couple decades, few peopleare more deeply immersed in the gold-stock realm than me.  Every quarter just after earnings season Idive into the actual operating and financial results of the major GDX goldminers.  I’m eagerly looking forward todoing that again with their new Q4’17 results, which will be reported betweenlate January and mid-February.

So now the latestquarterly results available from the major gold miners are Q3’17’s.  I explored them for the top 34 GDX gold miners,representing almost 92% of its total holdings, back in mid-November.  In Q3’17 these elite gold miners reportedaverage all-in sustaining costs of $868 per ounce.  That’s what it costs them not only to producegold, but to explore for more and build new mines to maintain productionlevels.

Q3’17’s average goldprice was $1279, which means the major gold miners were collectively earningprofits around $411 per ounce.  That madefor hefty 32% profit margins, revealing an industry actually thriving fundamentally instead of struggling asherd-sentiment-blinded traders wrongly assume. Gold miners make such excellent investments because their mining costsgenerally don’t follow gold prices.

Gold-mining costs are essentiallyfixed during mine-planning stages, when engineers and geologists work to decidewhich ore to mine, how to dig to it, and how to process it.  Once mines’ necessary infrastructure isbuilt, their actual mining costs don’t change much.  Quarter after quarter generally the samelevels of equipment, employees, and supplies are needed to mine gold.  So all-in sustaining costs hold pretty steady.

In the four quartersleading into Q3’17, the top-34 GDX gold miners’ all-in sustaining costs averaged$855, $875, $878, and $867.  That worksout to an annual average of $869, virtually identical to Q3’17’s $868 perounce.  Those flat AISCs happened despitethe gold price varying greatly in that five-quarter span, with this metalslumping as low as $1128 and surging as high as $1365.  Gold-mining costs are static.

So as long asprevailing gold prices remain well above all-in sustaining costs, mining goldremains very profitable and spins out big positive operating cashflows.  And relatively-flat mining costs generate biggold-miner profits leverageto gold.  These core fundamentaltruths about gold-mining stocks are what could help their upcoming Q4’17results ignite the buying necessary to propel GDX above $25 for a majorbreakout.

These new Q4 resultsaren’t going to be spectacular, as gold’s $1276 average price last quarter wasjust under Q3’s $1279 average.  Butassuming flat all-in sustaining costs as usual, $868 in Q4 would still yieldfat profit margins of $408 per ounce. That too is virtually unchanged from Q3’s $411.  So the major gold miners as a sector shouldn’t see collective downside surprises in earningsin Q4, avoiding damaging sentiment.

It’s not the Q4’17results that should spark major gold-stock buying, but their implications forthe current Q1’18 quarter.  While Q1 isyoung, gold is averaging nearly $1323 so far as of the middle of thisweek.  That is already 3.6% above Q4’saverage, which is a big move higher.  Ifthese gold levels hold and the major gold miners’ all-in sustaining costs hold,they are looking at Q1’18 profits way up at $455per ounce!

That’s a whopping 11.5% higher quarter-on-quarter!  Not many if any sectors in all the stockmarkets can even hope for such massive earnings gains.  And if gold continues powering higher in thecoming months in a major newupleg, Q1’s average gold price will be pulled higher accordingly.  That means even larger major-gold-minerprofits growth.  These super-bullishprospects ought to rekindle material gold-stock demand.

Investors usually buystocks not because of current earnings, but because of what they expect profitsto do over the coming year or so.  Risinggold prices coupled with flat costs give gold-mining profits growth in 2018some of the greatest upside potential in the entire stock markets.  Institutional investors should take notice ofthis as Q4’17 results are released, leading to funds upping their tiny allocationsto gold stocks.

On top of that Januarytends to be a big news month for the gold miners, as many publish their costand production outlooks for the new year. These reports tend to be bullish on balance, with the major gold minersforecasting higher production and lower costs tending to garner the mostattention.  So there’s good odds ofpositive newsflow over the coming weeks as well, drawing investors’ focus backto gold stocks.

All this shows why thegold miners’ stocks have usually enjoyed strong seasonal rallies inJanuary and most of February.  So GDX nowhas its best chance in a year of decisively breaking out above $25 in thecoming weeks.  That would work wondersfor bearish gold-stock psychology.  Themore gold stocks rally, the better herd sentiment, and the more traders want tobuy them.  And GDX’s potential upside ishuge.

This last chart encompassesnearly all of GDX’s entire history going back to early 2007, a half-year afterit was birthed.  Gold stocks remainwildly undervalued today, so GDX $25 and even its $31.32 seen at gold stocks’latest major interim high in early August 2016 are super-low in longer-term context.  GDX is actually still down near stock-paniclevels, highlighting vast upside as gold stocks inevitably mean revert higher.

The shaded area in thelower right encompasses the last couple years. Despite GDX seeing one heck of a bull-spawning upleg in early 2016, thegold stocks remain very low.  GDX itselfactually hit an all-time low in January 2016. The gold stocks were trading at fundamentally-absurd prices as I pointed out that very week.  Thatextreme anomaly was the product of fleeting herd sentiment, it had nothing todo with fundamentals.

So far in young 2018,GDX is averaging $23.66 on close.  That’sactually worse than Q4’08’s $25.13, which was during the most-extrememarket-fear event of our lifetimes.  Forthe first time since 1907, the general stock markets suffered a full-blown panic in late 2008.  Everything else including gold and itsminers’ stocks were sucked into that epic maelstrom of fear.  Traders were terrified, fleeing in horrorfrom everything.

So GDX plummeted as lowas $16.37 in late-October 2008, climaxing a devastating 71.0% drop in just 7.5months.  In that panic quarter of Q4’08,gold averaged just $797.  While industrycosts were lower then, the major gold miners were still earning much less inboth profit-margin and absolute terms than they are today.  Yet the average GDX share price was muchhigher in Q4’08 than it’s been over the past year!

The fact GDX couldtrade around $25.13 during a stock-panic quarter with $797 gold highlights thesheer madness of today’s gold-stock prices. Since 2017 dawned, GDX has averaged just $22.99 with $1261 average goldlevels.  Seeing gold-stock prices 8.5%lower despite strong profits and average gold prices being a whopping 58.2%higher makes zero sense!  The gold stockshave to mean revert far higher fromhere.

That’s what happenedafter the extreme pricing anomalies of that late-2008 stock panic too.  Over the next 2.9 years, GDX more thanquadrupled with a 307.0% gain!  Anotherproportional mean-reversion bull out of early 2016’s all-time GDX low wouldcatapult this ETF back up near $51.  That’sstill more than another double fromtoday’s levels.  And with gold mining soprofitable, this new bull’s gains should be far larger.

While investors and speculators alike cancertainly play gold stocks’ powerful coming upleg with major ETFs like GDX, thebest 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 theleading GDX gold-stock ETF looks to be on the verge of a major breakout.  The upcoming Q4’17 results from the majorgold miners along with Q1’s higher prevailing gold prices ought to catch investors’attention.  The gold miners should provevery profitable in Q4, with prospects for big and fast earnings growth in Q1and all of 2018 as gold powers higher. This should help GDX get bid well over $25.

Once gold stocks powerdecisively above that vexing upper resistance level of the past year, the shiftin trader psychology back to bullish will really accelerate.  Gold stocks should enjoy relatively-largecapital inflows from institutional investors looking for undervalued sectors inan extremely-overvalued stock market. The forgotten gold miners’ stocks have a good chance to outperformeverything again this year like in 2016.

Adam Hamilton, CPA

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