Gold Stocks Still Undervalued / Commodities / Gold and Silver Stocks 2020

Gold miners’ stocksrocketed out of mid-March’s stock panic, breaking out to major new bull-markethighs in mid-May.  Such blisteringly-fastgains, and gold stocks’ upleg stalling out since, have left many tradersnervous about this sector.  Calls for aserious selloff are mounting.  But arguingin favor for more near-term gains to come, gold stocks never grew overvalued inthis post-panic upleg and are still undervalued today.

The recent gold-stockaction is best understood through this sector’s most-popular benchmark, the GDXVanEck Vectors Gold Miners ETF.  Holdingthe world’s biggest and best gold miners, it dominates gold-stock-ETF capitalflows.  GDX’s world-leading $15.1b in netassets this week are triple the size of its little-brother GDXJ mid-tier gold miners ETF!  No other gold-stock ETFs comeremotely close to GDX’s scale.

And the major goldstocks of GDX have been on a wild ride in recent months.  As gold itself got sucked into mid-March’sstock panic, which was fueled by fears of the economic impact of COVID-19lockdowns, the gold stocks plummeted. GDX collapsed 38.8% in 0.6 months into mid-March.  And the final couple days of that weretechnically a full-on crash, a 20%+ cratering in 2 days.  GDX crashed 24.5% in that span!

That left gold stocks radically oversold and absurdlyundervalued, so they immediately staged a violent V-bounce.  The mean reversion out of the panic’sexceedingly-anomalous lows was wildly profitable for traders who addedgold-stock positions in that brutal carnage. That included our newsletter subscribers, as we started aggressivelybuying and recommending fundamentally-superior gold stocks right after thoselows.

From there GDX skyrocketed95.8% higher in just 2.2 months into mid-May!  That rare opportunity to ride a quickdoubling was awesome.  Hardenedcontrarians tough enough mentally to buy in crazy-low when everyone else wasfleeing in terror multiplied our wealth fast. But since then gold stocks have weakened on balance.  By last week GDX had slumped into correction territory,with a 12.8% loss in the post-peak month.

This gold-stock-bull-technicalschart illustrates this sector’s neck-snapping crashing and savage V-bouncehigher.  GDX not only soared, but broke out to major new bull-marketand secular highs in this massive post-stock-panic rebound.  With gold-stock price levels undeniably highin the context of this bull, traders are worried a serious selloff isbrewing.  Many have been exiting gold-stockpositions since mid-May’s peak.

There’s no doubt anear-doubling in a couple months or so really stretched gold stocks technically.  When GDX hit a 7.1-year secular high of $37.21in mid-May, it was far above its 200-day moving average.  The relationship between prices and their 200dmabaselines illuminates overboughtness and oversoldness.  At gold stocks’ latest interim high, GDX wastrading way up at 1.311x its 200dma. That was very overbought.

That’s one big reasonthe major gold stocks have consolidated high since, drifting sideways on balanceto bleed off the excessively-greedy sentiment of mid-May.  GDX didn’t plunge out of those lofty levels,but gradually drifted lower until it hit its 50dma.  That has acted as support since.  This technical behavior is much more typical of mid-upleg pauses than far-more-serious selloffs after major uplegs giveup their ghosts.

This gold-stock bull’sonly other comparable upleg to this current post-panic one was its maiden soaringback in the first half of 2016.  Then GDXskyrocketed 151.2% higher over 6.4 months, far-more-extreme gains than the recent95.8% in 2.2 months.  That left GDXwildly more overbought, as it soared as far as 1.646x its 200dma in July 2016!  That dwarfed that recent peak-overboughtness whichwas again only 1.311x.

After a tightdouble-top peaking in early-August 2016, GDX plunged 16.7% in the first monthor so after that greed-drenched topping. That was considerably worse than the major gold stocks’ recent 12.8% retreatinto mid-June 2020.  In August 2016 GDX’s50dma decisively failed just a couple weeks into that selloff.  This time around GDX’s same 50dma line has againheld strong as mid-upleg support for 5 weeks now.

The gold-stock priceaction since GDX’s mid-May peak has been way more consistent with a short mid-uplegpause than a long and deep post-upleg correction.  Stallings and subsequent high consolidationsare very healthy, rebalancing sentiment by bleeding off the excessive greed alwaysseen after fast gains to major highs. One key reason this already-big gold-stock upleg is likely still aliveand well is valuations.

Valuations measure wherestock prices are trading relative to underlying corporate earnings, which arethe ultimate driver of long-term price levels. The more expensive stocks are relative to their profits, the greater theodds a technical selloff will snowball into a much-larger major correction oreven bear market.  If the gold stocks hadbeen really overvalued in mid-May or since, it would really up near-termdownside risks.

Conventional stock-marketvaluation metrics like trailing-twelve-month price-to-earnings ratios certainlyapply to the gold miners.  But that voluminousdata is challenging and tedious to amass. Because of the unique nature of the gold-mining industry, there’s asimple valuation proxy that reveals whether gold-stock price levels arerelatively undervalued or overvalued. That’s the relationship of gold-stock prices to gold.

Gold-mining earningsare directly driven by prevailing gold prices. Since gold-mining costs are largely fixed quarter after quarter, profitsrise and fall amplifying changing gold prices. This is easy to understand with a quick illustration.  In Q1’20, the elite GDX gold miners averagedall-in sustaining costs of $932 per ounce. Let’s round that up to $950 to make the math easier.  At $1750 gold, that implies profits of $800per ounce.

If gold falls $200 or11.4% to $1550 in a correction, gold-mining profits also fall $200 but that’s alarger 25.0% contraction.  If goldrallies $200 or 11.4% to $1950, gold-mining earnings also surge $200 making for25.0% growth.  As goes gold, so go thegold miners’ profits in leveraged fashion because of their fixed miningcosts.  Gold prices are themost-important driver by far of gold-mining profitability, utterly dominatingit.

So looking atgold-stock price levels compared to gold prices over time offers a great proxy forvaluations in this sector.  If goldstocks are high relative to gold, they may be overvalued.  If they are low relative to gold, they are likelyundervalued.  There are various ways toexpress this ratio, but the easiest one for most people to chart today is theGDX/GLD Ratio.  GLD of course is theleading SPDR Gold Shares gold ETF.

Dividing GDX’s dailycloses by GLD’s daily closes and charting the resulting GGR reveals trends ingold-stock valuations.  And consideringrecent gold-stock price action relative to gold casts it in a differentlight.  This chart superimposes this GDX/GLDRatio over the raw GDX index during this secular gold-stock bull.  And it reveals gold stocks have yet to getparticularly overvalued despite their massive mean reversion higher.

Way back in mid-January2016, this gold-stock bull was born out of a super-low 0.120x GGR.  My essay that week was literally called “Absurd Gold-Stock Levels”,in which I explained that gold stocks were so ridiculously cheap compared togold that they were due for a massive mean reversion higher.  And that’s exactly what happened over thenext half-year or so, when GDX blasted 151.2% higher in this bull’s firstupleg.

That peaked near a GGRof 0.244x, GDX’s share price was trading at 24.4% of GLD’s share price.  Fast-forward to mid-March 2020’s stock panic,and the GGR cratered to 0.133x.  That deep4.1-year low sure wasn’t very far above gold-stock-bull-birthing levels!  It’s very rare for the major gold stocks ofGDX to fall that low relative to the dominant gold ETF.  And those anomalous lows soon yield to massiveV-bounces higher.

GDX nearly doublingbetween mid-March to mid-May, this blistering 95.8% upleg in just 2.2 months,was mostly the mean reversion out of absurd stock-panic lows.  Today’s secular gold bull began marching amonth before gold stocks’ bull in mid-December 2015.  During the 4.5 years since, the GDX/GLD Ratiohas averaged 0.187x.  That’s something ofa fair-value proxy for this gold-stock bull, like a GGR baseline.

During the brutalrecent COVID-19-lockdown stock panic, the GGR crashed 0.054x under its bullmean.  After gold-stock prices arehammered to extreme lows compared to gold, they don’t just mean revert but overshootproportionally in the opposite direction. That would imply the GGR surging as high as 0.241x, which is nearing its0.244x bull peak of August 2016.  But thehighest the GGR stretched in mid-May was just 0.227x.

The lack of a proportionalovershoot from the stock-panic lows so far argues this big mean-reversiongold-stock upleg isn’t over yet.  Ourhuman minds don’t parse decimals easily, so the difference between mid-May’s0.227x GGR and a full 0.241x overshoot might not sound like much.  Yet it is considerable.  GDX’s 7.1-year secular high of $37.21 inmid-May was 0.227x.  0.241x would’veyielded $39.59 at that point in time.

That would’ve extendedGDX’s upleg to 108.4% back then.  And oddsare that proportional post-panic GGR overshoot is still yet to come since ithasn’t been achieved yet.  Gold haspowered higher since the gold stocks originally peaked in mid-May.  A 0.241x GGR applied to this week’s GLD-shareprice would make for GDX $40.12.  Thehigher gold climbs in its own upleg, the higher gold-stock prices should run.

Despite blasting higherout of those extreme stock-panic lows, the gold stocks have yet to look particularlyovervalued relative to prevailing gold prices. That both lessens the risks of a serious selloff and argues this upleghas farther to run yet before kicking the bucket.  And there’s no reason gold stocks should juststop at that 0.241x GGR mean-reversion overshoot.  They have great potential to soar to much-higherGGRs.

Since late 2018, goldstocks have been gradually regaining ground relative to gold as is apparent inthe GGR’s current uptrend.  It was only brieflyinterrupted by that wild stock panic, then the GGR quickly surged back up intotrend.  GDX shifting back to consistentlyoutperforming gold again makes higher GGRs quite likely.  Historically the GGR has meandered atfar-higher levels than this young gold bull has yet witnessed.

I wrote my lastgold-stock valuation essay back in late December, which included a longer-term GGR chart startingin 2007.  From 2009 to 2012 after the previousstock panic, the GGR was meandering way higher averaging 0.381x!  And even that was lower than the 0.591x inthe 2 years before October 2008’s stock panic, and 0.422x in the 2 calendaryears after.  The GGR ground lower onbalance for about 8 years!

That long trying periodof gold outperforming gold stocks finally ended in early 2016 when today’sgold-stock bull was born.  After aninitial sharp mean reversion in the first half of 2016, GDX’s outperformance comparedto gold has stalled.  But odds are thiskey fundamental ratio still needs to mean revert much higher in asecular sense.  As gold and gold stocksregain favor, more capital shifting in will push prices higher.

A couple weeks ago Iwrote about what’s driving gold’sstrong investment demand, and why that is likely to persist for years.  Stock panics motivate investors to diversifytheir stock-heavy portfolios with gold long after those scary selloffspass.  The Fed’s mind-boggling epicrecord monetary inflation since to attempt to stave off a COVID-19-lockdown-spawneddepression has made gold an essential investment for everyone.

The more popular goldgrows and the higher its prices get, the more interest will mount and capitalflow into the gold miners’ stocks.  GDX generallyleverages material gold-price moves by 2x to 3x, making gold stocksattractive for multiplying wealth during secular gold bulls.  Just like gold, gold stocks will grow morepopular with investors the higher their prices go.  So much-higher GDX/GLD Ratios aren’t just possible,but likely.

While predicting exactlywhere the GGR will meander is impossible, it seems reasonable for it to returnto its 2009-to-2012 average after the last stock panic of 0.381x.  Applied to this week’s GLD prices, thatimplies an awesome $63.43 GDX!  That’snot even back to its $66.63 peak in September 2011 near the end of the last seculargold bull.  Gold stocks look reallyundervalued relative to gold today compared to history!

And this sector’sundervaluation isn’t just apparent in that GGR proxy, but in current implied earnings.  In their recently-reported Q1’20 results, the eliteGDX gold miners again averaged $932 AISCs. And gold averaged $1582 last quarter. Those implied profits of $650 per ounce had skyrocketed 58.5% YoY from Q1’19’s $410!  With higher goldprices driving such massive earnings growth, gold stocks need to soar.

That profits trend ispersisting with gold consolidating high after its own post-stock-panicmean-reversion upleg.  In the almost-overQ2’20, gold has averaged a much-better $1710. Over the last 4 quarters, the GDX major gold miners have averaged $920AISCs.  Assuming this quarter’s aresomewhere around there, the gold miners could be earning $790 per ounce this quarter!  That’s up 90.8% YoY fromQ2’19’s $414!

Now actual Q2’20results won’t reach that potential because countries’ national COVID-19lockdowns temporarily disrupted plenty of mining operations.  That means lower Q2 production, whichproportionally boosts AISCs.  But as outputshave quickly scaled back up after governments let miners resume work, higher prevailinggold prices mean much-bigger earnings going forward.  That’s super-bullish for this sector.

Current gold-stockvaluations remain relatively low, arguing this post-stock-panicgold-stock upleg still has lots of room to run higher.  Add in recent high-consolidation technicalsthat much more closely resemble mid-upleg pauses ratherthan post-upleg serious selloffs, and sentiment shifting more bearish sincethis gold-stock upleg stalled in mid-May, and this powerful gold-stock run suredoesn’t look like it is over yet.

Far from being threats,mid-upleg selloffs are great gifts to traders. They offer the best mid-upleg entry opportunities to add newgold-stock trades at relatively-low prices! So if your gold-stock allocations aren’t yet sufficiently large, mid-uplegselloffs are when to buy more.  While gold-stockgains are already huge since the stock-panic lows, they will grow much biggerstill as this gold-stock upleg keeps powering higher.

At Zeal we started aggressivelybuying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscriptionnewsletters back in mid-March right after the stock-panic lows.  We’ve been layering into new positions eversince, with unrealized gains already growing huge.  Today our trading books are full of these fundamentally-thrivinggold and silver miners that aren’t done running yet.

To profitably trade high-potentialgold stocks, you need to stay informed about the broader market cycles that drivegold.  Our newsletters are a great way,easy to read and affordable.  They drawon my vast experience, knowledge, wisdom, and ongoing research to explain what’sgoing on in the markets, why, and how to trade them with specific stocks.  Subscribe today and take advantageof our 20%-off sale!  Seizethis gold-stock weakness to mirror our many winning trades before this powerfulupleg resumes.

The bottom line is majorgold stocks still look undervalued relative to gold today despite their massivepost-stock-panic upleg.  Ratios ofgold-stock prices to prevailing gold levels remain fairly low compared to thisgold bull’s own precedent.  And they arereally low based on historical levels in the years after the last stock panic!  This latest post-panic gold-stock upleg haslots of room fundamentally to keep powering higher.

Recent gold-stocktechnicals support this bullish outlook, with gold stocks consolidating high sincetheir mean-reversion surge stalled out. That price action looks like a healthy mid-upleg pause that’s necessaryto rebalance sentiment.  The gold miners’earnings growth is going to be strong in coming quarters after the COVID-19disruptions to mining operations pass.  Thatshould continue to fuel strong gold-stock buying.

Adam Hamilton, CPA

So how can you profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence , that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research. Please consider joining us each month for tactical trading details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm

Questions for Adam? I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/adam.htm for more information.

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com . Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

Copyright 2000 - 2019 Zeal Research ( www.ZealLLC.com )

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.