Gold Stocks Bouncing Hard
Adam Hamilton October 15, 2021 2512 Words
The battered gold stocks are bouncing hard, blasting higher over the past couple weeks! That’s despite the Fed still looking to soon start slowing the pace of its epic money printing. Fed-tightening fears had weighted heavily on the precious-metals realm since June. Gold stocks’ sharp rally confirms they have started mean reverting much higher after withering capitulation selling, portending massive gains coming.
As a professional speculator and newsletter guy for over two decades now, herd sentiment never ceases to amaze me. The vast majority of traders have no perspective, just a what-have-you-done-for-me-lately mentality on the markets. That foolish self-imposed myopia greatly limits their gains, all but guaranteeing they will fail to buy low then sell high. Succumbing to popular greed and fear usually leads to the opposite.
The leading gold-stock benchmark and trading vehicle remains the GDX VanEck Gold Miners ETF. Its price trends reflect prevailing gold-stock psychology. Between mid-May to late September, the major gold stocks per GDX dropped 27.1% in 4.4 months. Nearly all those demoralizing losses accrued across just several brief episodes. And they were all triggered by heavy gold-futures selling on Fed-tightening fears.
That was essentially a slow-motion taper tantrum in anticipation of the Fed starting to slow its colossal fourth quantitative-easing money-printing campaign! Gold-futures speculators started worrying about that in mid-June, and their extreme leverage grants them outsized influence over gold prices. At the mid-June FOMC meeting, just a third of top Fed officials saw maybe two quarter-point rate hikes way out into year-end 2023.
Despite that being an unofficial projection the Fed chair himself warned against, and being an eternity away in market time, gold-futures speculators irrationally freaked out. They dumped a colossal amount of long contracts, crushing gold 5.2% lower in just three trading days! GDX, which tends to amplify material gold moves by 2x to 3x, collapsed 9.2% in sympathy. That short-lived episode really damaged sentiment.
That gold-futures puking actually interrupted a nice young upleg in gold stocks, which had increasingly bred bullish sentiment. Between early March to mid-May, GDX powered 28.4% higher in just 2.5 months. The gold-stock fundamentals were awesomely-bullish, with gold miners earning fat profits with the high prevailing gold prices. Their valuations were so darned low it made no sense to flee them on gold-futures selling.
Indeed this sector quickly started recovering into early August, when extreme gold-futures selling again flared on Fed-tightening fears. A better-than-expected monthly US jobs report upped the odds the Fed would start its QE taper soon. Speculators aggressively short sold gold futures on that, culminating in a rare gold-futures shorting attack on the following Sunday evening! Gold plunged 4.1% in two trading days.
While GDX dropped 5.4% in that brief span, bearishness flared so intensely that heavy gold-stock selling persisted even as gold recovered sharply. Over a couple weeks or so into mid-August, GDX cratered an ugly 11.8%. Gold stocks were becoming despised again, pariahs of the stock markets. But there were still enough contrarians left to fuel another recovery, until yet more big gold-futures selling short-circuited it.
In mid-September better-than-expected US retail-sales data spawned another round of gold-futures long and short selling. That report was seen as Fed-hawkish, igniting a US Dollar Index rally just like the mid-June dot plot and early-August jobs print had. Gold-futures speculators watch the dollar’s fortunes as their primary trading cue. So gold plunged another 2.2% that day, which GDX amplified to a nasty 4.2% loss.
That gold-futures and gold-stock selling lingered into and slightly past the Fed’s long-feared QE-taper pre-announcement at the late-September FOMC meeting. By then this gold-futures-driven gold-stock rout had cascaded into a full-blown capitulation! Traders weren’t only exceedingly-bearish on this sector, but hostile to any contrarian analysis arguing that selling was wildly overdone. Gold stocks were ignored or hated.
Just three episodes of heavy selling since mid-June had all but eradicated any remaining vestiges of bullishness. The foolish myopia of super-bearish herd sentiment was astounding. Only 13.8 months earlier in August 2020, gold stocks were a red-hot universally-adored sector. Traders were rushing to buy in high after GDX skyrocketed 134.1% over 4.8 months in a massive upleg! Those aren’t unusual in this sector.
That happened to be the fourth upleg of this secular gold-stock bull, and all of them averaged awesome 99.2% GDX gains over 7.6 months! Who wouldn’t want to double their capital in such a short span? And if traders really liked gold stocks with GDX over $44 in early August 2020, they should have loved them at deep discounts with GDX under $29 in late September 2021! Buying low is necessary before selling high later.
But the sad hard truth is most speculators and investors are too lazy to study market cycles, which leaves them not mentally-tough enough to fight herd sentiment. So they miss the fantastic opportunities to buy in low when fear soars, like in recent months. Instead they foolishly wait until gold stocks grow hot again, then buy in high right near major upleg toppings. Then they suffer big losses as gold stocks naturally correct.
But after any correction-grade selloff as herd fear peaks, gold stocks carve major bottomings preceding their massive uplegs. The exact timing is never knowable in real-time, but in general the worse sentiment feels the higher the odds a major reversal higher is imminent. Smart contrarian traders know that the best times to buy gold stocks are when it feels the worst. That’s when despair reigns as everyone else flees.
The telltale sign of durable capitulation bottomings is what comes shortly after, the screaming V-bounces out of those deep lows. Those sharp reversals into powerful mean reversions higher imply selling was exhausted, that the weak hands were forced out near recent major lows. And the past couple weeks or so have certainly seen a face-ripping rally in gold stocks. They are even seeing big gains relative to gold.
That’s an exceptionally-bullish sign, and is evident in this chart. The ratio of gold-stock prices to gold’s own is rendered here in blue in GDX/GLD Ratio terms. The GLD SPDR Gold Shares of course is the dominant global gold exchange-traded fund. The underlying GDX closes are shown in red. This recent blistering gold-stock rally is unlike anything witnessed since spring in both absolute and relative terms!
Since carving that deep $28.91 closing low on September 29th, GDX has rocketed 11.2% higher as of the middle of this week to $32.15! That dwarfs gold stocks’ previous recoveries in late July and late August during recent months’ sharp selloff. More importantly, recent weeks’ big gold-stock surge has amplified the parallel 3.9% gold gain by 2.9x. That’s on the high side of that normal-GDX-leverage range of 2x to 3x.
But while this entire ten-trading-day V-bounce is really impressive, it is the middle seven days I’m really marveling at. Nearly all of gold’s gains were bookended on the first and last days of this rally, with 1.8% surges on both September 30th and October 13th. Sandwiched in between those, gold only eked out a trivial 0.1% gain over seven trading days. Yet over that same span, GDX blasted up a phenomenal 6.2%!
Such hugely-outsized gold-stock gains contrary to gold are really unusual. Gold stocks are essentially just leveraged plays on the metal they mine, as prevailing gold prices directly drive their earnings and thus ultimately stock prices. Seeing gold stocks bounce back so strongly while gold languished between $1,754 to $1,768 was remarkable! On that FOMC QE-taper-pre-announcement day, gold closed at $1,767.
So the myopic traders who succumbed to bearish herd sentiment and sold gold stocks low during a major bottoming are almost certainly gone. Good riddance to those weak hands! With their foolish selling likely exhausted, that leaves only hardened contrarian buyers. And they are fueling strong upside that will soon start attracting in new momentum traders. The battered gold stocks still have enormous room to soar higher.
Remember GDX’s four previous uplegs in this secular bull before this year’s interrupted one averaged those huge 99.2% gains. Taken from the original pre-June-FOMC-meeting correction bottoming in early March, that implies a $61.55 GDX target. If instead measured from late September’s silly capitulation low on Fed-QE-tapering fears, that retreats to $57.59. But that’s still another 79.1% above this week’s levels!
Gold stocks’ short-term upside potential is also massive on mean-reversion-relative-to-gold potential. As this chart shows, the GGR has been grinding higher on balance in a secular uptrend in recent years. This is normal during secular gold bulls, as the longer they persist the more traders migrate into gold stocks to ride them. The GDX/GLD Ratio plunged as low as 0.178x as October dawned and traders rushed to sell low.
By the middle of this week it had rebounded strongly to 0.192x as gold-stock gains far outpaced gold’s own. But that remains well under the support line of the GGR’s secular uptrend. And after gold stocks are hammered well under their normal levels relative to gold in capitulation selling, they usually not only mean revert but overshoot above GGR resistance. That is currently running about 0.242x as this chart shows.
At this Wednesday’s $167.59 GLD close, that mean-reversion-overshoot GGR implied a GDX trading at $40.56. That’s another 26.2% higher from this week’s levels, a nice chunk of gains. But that assumes gold itself doesn’t mean revert way higher after recent months’ episodes of extreme gold-futures selling, and that GGR uptrend resistance doesn’t keep climbing. Neither is likely to prove true, arguing for bigger gains.
My essay last week analyzed why gold will follow the money supply much higher. Since the March 2020 pandemic-lockdown stock panic, this profligate Fed has mushroomed its balance sheet by a truly-insane 103.5% or $4,305b over just 19.3 months! And more than doubling the US dollar supply in such a short span isn’t over with QE tapering. If that unfolds as planned, another $660b of new money is coming by June!
This radically-unprecedented deluge of money printing is what is driving the raging price inflation in the US. That will ultimately greatly boost gold investment demand, driving the yellow metal way higher. Like the gold stocks, gold has seen four previous uplegs during this secular bull. They averaged hefty 33.3% gains. Unlike gold stocks, gold’s early-March correction low held solid despite that recent gold-futures dumping.
Measured from that $1,681 major bottoming, a merely-average bull upleg would carry this metal up to $2,241. That’s not even particularly high, not far above the last upleg’s $2,062 peak in August 2020. And since the US central bank has never before doubled the US money supply in just over a year-and-a-half, it’s hard to imagine the ultimate inflation hedge gold only enjoying an average upleg in this flood of fiat dollars.
Translated into GLD terms to plug into this GGR metric, another 33.3% gold upleg out of GLD’s early-March correction bottoming implies a target price around $209.93. And the GGR uptrend should continue to rise as gold’s secular bull marches on, raising that upper resistance line. Let’s assume 0.25x for that, the lowest a gold-stock mean-reversion overshoot relative to gold should peak. That yields a GDX target of $52.48.
That’s another 63.2% above this week’s levels, and would make for an 81.5% upleg gain off those recent capitulation lows! While these specific targets aren’t important, the essential takeaway is gold stocks are due to power way higher from here! The GDX major gold miners’ low valuations support that. While their new Q3’21 quarterly results are coming soon, the previous Q2’21 ones remain the latest available to analyze.
In the second quarter as Fed-tightening fears started to mount, the top 25 GDX gold miners commanding 7/8ths of that index’s total weighting were thriving. While gold averaged $1,814 in Q2, these gold miners’ all-in sustaining costs were far lower averaging $1,037. That implied massive sector profitability of $778 per ounce, the third-highest on record! Many of GDX’s stocks were trading at really-low valuations exiting Q2.
Even though GDX was considerably higher then near $34, plenty of major gold miners were sporting trailing-twelve-month price-to-earnings ratios way down in the teens and even single-digits! Naturally they were even lower after recent months’ excessive emotional selling. And despite those several bouts of extreme gold-futures purging since mid-June, prevailing gold prices remained high and very profitable to mine.
Gold still averaged $1,789 in the just-finished Q3, only 1.4% under Q2’s levels that fueled huge gold-miner earnings. And as plenty of gold miners were forecasting higher production in Q3, their AISCs probably shrunk with more ounces to spread the big fixed costs of mining across. So gold-stock fundamentals are going to continue to look awesome as these companies release their Q3 results over the next month or so.
The gold stocks’ powerful V-bounce out of their recent deep lows far outperforming gold strongly suggests a major upleg is getting underway. It’s the resumption of the Fed-tightening-fear-interrupted fifth one of this secular bull. And the beaten-down gold stocks have a long ways higher to run before reflecting normal levels relative to today’s gold prices, let alone where the yellow metal is heading. This is an excellent opportunity.
Our newsletter trading books are currently full of great fundamentally-superior mid-tier and junior gold miners. Their gains during gold-stock uplegs tend to well exceed the majors’, amplifying gold even more. While we’ve taken lumps in stoppings on those several episodes of extreme gold-futures selling, the gold-stock upside potential is so bullish we redeployed low. Our unrealized gains are already soaring in this sharp bounce.
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The bottom line is gold stocks are bouncing hard, rallying sharply in recent weeks. The size and speed of this surge dwarfs other rallies during recent months’ selloff, and this sector’s blistering gains far outpaced gold’s own. All that implies a major mean reversion higher is underway, the resumption of gold stocks’ Fed-tightening-fears-interrupted upleg! And that means capitulation selling exhausted itself in late September.
This technical and sentimental evidence for a young upleg gathering steam is greatly bolstered by gold stocks’ deeply-undervalued fundamentals. They are earning huge profits at these high prevailing gold prices, and gold itself is likely to power way higher on the Fed’s extreme monetary excess. While mostly contrarians are deploying capital now, gold stocks’ upside momentum will soon attract back other traders.
Adam Hamilton, CPA October 15, 2021 Subscribe at www.zealllc.com/subscribe.htm