Gold Stocks Screaming Buy
Adam Hamilton | Oct 16, 2016 04:03AM ET
The gold miners’ stocks are suffering from universal and overwhelming bearishness today, with nearly everyone expecting further selling. That’s the natural reaction following this sector’s recent massive correction, which climaxed in one of its biggest daily plummets ever witnessed. But within bull markets, there’s no better time to buy aggressively than deep in a major selloff that’s riddled with great doubt and fear.
The core mission of speculation and investment is so simple even children can easily grasp it, buy low sell high. The great challenges arise not from understanding, but execution. Actually buying low then selling high in real markets is exceedingly unnatural and uncomfortable. It requires traders to overcome their own greed and fear to do the exact opposite of everything their own instincts are screaming to do.
The only times speculators and investors want to buy aggressively is when it feels great to do so. That only happens late in powerful rallies, when everyone can clearly see how strong a sector’s performance has been. Traders then commit one of trading’s cardinal sins, extrapolating recent performance out into the indefinite future. They assume a red-hot sector will keep on rising, and eagerly rush to buy high after a rally.
That’s exactly what happened in gold stocks this past summer. This battered sector finally skyrocketed higher in 2016 after hard years of neglect. By early August, the flagship HUI NYSE Arca Gold BUGS Index had blasted an incredible 182.2% higher in just 6.5 months! Who wouldn’t love a sector that had nearly tripled in just over a half-year? Epic performance like that dwarfs everything else in all the stock markets.
So excited traders greedily threw capital at the gold stocks, succumbing to herd groupthink to believe this sector was on the verge of soaring even though it already had. That wasn’t buying low, but buying high. I warned in early July as gold stocks were starting to peak that a major correction was inevitable after such a radical surge higher. While it tarried for a few more weeks, it eventually arrived with a vengeance.
Buying high into widespread greed after a powerful rally is very foolish, as markets always experience sharp reversals soon after popular emotional extremes. The only traders who rode gold stocks’ mighty new bull to multiply their wealth were the smart contrarians who bought in low early in 2016. That was when gold stocks were universally despised, languishing at fundamentally-absurd price levels relative to gold.
Traders only want to buy when it feels good, when they’re excited like everyone else, after a sector has already rallied dramatically. But buying high almost always ends in major losses and many tears. This whole game demands buying low, which means when it feels bad. Any sector including gold stocks is only relatively cheap after a major selloff when most traders have already fled due to exceeding popular bearishness.
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This demands contrarianism, a tough discipline of actively suppressing and fighting your own emotions that can only come from hard years of experience. Instead of doing what you want to do in the markets, you have to do the exact opposite. You buy stocks when it feels very uncomfortable, after a major selloff everyone is convinced will keep spiraling lower. Buying stocks low is always riddled with internal conflict.
The forging of battle-hardened contrarians able to multiply wealth in the markets by actually buying low and selling high is a difficult and demanding road. I’ve been trudging along it for decades now, and it truly never gets easy. For the past 17 years I’ve been sharing my own extensive market research and real-world trades through our financial newsletters, helping others overcome their own greed and fear.
One of the greatest challenges of this business is the great majority of speculators and investors still get excited about or ignore a particular sector at exactly the wrong times. They didn’t want anything to do with gold stocks back in January near 13.5-year secular lows, totally ignoring my contrarian pleas then to buy aggressively. Instead they foolishly stuck their heads in the sand, missing an epic buying opportunity.
The same thing is happening again today to a lesser degree. Gold stocks are screaming buys right now after a massive correction within their powerful young bull market. Yet traders are so wrapped up in their own fear, so influenced by groupthink herd fear, that they are blind to this incredible opportunity. While they refuse to buy low now, they will foolishly again eagerly rush to buy high after gold stocks double from here.
I’ve found the best thing to combat internal and prevailing fear is perspective. The gold-stock technicals indeed look rotten over the past couple weeks and months, and that’s what traders are extrapolating forward which is breeding today’s excessive bearishness. But within broader context, the technical and fundamental situations in the gold miners’ stocks today are amazingly bullish. Now is the time to buy Buy BUY!
Last week this leading benchmark HUI gold-stock index plummeted 10.1% in a single trading day! That was the result of cascading selling driven by gold-stock stop-loss orders being triggered, which itself was driven by the same thing happening in gold futures. Last week I explained this running of the stops in gold and its miners’ stocks in depth if you need to get up to speed. It was a supremely-disheartening event.
This extreme selling anomaly that has decimated gold-stock sentiment truly erupted out of the blue with zero warning. The gold stocks had already corrected sharply in August, plunging 22.0% in just under a month per the HUI. Then they spent all of September grinding higher on balance along support of their strong bull-market uptrend. An entire month of higher lows confirmed technically their correction was over.
So last Tuesday’s brutal 10.1% plummet knifing through that late-August low like nothing was a big and ugly surprise. Such extreme down days in gold stocks are exceedingly rare, and therefore impossible to predict. Since 2001, the entire modern era, there have been 3976 trading days. And that was a volatile span for gold stocks, seeing them skyrocket 1664% higher at best in a mighty secular bull running 10.8 years!
Then after their September 2011 peak, the gold stocks spent the next 4.4 years plummeting a staggering 84.1% in a brutal bear. So volatility is no stranger to this sector. Yet since 2001, the HUI only suffered worse daily plunges than last Tuesday on 10 other trading days! That works out to a minuscule one-quarter-of-one-percent chance of a down day of that extreme magnitude. That’s wildly too seldom to be predictable.
On top of that, 7 of those top-10 HUI down days since 2001 came in the fourth quarter of 2008 during that first stock panic in a century. So excluding that exceedingly-anomalous epic maelstrom of fear, the HUI’s 11th-worst down day of the modern era last Tuesday is more like the 4th worst seen in non-panic normal market conditions. Something that radically abnormal and rare defies any attempt to model it.
When gold stocks plummet 10%+ in a single trading day, pretty much everyone prudently running stop-loss orders is going to be forced to sell. This spawns a gold-stock-downside feedback loop that quickly snowballs. The more gold stocks are driven to stop-loss levels leading to automatic selling, the farther they drop triggering still more stops. While very rare, cascading stop-loss selling is a downside juggernaut.
That extreme down day last Tuesday catapulted gold stocks’ total correction to 28.4%, while some minor follow-on selling pushed it to 30.9% over 2.2 months by this week! Naturally this has spawned universal fear and bearishness. In the general stock markets, a 20% drop is considered a new bear market. How can gold stocks hope to salvage their battered young bull if they’ve just lost nearly a third of their value?
The gold-stock sector is kind of like Texas, everything is outsized. Gold stocks enjoy massive uplegs that often grow radically larger than those seen in every other sector, and subsequently suffer proportionally massive corrections. All healthy bull markets see corrections arise periodically to rebalance sentiment, which keeps bulls healthy. The selling bleeds away the excessive greed seen at the preceding tops.
This paves the way for the next major upleg to start powering higher. Provocatively, massive corrections above 20% are par for the course in gold-stock bulls. Between 2001 and 2011, the average gold-stock correction in that epic secular bull was 26.1% excluding late-2008’s extreme stock-panic plunge. And a third of the dozen major corrections in that span even exceeded 30%, with the non-panic peak at a whopping 35.7%!
After gold stocks nearly tripled in just over a half-year, an extraordinary feat, correcting by a third isn’t out of line at all. The bigger the bull-market uplegs, the bigger the necessary corrections to keep popular greed in check. Greed naturally morphs into fear throughout corrections’ lifespans, and they ultimately bottom once nearly everyone has given up and written off the bull market for dead. That sound familiar?
Gold stocks are feared, hated, and despised today. You can hardly find any analysts or commentators who are not calling for and warning of more imminent selling. No one wants to touch this damaged sector with a ten-foot pole. Yet even at this week’s deep correction low following that anomalous plunge last week, the HUI was still up an astounding 76.5% year-to-date! Gold stocks still command 2016’s performance crown.
Despite all the wailing and gnashing of teeth these days, the gold miners’ young bull market remains very impressive technically. While the bull-market uptrend rendered above was shattered by the HUI’s precipitous stop-running plunge, it’s perfectly normal for bull uptrends to redraw themselves. They tend to steepen during uplegs before flattening in corrections, yet the bull itself keeps marching higher on balance.
The gold stocks bottomed right near their 200-day moving average, which is the strongest support zone seen in bull markets universally. Considering the gold stocks had stretched a whopping 74%, 70%, and 63% beyond the HUI’s 200dma in late April, early July, and early August, a 200dma approach is actually quite healthy for the ultimate longevity of this young gold-stock bull. Such convergences are strong buy signals.
In addition, all the gold stocks’ latest massive correction did was push them back to mid-April levels well into their new bull market. How many of the speculators and investors who were buying high during the summer upleg topping would have loved to have bought back in April instead? The gold stocks were poised to soon head another 47% higher then, and their upside from these same levels today is much larger.
Throughout bull markets, each subsequent upleg blasts gold stocks to new higher highs. There’s little doubt gold stocks’ next major upleg will catapult them to a new bull high way above their recent early-August peak. And bigger corrections make for more upside potential between their lows and the next uplegs their very selling births. Traders should be scrambling to buy gold stocks today after such a huge selloff.
While gold stocks’ miserable sentiment and exceedingly-bullish technicals are super-compelling, their fundamentals are even much more so. Gold stocks are ultimately just leveraged plays on gold, because gold-mining profits and thus ultimately stock prices greatly amplify gains in their primary driver. While gold’s own futures stop running pounded it last week, gold-mining operating profitability is still heading far higher.
Gold averaged $1185 in the first quarter of 2016 and $1259 in Q2. That 6.3% quarter-on-quarter gain in average gold prices led to enormous surges in operating profitability of the elite gold miners. They are represented by the leading gold-stock ETFs, the GDX VanEck Vectors Gold Miners ETF (NYSE:GDX) for the majors and its sister GDXJ VanEck Vectors Junior Gold Miners ETF for the juniors. Their component stocks are excellent.
Each quarter I analyze the operating performances of the individual gold stocks included in these top ETFs. Their cash flows generated from operations are a great proxy for their current profitability. In Q2’16 on that 6.3% average-gold-price increase, the top 34 component companies of GDX saw their operating cash flows surge 32.3% higher quarter-on-quarter. And GDXJ’s skyrocketed an incredible 51.1% QoQ!
The gold miners’ latest quarterly results for Q3 are gradually coming out over the next month or so. And last quarter the average gold price climbed another 6.0% QoQ from Q2 to $1334. So those elite gold miners of GDX and GDXJ are very likely to soon report another major surge in operating profitability. It wouldn’t surprise me to again see big gains approaching Q2’s, which would spark great trader interest.
The more gold-mining profitability grows, the more undervalued the gold miners look fundamentally. Given the dismal gold-stock sentiment out there today, I suspect most speculators and investors will be surprised by the gold miners’ strong Q3 results coming out soon. That’s a major buying catalyst just right around the corner, and an important fundamental reason to be aggressively buying gold stocks today.
Provocatively even at today’s gold-futures-stop-running-spawned low gold prices in the $1250s, gold stocks remain radically undervalued relative to this metal that drives their profits. This next chart looks at a proxy for that critical relationship in the form of the HUI/Gold Ratio. This simple construct shows when gold stocks are underperforming or outperforming gold, and how low or high they happen to be relative to it.
It was this very chart back in mid-January that convinced me to aggressively buy and recommend gold stocks when no one else wanted them. This hardcore contrarian buying into extreme bearishness led to realized gains for our subscribers running as high as 467% this year! While gold stocks are now well off their all-time lows relative to gold seen in mid-January, they remain way too cheap compared to the metal they mine.
Despite their immense gains this year, gold stocks have still only just begun the inevitable process of mean reverting out of their anomalous extreme undervaluations of late 2015 and early 2016. As of gold stocks’ latest massive-correction low this week, the HGR was merely running 0.157x. As revealed by this wildly-bullish chart, that’s still among the lowest levels ever witnessed. Gold stocks are still far too low!
The last normal years between 2008’s first stock panic in a century and the dawn of the Fed’s extreme market distortions in early 2013 were 2009 to 2012. During that post-panic span, the HGR averaged 0.346x. And that itself was pretty low, considering the pre-panic 5-year-average HGR of 0.511x. But for conservatism’s sake, let’s consider that post-panic-average 0.346x the mean-reversion upside target for gold stocks.
Even if gold does nothing and continues languishing in the $1250s, the gold stocks still need to surge another 121% higher from here merely to regain average pricing relative to gold! But this fundamental upside target is wildly too modest. Gold itself is due to head much higher as 2016’s heavy investment demand resumes. And market mean reversions out of extremes tend to overshoot proportionally, not just normalize.
Gold’s powerful young bull market fueling this year’s amazing gold-stock bull was overwhelmingly the result of American stock investors flooding into GLD (NYSE:GLD) gold-stock-ETF shares in response to the early-year cracking of the Fed’s stock-market levitation. As soon as today’s ridiculously-fake near-record US stock markets roll over again, investment demand for gold which moves counter to stocks will come roaring back.
Gold should easily regain 2012’s average levels of $1669 prior to the Fed’s extreme distortions from its unprecedented open-ended QE3 debt-monetization campaign. At that post-panic-average HGR level of 0.346x, that would yield a HUI upside target of 578 which is 194% higher from this week’s levels! I don’t know why any speculator or investor would forgo upside like that, no matter how scared they happen to be.
And if that HGR mean reversion overshoots proportionally to the opposite extreme above that average, it could briefly go as high as 0.599x. At 2012’s average gold levels of $1669, that implies a HUI target of 1000! While such an extreme would likely be short-lived in a greed-drenched peak, it leaves room for a quintuple from here. Traders should be buying today’s massive-correction gold-stock lows with reckless abandon.
The vast gold-stock upside coming as this young bull matures in the years ahead can certainly be played with those popular GDX and GDXJ ETFs. But since these ETFs hold so many gold stocks, their ultimate bull-market gains can merely pace the HUI at best. A carefully-handpicked portfolio of elite individual stocks with superior fundamentals will really amplify sector gains, dwarfing the ETFs’ performances.
The bottom line is gold stocks are a screaming buy today. Their powerful young bull already suffered a massive correction before being wracked by an exceedingly-anomalous stop-running-fueled plummet. That reignited and ballooned the healthy mid-bull selloff, naturally leading to extreme bearishness on this sector. But the gold miners’ technicals and underlying fundamentals still remain exceedingly bullish.
As gold’s own bull starts powering higher again as investment demand resumes when these lofty Fed-levitated stock markets inevitably roll over, the gold stocks are going to soar again. But as usual the only traders who will reap the coming massive gains are the prudent contrarians who can fight their own fear to buy low in this massive correction. Psychological discomfort is a small price to pay for multiplying your wealth.
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