Gold Stocks Triple Breakout / Commodities / Gold and Silver Stocks 2018

The beleaguered goldstocks are recovering from their late-summer capitulation, enjoying a solidyoung upleg as investors gradually return. Their buying has pushed the leading gold-stock ETF near a major triplebreakout technically.  That event should reallyboost capital inflows into this sector, accelerating the rally.  A major gold and gold-stock buying catalystis likely imminent too, a more-dovish Fed next week.

The gold miners’ stockshave always been a small contrarian sector, a little-watched corner of thestock markets.  But they’ve been evenmore unpopular than usual in recent months. That pessimistic sentiment is driven by price action, which has mostlyproven poor in 2018.  That’s reallyevident in the performance of the flagship gold-stock investment vehicle, theGDX VanEck Vectors Gold Miners ETF which is struggling.

As of the middle ofthis week, GDX was down 12.0% year-to-date. That leveraged gold’s YTD decline of 4.4% by 2.7x, which is perfectly normal.  Because gold-stock earnings are heavilydependent on prevailing gold levels, gold-stock prices tend to amplify gold’smoves by 2x to 3x.  That’s a double-edged sword, reallyprofitable when gold rallies but cutting deeply when it retreats.  The drawdowns are challenging to weather.

But gold stocks’inherent leverage to gold is starting to work again on the upside, portendingbig gains ahead.  This first chart looksat the major gold stocks’ technicals through the lens of GDX over the pastseveral years.  This sector soared in anew bull market, plunged with gold after Trump’s surprise election win goosedthe stock markets, consolidated sideways to base, and then suffered an extremecapitulation selloff.

Investors andspeculators often forget how explosive gold-stock upside is when gold ispowering higher in an upleg.  In largelythe first half of 2016, GDX skyrocketed 151.2% higher in just 6.4 months!  Capital just flooded back into the goldminers driven by a new gold bull’s parallel 29.9% upleg.  That catapulted GDX to very-overbought levelsand a 3.3-year high in mid-2016.  So anormal correction got underway soon after.

GDX found support atits critical 200-day moving average, which is often the strongest support zoneseen in ongoing bull markets.  But that failedin November 2016 after an anomalous surprise. Trump defied the polling and odds to win the presidency while Republicanscontrolled both chambers of Congress.  Sothe stock markets soared in that election’s wake on euphoric hopes for big taxcuts soon.  Gold wilted on that rally.

So the gold stocksnaturally followed it lower, again mirroring and amplifying its price action.  After it had enjoyed stellar 5.1x upsideleverage to gold in its powerful H1’16 upleg, GDX dropped 39.4% over the next 4.4months.  That leveraged gold’s owncorrection by 2.3x, relatively low in that usual 2x-to-3x range.  GDX soon bounced sharply with gold andestablished a new consolidation trading range between $21 to $25.

The major gold stocks mostlymeandered within that GDX range for 21.5months.  While it was vexing at timesto see upside-breakout attempts fail, basing consolidations are verybullish.  They provide time for bullishnewer investors to acquire shares from bearish exiting ones, establishing newprice norms well above previous bear-market lows.  And the $23 midpoint of that GDX tradingrange proved relatively high.

This gold-stock bullwas born out of fundamentally-absurdlows of GDX $12.47 in mid-January 2016. It peaked at $31.32 in early August that year.  Oscillating around $23 on balance, GDX wasbasing 4/7ths up into its young bull’s entire range.  The major gold stocks GDX holds were bidingtheir time waiting for another major gold upleg to catapult them higher.  They nearly broke out above $25 in early-September2017.

But that attempt’s failuredamaged psychology so traders gradually sold, this small contrarian sector leftfor dead.  The subsequent lower highsover the next 10.4 months into mid-July 2018 formed a downward-slopingresistance line.  Gold-stock prices werebeing compressed into a bearish descendingtriangle, as lower highs slumped ever closer to that major $21support.  This sector really needed amajor gold rally.

Unfortunately theopposite happened this past summer, gold got hammered crushing the weakenedgold stocks.  The US stock markets werepowering higher trying to regain record highs in July and August 2018, heavily retardinggold investment demand.  On top of that theUS Dollar Index was surging too, both on expectations for more Fed rate hikesand an emerging-markets currency crisis led by the Turkish lira.

So gold-futuresspeculators started short selling gold at extreme record levels,blasting their aggregate downside bets far up into anomalous territory neverbefore witnessed.  Gold fell sharply onthat record gold-futures shorting spree, dragging the struggling gold stocksdown with it.  So in early August GDX plungedand knifed through its longstanding $21 support.  That major breakdown spawned self-feedingselling.

Gold stocks are anexceptionally-volatile sector not for the faint of heart.  So it is essential to run loose trailing stoplosses on gold-stock positions.  Whilethese protect investors from excessive losses, they greatly exacerbateselloffs.  The lower gold stocks fellthis past summer, the more stop losses were hit.  These mechanical automatic sell orders thenadd to the downside pressure, pushing gold stocks lower still.

That vicious circle of selling begetting selling snowballed intoan extreme capitulation in gold stocks, as GDX plummeted in August and early September.  In just 5 weeks GDX collapsed 17.0%, farworse than gold stocks should’ve performed with gold merely slipping 1.4% lowerin that span.  That devastated already-shakysentiment, leaving most investors and speculators to throw up their hands indisgust and flee.

But with GDX beingpummeled to a deep 2.6-year low, the major gold stocks were wildly oversold.  I explained all this in depth in an essay on gold stocks’ forcedcapitulation in mid-September.  Theywere due to mean revert dramatically higher after that extreme selling anomaly.  And that process has indeed been underway eversince.  The gold stocks have been recovering,clawing their way out of those deep lows.

As usual gold stocks’dominant primary driver has been gold, which has been grinding higher in itsown young upleg as speculatorscover their record gold-futures shorts. Investors started returning too when the lofty US stock markets began rolling over hard inmid-October.  As of the middle of thisweek, GDX just hit a new upleg high of $20.45 on close.  That extended gains since the capitulationlow to 16.4% in 3.0 months.

Although considerable,the gold stocks’ rally still hasn’t grown large enough to return to the radarsof contrarian investors.  That could beabout to change though as a rare triplebreakout looks imminent!  GDX, theleading gold-stock investment vehicle, is on the verge of simultaneous upsidebreakouts from its 3 major upper-resistance zones.  That will likely unleash big gold-stock buyingfrom technically-oriented traders.

These major resistancelevels have all converged near $21.  The first and most important is GDX’s key 200-daymoving average, which was $20.78 this week. 200dmas are seen as the dividing line between bull and bearmarkets.  When prices surge back above200dmas after long periods underneath them, the upside momentum oftenexplodes.  Traders love chasing gains and200dma breakouts portend big ones.

The past few years haveseveral examples of gold stocks surging dramatically after 200dmabreakouts.  The main one was in early February2016, when GDX rocketing back over its 200dma after deep lows confirmed a new bull market was underway.  The great majority of its initial massive151.2% upleg came after that 200dma upside breakout.   Anotherupleg surged after a 200dma breakout in mid-August 2017.

The latest one came inlate December 2017, although that was truncated early by gold stallingout.  Realize that no technical line ismore important to traders than 200dmas. When they see major gold stocks power decisively back over their 200dmaas measured by GDX, they are likely to rush to buy in to ride the momentum.  Like selling, buying begets buying.  Themore gold stocks rally, the more traders want them.

That imminent 200dmabreakout will be all the more potent as a new-upleg signal because 2 othermajor resistance lines have converged there. That downward-sloping resistance line of the descending triangle has alsoextended right on $21.  So once GDX powersdecisively above it, this past year’s vexing trend of lower highs will end.  Traders will see that as evidence the majorgold-stock trend is reversing tohigher.

The final resistanceline of that triple breakout is the major $21 support of GDX’s consolidatingbasing range that held rock solid for over a year-and-a-half.  When prices fall, old support zones oftenbecome new overhead resistance.  Traders tend to want to sell again when thoseold support levels near.  So when GDXdecisively breaks back out above $21, technical fears of that former support levelwill vanish.

Once back over $21, GDXwill return to its multi-year consolidation basing trend between $21 to$25.  So the triple breakout above that oldsupport line, downward-sloping resistance line, and 200dma would set the stagefor a sharp surge back towards the top of that old trading range.  While GDX $25 isn’t very high in absoluteterms, it’s still another 22.2% above this week’s levels.  Such a rally would spark some excitement.

Because historical gold-stockuplegs have been so enormous, generating life-changing wealth, there is always latentgold-stock interest lurking.  Contrarianinvestors and speculators alike sour on gold stocks when they are weak, butquickly return when they show technical signs of life.  A GDX triple breakout sure qualifies as that!  And much-higher gold-stock prices are certainlyjustified fundamentally, long overdue.

Gold miners’ earningsand thus ultimately stock prices are largely a function of gold levels.  Mining costs are essentially fixed duringmine-planning stages.  So higher goldprices flow directly through to bottom lines in amplified fashion.  This is easy to understand with an example.  A month ago I waded through the Q3’18 results of GDX’s majorgold miners.  Their average all-in sustainingcosts weighed in at $877 per ounce.

That is what it coststhem to produce and replenish gold, and $877 was right in line with theirprevious 4 quarters’ average of $867. Those collective costs will remain stable even as gold’s uplegaccelerates.  At gold’s own extreme-futures-short-selling-drivenbottom of $1174 in mid-August, the major gold miners of GDX were still earningabout $297 per ounce.  Such solid levelsprove that capitulation wasn’t righteous.

Last Friday gold hit anew upleg high of $1248, up 6.3% from its anomalous late-summer lows.  Imagine this young upleg grows to 30% likethe H1’16 one, which is quite small by historical standards.  That would leave gold near $1525.  At those $877 average GDX AISCs, the major goldminers’ profits would rocket to $648 per ounce. That’s 118% higher on a 30% gold upleg! Big gold-stock upside is fundamentallyjustified.

The ratio between theclosing prices of GDX and the dominant GLD SPDR Gold Shares gold ETF is an easyapproximation of the critical fundamental relationship between gold-stockprices and gold levels.  This last chartis updated from a mid-October essay where I explained why gold stocks are the last cheap sector inall the stock markets.  The GDX/GLD Ratioshows gold stocks have vast room to mean revert higher.

This GGR construct hasaveraged 0.186x during the 3.0 years of this current gold bull so far.  This week the GGR clawed back to 0.174x,hitting its own 200dma.   But at the gold stocks’ deep capitulation lowin mid-September, the GGR plunged all the way down to 0.155x.  That’s 0.031x below normal for thisbull.  After GGR extremes in eitherdirection, this key ratio tends to mean revert the other way and overshoot proportionally.

That argues GDX is easilylikely to surge far enough leveraging gold’s gains to regain a 0.217x GGR.  That’s certainly not a high level even in themodest context of this gold bull.  Atthis week’s $1245 gold levels which translated near $118 in GLD terms, GDX wouldhave to surge to $25.56 to accomplish that normal mean-reversionovershoot.  That’s another 25.0% higher, whichwould make for a solid upleg well worth riding.

And that GGR target isstill incredibly low in longersecular context.  In the 2 years before2008’s first stock panic in a century, the GGR averaged 0.591x.  Though gold stocks plummeted in the extremefear that panic spawned, the GGR rebounded to average 0.422x in the 2 years afterthat epic anomaly.  Over a longer 4-yearpost-panic span, it averaged 0.381x.  Soseeing it regain 0.217x is nothing, it should go far higher.

The bigger gold’s ownupleg, the more the gold stocks will outperform by the usual 2x to 3x and forcethe GGR higher.  At $1525 gold after a relatively-small30% upleg, that 2009-to-2012 post-panic-average GGR of 0.381x would yield a GDXupside target around $55 per share.  That’s 169% higher from this week’s levels,even without an overshoot!  Gold-stock profitsgrowth from higher gold prices justifies huge gains.

And rather convenientlyon the verge of that GDX triple breakout, a major gold-buying catalyst is likely next week.  On Wednesday December 19th, the Fed’s FOMCmeets to decide on whether or not to hike rates for the 9th time in thiscycle.  That rate hike has been universallyexpected for months now, it is fully baked in. But the thing gold-futures and dollar-futures traders are reallywatching is the rate-hike forecast.

While the FOMC meets 8times per year, at every other meeting it releases something called the dot plot.  That summarizes where top Fed officials makingthe decisions think the federal-funds rate should be in coming years.  The last dot plot was published on September26th when the S&P 500 remained just 0.8% under its all-time record highfrom a week earlier.  Fed officials are boldlyhawkish when stocks are high.

But the stock marketssoon fell apart in Q4’18, the first in history seeing full-speed quantitative-tightening monetary destruction by the Fed!  VariousFed officials including the chairman have waxed more dovish since stocksstarted sliding.  Fearing a negativewealth effect adversely impacting the US economy, their resolve to hike rates withers.  So there’s a good chance next week’s dot plot will be more dovish than the lastone.

Late September’s had effectivelyforecast 5 more Fed rate hikes including at next week’s meeting.  So if this new dot plot shows less than 4 total rate hikes forecast in2019 and 2020, dollar-futures speculators will likely sell motivating gold-futuresspeculators to buy aggressively.  Fewer expectedrate hikes are very bullish for gold, as proven in past dot plots.  A great example was the 5th hike of this cycle in December2017.

A year ago this week theFOMC hiked, but its dot-plot rate-hike forecast was dovish.  Instead of upping it to 4 rate hikes in 2018as traders expected, Fed officials left it at 3.  So over the next 6 weeks, gold shot up 9.2%to $1358 on heavy gold-futures buying by speculators.  A similar rally afternext week’s meeting if the dot plot forecasts fewer rate hikes than the lastone would drive gold right back up near $1360 again.

That’s on the verge ofa major bull-market breakout which would likely unleash massive new investment buying.  And any material gold rally will light a bigfire under the gold stocks, rapidly driving them higher.  That would put GDX’s triple breakout in thebag with haste.  Nothing drives bigcapital inflows into the gold stocks faster than seeing them decisivelyrally.  They are perfectly set up formajor gains in coming months!

A big mean-reversionrebound higher is inevitable and likely imminent.  While traders can play it in GDX, that’smostly a bet on the largest gold miners with slowing production.  The best gains by far will be won in smallermid-tier and junior gold miners with superior fundamentals.  A carefully-handpicked portfolio of elitegold and silver miners will generate much-greater wealth creation than ETFsdominated by underperformers.

The key to riding anygold-stock bull to multiplying your fortune is staying informed, both about broader markets and individualstocks.  That’s long been our specialtyat Zeal.  My decades of experience bothintensely studying the markets and actively trading them as a contrarian ispriceless and impossible to replicate.  Ishare my vast experience, knowledge, wisdom, and ongoing research through ourpopular newsletters.

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The bottom line is the goldstocks are nearing a rare triple breakout. Three major GDX resistance zones have converged just above current levels. Once the gold stocks surge decisivelyover, the technically-oriented traders will take notice.  They will likely start chasing the momentumaccelerating the gains, with buying begetting buying.  And gold stocks are so undervalued big gainsare totally justified fundamentally.

This bullish outlook shouldbe really bolstered by next week’s FOMC meeting.  Worried about the recent stock-market selloffand surging volatility, top Fed officials are likely to dial back their rate-hikeforecasts for next year.  That willalmost certainly hit the US dollar and goose gold.  If gold surges again on a dovish dot plot likeit has after other rate hikes in this cycle, the gold stocks will blast higher achievingthat triple breakout.

Adam Hamilton, CPA

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