By Adam Hamilton – Re-Blogged From http://www.Gold-Eagle.com
The get-no-respect gold-stock sector is in a strong young bull market. Past gold-stock bulls have grown to utterly-massive proportions before giving up their ghosts, greatly multiplying the wealth of contrarian investors and speculators. Today’s gold-stock bull is very likely to grow vastly larger before fully running its course. Fundamental gold-stock-bull upside targets reveal the lion’s share of gains are still yet to come.
A little over a year ago in January 2016, a monstrous gold-stock bear finally climaxed. The gold miners’ stocks fell to fundamentally-absurd 13.5-year secular lows as measured by their leading index, the HUI NYSE Arca Gold BUGS Index. Out of those dark depths of despair, a new gold-stock bull was stealthily born. And it soon started flexing its muscle, rocketing 182.2% higher in just 6.5 months by early August!
Nearly tripling your capital in a half-year is one heck of a ride, leaving gold stocks really overbought. So they naturally corrected. But that selling was soon greatly exacerbated by a series of low-probability events including a gold-futures-driven mass stopping and the post-election Trumphoria stock rally hammering gold. So the HUI’s normal and healthy correction ballooned into a huge 42.5% rout over 4.4 months.
That understandably fueled excessively-bearish psychology that still persists. But this extreme sector pessimism is really distorting the big picture, blinding traders to vast opportunities. Despite that outsized correction, the HUI still blasted 64.0% higher in 2016! That’s certainly the best-performing sector in all the stock markets. And the gold stocks are no slouch in 2017 either, up 17.0% year-to-date as of this week.
In less than 15 months, the gold-mining stocks as measured by the HUI have soared 111.8% higher! In any other sector, such huge gains would be widely celebrated. But not in gold stocks, which remain too contrarian to warrant a second glance from Wall Street. Yet despite this young bull’s already-impressive magnitude, it still remains a baby in gold-stock-bull terms. A doubling for gold stocks is just getting started.
The gold stocks’ last secular bull ran between November 2000 and September 2011. During that 10.8-year span, the HUI skyrocketed an epic 1664.4% higher! While gold-stock investors enjoyed multiplying their capital by 17.6x, the leading stock-market benchmark S&P 500 slipped 14.2% over that exact span. And the gold stocks leveraged gold’s 602.9% bull-market gain during that timeframe by an excellent 2.8x.
So a near-tripling or doubling in gold stocks so far in their young new bull is nothing. This bull is still a calf, just learning to walk. It will continue to grow and strengthen, eventually maturing into yet another raging monster. Only the future will reveal how large today’s gold-stock bull will ultimately get, but its gains so far remain tiny. Still, some gold-stock-bull upside targets illuminate the great potential from here.
Speculating on upside targets is fraught with peril. As no mere mortal can predict the future, no forecast will ever prove precisely correct. So don’t make the mistake of reading too much into bull upside targets. Their purpose isn’t to luckily guess an uncertain future outcome, but to help investors and speculators understand that this gold-stock bull’s best gains are still yet to come. It’s not too late to amass large positions.
While many analysts use pure technical analysis to extrapolate trends, a stronger case for the coming gold-stock upside can be made fundamentally. The gold miners’ stocks are heading much higher not because of mere trend lines on price charts, but because higher gold prices are going to fuel explosive profits growth. Gold-mining earnings amplify gold-price gains, and this core relationship is way beyond linear.
A month ago, I looked at the actual Q4’16 results of the elite gold miners of the leading GDX VanEck Vectors Gold Miners ETF. Since its birth nearly 11 years ago, GDX has grown into the world’s dominant gold-stock trading vehicle. As GDX’s component list contains the same major gold miners as the HUI, this ETF’s price action closely mirrors that older index’s. GDX and the HUI are functionally interchangeable.
Since the gold miners haven’t yet reported their Q1’17 results, Q4’s are the newest available. During that quarter, the elite major gold miners of GDX averaged all-in sustaining costs of $875 per ounce. This AISC measure reveals true operating profitability, showing the per-ounce costs for miners to maintain and replenish operations at current levels. This real-world average AISC can illustrate profits leverage to gold.
In just-completed Q1, gold averaged $1220 per ounce. That means the major gold miners likely earned profits of $345 per ounce based on $875 AISC. Gold-mining costs are essentially fixed, mostly locked in during mine-planning stages when engineers decide which ore bodies to dig up and how to extract the gold from that rock. So higher gold prices generally don’t lead to higher operating costs, they are pure profit.
If gold rallies 10% to $1342, flat AISC of $875 imply profits of $467 per ounce. That’s big 35% growth on a mere 10% gold rally. If gold climbs 25% to $1525, gold-mining profits would soar 88% to $650 per ounce! Gold stocks are so attractive and fantastically-lucrative in rising-gold-price environments mainly because their core fundamental foundation of profitability soars so dramatically. This justifies big stock-price gains.
This ironclad relationship between gold-mining profitability and gold prices can be modeled in depth for individual gold stocks, and then combined for complex sector models. But similar results are yielded by a simple approximation. The HUI/Gold Ratio looks at the relationship between gold-stock price levels and gold prices over time. It reveals when gold stocks are overvalued or undervalued relative to gold.
While there are many ways to project gold-stock-bull upside targets, this HGR approach is my favorite. It’s easy to execute, without extensive individual-miner historical data to crunch. It’s easy to understand, with no complex math or accounting knowledge required. And most important of all, it is fundamentally-based. Gold price levels drive gold-mining earnings, and those profits ultimately drive gold-stock price levels.
Like any indicator, absolute HGR levels don’t mean much in isolation. The HGR’s value is derived from its current position relative to historical context. And as this blue line shows, the HGR remains really low today. Over this chart’s long secular 14.3-year span, the HGR has only been lower than today’s levels for a few months over one year. Only 2015 and surrounding months saw gold stocks lower relative to gold.
That brutal gold-stock bear that ultimately birthed today’s young bull was climaxing in late 2015. Back in late September that year, the HGR fell to an extreme new all-time low of 0.093x. That exact-same level was briefly seen again in January 2016, the very day gold stocks fell to a 13.5-year secular low per the HUI. Gold stocks had never been cheaper compared to prevailing gold prices, which drive their profits!
That very week gold stocks decisively bottomed, I used this very chart to argue a major new gold-stock bull was imminent. Those gold-stock prices were truly fundamentally-absurd compared to where gold was trading, so a mean reversion higher from those extreme gold-stock lows was a certainty. And of course that’s exactly what’s happened since, this young gold-stock bull beginning that inevitable normalization.
At best in early August 2016 when gold stocks last peaked, the HUI/Gold Ratio had recovered to 0.209x. And at worst in mid-December, it collapsed back to 0.145x in that anomalous massive correction. Today the HGR is a little higher at 0.166x. But despite this young bull’s newest upleg starting to gather steam, gold stocks remain extremely undervalued relative to gold by all historical standards. This disconnect can’t last.
One of the key questions for defining gold-stock-bull upside targets is what a normal HGR level is. Over the entire span of this chart, the HGR average is 0.350x. Before the first stock-market panic in just over a century in late 2008, the HGR averaged 0.511x for a 5-year secular span. After that panic’s extreme anomalies passed, the HGR averaged 0.346x in the relatively-normal post-panic years between 2009 and 2012.
So regardless of what secular span through which the HGR is considered, it remains exceedingly low today. Gold stocks generally meander around some fair-value level relative to gold prices, where their profitability fundamentally supports their stock prices. But gold-stock prices overshoot this mean when investors get greedy and bid them too high, and then undershoot it when fear reigns and investors flee.
Visualize a straight line as the fundamentally-righteous HGR. The actual HGR is like a sine wave that oscillates around that, getting too high or too low to be sustainable late in bulls or bears. So once an extreme in either direction is hit, a subsequent mean reversion back to normal is guaranteed. And those don’t just stop at the average, but overshoot proportionally in the opposite direction from the preceding extreme.
A strong case can be made for the post-panic-average HGR of 0.346x between 2009 to 2012 being fully sustainable over the long term. Those years occurred between that wildly-anomalous stock panic in late 2008 and also-extreme gold-market distortions starting in early 2013. That’s when the Fed ramped its unprecedented open-ended third quantitative-easing campaign to full speed, levitating the stock markets.
Since gold is a unique asset that tends to move counter to stocks, investment demand wanes if stock complacency is high. Every time the stock markets looked to be rolling over into a healthy selloff from late 2012 to late 2014, top Fed officials rushed to assure traders that they were ready to expand the QE3 bond monetizations if necessary. That looked like a Fed Put on the stock markets, so dips were quickly bought.
As the stock markets surged higher from 2013 to 2015 in unnatural calm generated by the Fed, investors fled gold at dizzying rates. Gold is effectively the anti-stock trade, the ultimate portfolio diversifier. So when stock markets apparently do nothing but rally on balance indefinitely, investors feel no need to offset some of their heavy stock exposure with gold. Thus gold spiraled lower, dragging the gold stocks down.
So 2009 to 2012 was really the last time the markets functioned reasonably normally before the extreme and radically-unprecedented Fed distortions since. There is no doubt the HGR will eventually return to its 0.346x average levels from that span in its current bull. At $1275 gold, that implies a HUI level way up at 441. That’s a whopping 107% higher from this week’s levels. Think about this incredible revelation.
Even if gold does nothing, gold stocks remain so undervalued relative to their profits driven by prevailing gold prices that they still need to more than double from here! There is no other sector in all the stock markets with such amazing upside potential, with pretty much everything else greatly overvalued from the post-election Trumphoria stock surge. The near-term upside potential in gold stocks is unrivaled anywhere.
But remember market mean reversions out of major extremes never just stop at averages. Instead they first fully mean revert and then that resulting momentum keeps carrying them on to proportional overshoots. With that post-panic average of 0.346x and the all-time-low HGR last seen in January 2016 of 0.093x, that shows a massive 0.253x downside anomaly. So a temporary overshoot could hit mean plus 0.253x.
That yields a mean-reversion-overshoot HGR target of 0.599x. That wouldn’t last long and would likely mark the peak of a secular bull, when gold-stock psychology waxed exceedingly greedy nearing mania territory. Yet 0.599x isn’t unprecedented. Such levels were hit multiple times over several different years in the mid-2000s before 2008’s stock panic knocked the markets way off kilter, where they’ve been stuck since.
At today’s $1275 gold prices and a full 0.599x mean-reversion overshoot, that implies a gold-stock-bull upside target of 764 in HUI terms. That’s another 258% higher from today’s levels, incredibly enticing gains. And even that would still make for a relatively-small total gold-stock bull of 658%, merely 4/10ths the size of that last secular gold-stock bull that peaked in mid-2011. Gold-stock upside from here is vast.
But gold-stock bulls can’t grow in a vacuum, they need rising gold prices to fuel them. Not only does higher gold drive much-higher profitability which fundamentally supports much-higher stock prices, but higher gold is necessary to shift gold-stock sentiment back to bullish. Investors aren’t interested in owning gold stocks until gold has rallied far enough for long enough to convince them its own bull is sustainable.
Gold too is in a new bull market, born in mid-December 2015 after the Fed’s first rate hike in nearly a decade. Gold fell to a deep 6.1-year secular low the very next day, climaxing a major bear. Then over the next 6.7 months leading into early July 2016, gold powered 29.9% higher. That easily exceeded the 20%+ threshold necessary to declare a new bull. But 30% is nothing for a gold bull, it too remains a mere calf.
Gold’s last secular bull in the 10.4 years between April 2001 and August 2011 soared 638.2% higher. It’s hard to imagine a gold bull seeing a gain of less than 100% no matter what, which would ultimately take gold to $2102. That’s not much higher than gold’s $1894 peak in mid-2011. We’ll get to that, but let’s first consider far-more-conservative gold levels. In 2012, the last year before full QE3, gold averaged $1669.
To get back there would require a total gold bull of just 59%, laughably small by historical standards. Yet $1669 gold at that post-panic-average 0.346x HGR implies a HUI at 577 or 171% higher from here. And at the proportional-overshoot bull-topping 0.599x level, that yields a magnificently-round gold-stock-bull upside target of 1000 in HUI terms! The gold stocks would need to rally another 369% from this week’s levels.
And HUI 1000 really isn’t much of a stretch at all. That would make for a total secular bull of 893% from January 2016’s extreme secular low. That is a little over half the size of gold stocks’ last bull during the 2000s! Investors and speculators alike need to realize that enormous life-changing gold-stock gains are likely even with quite-anemic gold and gold-stock bulls by historical standards. Exceptional bulls aren’t necessary.
Finally consider gold’s bull merely ultimately doubling to $2102, which would make for one of the worst gold bulls ever. At that post-panic-average HGR, the HUI’s bull upside target is 727 which is 241% over this week’s levels. And at that proportional-overshoot HGR, this gold-stock-bull upside target rockets to an extraordinary 1259! That’s another 490% above current levels. But you don’t have to get that wild and crazy.
To see gold stocks double again from here is utterly trivial, nothing by historical standards. And if you think another doubling is probable, you should be heavily invested in this forgotten contrarian sector. Sadly even most contrarians continue to drag their feet. By the time gold stocks get exciting enough to garner real enthusiasm, the easy gains will have already been won. You want to buy before most others.
As January 2017 dawned, I wrote an essay explaining why gold stocks would shine again this year. I used this same HGR chart to illustrate why. Then in early March as gold stocks corrected hard to new-year lows, I pointed out their usual major spring rally would be starting in a couple weeks. That was a great time to buy low, so we aggressively bought and recommended superior gold-mining stocks in our newsletters.
Just last week, I explained how major gold-stock breakouts were nearing due to this sector’s sentiment and technicals. They indeed happened this week. If you’ve been ignoring this gold-stock bull’s newest upleg, or procrastinating, or too scared to buy, you’re really missing out! The markets will never give you an engraved invitation. You have to take the initiative to invest before trends mature and big gains are already won.
The gold stocks are really heating up, so it’s imperative to start following this sector now. It wouldn’t surprise me one bit to see the HUI’s 2017 gains approach or exceed its big 64% surge last year. The earlier you get informed and get deployed, the greater your odds of enjoying wealth-multiplying gains in this sector that can give your family a brighter future. You gotta be in it to win it, fortune favors the bold.