Gold And The Ostrich Investors: An Investment Opportunity
Adam Hamilton | Oct 06, 2013 03:52AM ET
Gold stocks are inarguably the most-hated stock sector on the planet these days. After they spent 2013’s first half plunging precipitously, investors have left them for dead. Even most former contrarians who earned vast profits in gold stocks over a decade have gone ostrich. This is a terrible mistake, as the best times to buy low are when sectors are universally loathed. Peak bearishness occurs right before they soar.
I first wrote about ostrich investors back in early 2009, in a very different context. Ostriches are the kings of birds, mighty animals growing up to 9 feet tall and weighing up to 320 pounds! They can run well over 40 miles per hour, and their tremendously powerful kicks can even prove lethal for humans. Yet they have the metaphorical reputation of hiding their heads in the sand in the face of danger. It’s untrue, but useful.
Investors tend to take this ostrich approach in down markets. Falling prices discourage and dishearten them, and this feeds a downward spiral that eventually leaves them consumed by depression. So they withdraw, effectively burying their heads in the sand. Instead of staying abreast of markets so they can wisely buy low when bearishness peaks, they totally miss the greatest opportunities to multiply wealth.
My first two essays about ostrich investors were not about gold stocks, but the general stock markets. In April 2009 as the flagship S&P 500 stock index traded at 870, and then again in August 2010 as it hit 1065, I argued against the extreme folly of the pervading bearishness then. The stock markets still had vast potential to rally as their new cyclical bull was young, and indeed the S&P 500 would power to 1726.
Gold stocks are in a similar position today, drowning in apathy and antipathy. Most investors have forgotten gold stocks even exist, and the small minority that’s aware of them has spent all year working to convince themselves gold stocks will never rally again. This prevalent worldview today is shockingly dumb, as all markets perpetually flow and ebb. Extreme hyper-bearish lows in market cycles are the best times to buy!
The only way to successfully invest is to buy low then sell high, and what better time to buy low than when universal bearishness has left a sector radically underpriced? Buying cheap requires being brave when others are afraid, the core tenet of contrarian investing. If you lack the courage to buy when few others will, you will be forever doomed to buying high after stocks are already popular. That’s the recipe for failure.
Today’s gold-stock ostrich investors are missing one of the greatest opportunities of the past decade’s secular gold-stock bull. It’s hard to believe given the horrendous sentiment plaguing this sector today, but its performance over the past decade created countless millionaires including me. Over an 11-year span ending in September 2011, the flagship HUI gold-stock index powered an astounding 1664% higher!
How on earth can investors forget that? It’s even more impressive considering this epic bull run occurred during a secular stock bear, when general stocks as measured by the S&P 500 fell 14.2%. Gold stocks generated vast wealth for smart contrarian investors over a decade-plus span when little else did. And they will absolutely rise again from today’s brutal depths, as they are cyclical like everything else in the markets.
These gold-stock cycles are readily apparent, easy to see and understand. But like all knowledge, it only comes to the seekers. If you are a student of the markets, your understanding of how they work and resulting profits will grow and grow. But the foolish gold-stock ostrich investors’ act of hiding their heads guarantees they will never understand and profit. People who refuse to strive for knowledge get dumber.
Gold is a totally unique asset class that investors have demanded for thousands of years for wealth preservation, essential portfolio diversification, inflation protection, and capital gains. Despite the pervasive bearishness dogging it this year, gold isn’t going anywhere. And neither are its miners. As long as investors want gold, the industry involved in painstakingly wresting it from the bowels of the earth will thrive.
But like all stock-market sectors, the gold-mining stocks slowly meander through great sentiment cycles. As gold rises and gold stocks follow, eventually investors grow greedy and ultimately euphoric which drives massive gains. This leaves gold stocks too expensive relative to gold, so they correct. From time to time these healthy corrections snowball, leading to extreme fear and despair and far-too-low stock prices.
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These cycles are readily apparent in this simple chart. It superimposes the flagship HUI gold-stock index in blue over the gold price in red over the past decade or so. Both vertical axes are zeroed, so the close relationship between the gold miners and the metal which drives their profits and thus ultimately stock prices is not distorted. Gold stocks are now languishing near a radically-undervalued major cyclical low.
The knowledge of market cycles ostrich investors foolishly spurn is so simple a child could understand it. I’ve actually taught 10-year-old kids about the similar cycles in general stock markets. I’m certain they could also grasp these gold-stock cycles. So for adult investors, there is truly no excuse. If you want to multiply your wealth in the markets, you have to stay engaged and keep learning. If you don’t, you’ll fail.
Gold-stock prices flow and ebb along with investor greed and fear. The first great greed-driven upleg of this secular gold-stock bull ran from early 2003 to early 2008, when the HUI soared 350% over a 5-year span. The brave contrarian investors, including our newsletter subscribers, who bought low early on in this run made fortunes. It’s just a no-brainer to buy into a sector that is universally loathed and radically mispriced.
With greed excessive at that peak, the gold stocks started one of their normal healthy corrections. But the arrival of 2008’s brutal once-in-a-century stock panic sucked them in and drove a catastrophic 71% plunge in a matter of months! The impact of this panic on gold-stock sentiment was epic, bearishness exploded off the charts and most investors sold low on their misguided groupthink belief gold stocks were dead.
But extreme fear and despair aren’t the times to capitulate and go ostrich, but to buy low! The greatest bargains ever found in the markets occur when blood is running in the streets, when everyone else is scared out of a sector. That certainly described gold stocks in late 2008. And for the wise students of the markets who could look past the suffocating hyper-bearish fog, gold stocks were massively undervalued.
I wrote about this extensively at the time, urging our subscribers to buy aggressively in the midst of 2008’s stock panic. Why? The HUI was trading at the same levels last seen in mid-2003. Back then gold was only trading in the $350s, yet in late 2008 it was over twice as high. With gold prices driving gold-stock profits, did it make any sense fundamentally for gold stocks to trade as if gold was half the levels it was actually at?
Of course not. One of the telltale hallmarks of periods of extreme bearishness is the great irrationality they spawn. Investors get caught up in the popular bearish hype, and refuse to use their brains. Instead they think with their hearts, which always leads to terrible decisions in the financial markets. They let the pervading despair override their rationality, and started extrapolating gold stocks falling forevermore.
What a foolish mindset to succumb to! Markets are perpetually cyclical, rising and falling. So whenever you hear popular consensus assume they will move in one direction forever, you know a major reversal in trend is imminent. And indeed we were soon vindicated in our hardcore contrarian position of being extremely bullish and buying aggressively while extreme bearishness abounded. The HUI soon soared!
Between its brutal stock-panic lows of late 2008 and its subsequent greedy top in late 2011, the HUI blasted 319% higher over a 3-year span. This performance was incredible, the general stock markets as measured by the benchmark S&P 500 only rose 40% over that span. The investors who fought their fear and chose to buy cheap gold stocks earned fortunes, while the ostrich investors missed most of the gains.
Note in the chart above how closely the gold stocks followed gold in that giant post-panic upleg. Rising gold prices lead to rising profits for mining it, and ultimately in all the stock markets profits drive stock prices. Since building any gold mine is so incredibly capital-intensive, essentially most costs are fixed at the mine build. Thus the vast majority of rising gold prices translate directly into higher profits for mining.
Once again gold and gold stocks started correcting in late 2011, after the last US debt-ceiling fight left gold very overbought. In early 2012, the gold stocks started to disconnect from gold. The HUI fell far faster than the metal itself, evidence of deteriorating psychology. Greed was starting to give way to fear, the gold-stock cycles had turned. But this didn’t last long, as gold stocks regained ground in late 2012.
But unfortunately 2013 proved to be another extreme anomaly like 2008’s stock panic. The Fed’s QE3 campaign led to levitating general stock markets, resulting in a mass exodus of capital out of the flagship GLD gold ETF to chase general stocks. This resulting unprecedented GLD bullion selling pushed gold prices lower, eventually triggering a couple of ultra-rare futures forced liquidations. So gold plunged in Q2.
That was actually gold’s worst quarter in something like a century, wildly unprecedented in modern times. Even though market history is crystal-clear, after extreme selloffs come extreme mean-reversion rallies, gold-stock traders freaked out. They sold and sold and sold gold stocks, forcing their prices far lower than gold warranted. You can see the huge disconnect today in this chart, the biggest of this entire secular bull by far.
Much like during 2008’s stock panic, gold stocks plunged far faster than gold earlier this year. While gold dropped back to levels first seen in late 2010, call it a $1300 midpoint, the HUI plunged to levels first seen way back in late 2003! The problem is this is a massive, crazy fundamental disconnect. Back then the prevailing gold prices were only around $400 per ounce! For silver stocks, silver was only near $5.25.
Is it rational or logical for gold stocks to trade at the same place they first did when gold was less than a third of its recent prices? Absolutely not! Profits ultimately drive stock prices, and many of the elite smaller gold miners we prefer to invest in are trading between 7x and 14x earnings today. These price-to-earnings ratios are exceedingly cheap, especially at the low end. Stock prices are disconnected from profits.
In times of extreme bearishness, investors seek to rationalize their irrational emotional biases. So they look for excuses to make them feel smart for believing the popular bearishness and selling low. One of these rationalizations today is that gold miners can’t make money. That blows my mind! Sure, some on the high-cost side are struggling. But the best operators are thriving even in this dismal environment.
This is once again a symptom of the foolish ostrich approach to investing. Rather than take an hour or two to do a quick survey of gold-miner profitability, investors simply hide their heads and refuse to get smarter. They assume gold stocks will fall forever, and that stock prices are always rational reflections of underlying fundamental realties. Nothing could be farther from the truth, emotions drive unsustainable price anomalies.
Seeing gold stocks at 2003 levels while gold trades at 2010 levels is fundamentally absurd, even more extreme than the stock-panic anomaly that led to gold stocks more than quadrupling in the subsequent years. Provocatively, there is even more in common with those earlier stock-panic lows. Back then after plummeting 71%, the HUI formed an extreme-fear secular support line. That was just hit again this year!
As of its brutal 2013 lows in late June, the HUI had plunged a similar 67% in just under 2 years. And it just happened to bounce right at that extreme-fear secular support line defined by 2008’s stock panic. In each of the previous two major-upleg cycles where extreme fear gradually morphed into greed, gold stocks more than quadrupled. There is no reason at all they won’t at least quadruple again in the coming years.
As always, gold is the key. Because of the epically-anomalous third quantitative-easing campaign by the Fed, the general stock markets inexorably levitated this year as traders assumed the Fed wouldn’t let stocks fall. This crushed demand for alternative investments including gold, leading to professional money managers abandoning it to chase general stocks. So American gold investment demand plunged this year.
But can a unique asset that has been in high demand from investors worldwide for thousands of years be knocked out of favor forever by one anomalous quarter? Not a chance. There is no doubt investment demand for gold will recover and thrive again, as it too is cyclical like everything else in the markets. After such an extreme depth of out-of-favorness, gold investment will mean revert and overshoot to being greatly in favor.
And as long as investors demand gold, the miners who supply it will be highly valuable. Thus there is zero doubt 2013’s gold-stock anomaly will soon unwind, that capital will flood back in and bid this radically-undervalued sector far higher to reflect its underlying fundamental reality. The only question is whether or not you have the courage to make this high-probability bet that is very likely to quadruple your money.
Being a contrarian is exceedingly hard, it fights against our very human nature. Ever since we were young children, we all felt the deep emotional need to be accepted by our peers. We didn’t want to stand out, to be ostracized from the crowd. All our lives we learn to accept groupthink, to align our thinking with others’. So in the markets, most investors simply reflect the prevailing popular opinion to feel accepted.
Thus they are greedy when stocks are high after a long upleg, the worst time to buy and the best time to sell. And they are scared when stocks are low after a long selloff, the worst time to sell and the best time to buy. Thus it is impossible to buy low and sell high if you want to run with the crowd, to be popular and accepted. The only way to make fortunes in the stock markets is to become a black sheep, a contrarian investor.
While contrarianism is simple in concept, this knowledge only comes from seeking. The foolish ostrich investors who turn off their brains and hide their heads in the sand don’t stand a chance, they’ll never be successful in the markets. They’ll buy high then sell low, and ultimately lose everything. We all know people in our spheres who live life like this, falling headlong into the latest fads and ending up broken.
But the only investors who enjoy these are the brave contrarians mentally tough enough to fight the crowd and buy low. It isn’t easy, but getting rich in the markets sure is fun. The foolish ostrich investors hiding their heads and refusing to get smarter will sadly never experience this. They won’t get interested in gold stocks again until after they’ve doubled or tripled, after which they will rush to buy high far too late.
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