Gold stocks pummeled by precious metals fundamentals

Stress spawned by weakness "intense"

But the gold-stock investors and speculators have wildly overreacted to this relatively minor gold selloff in the grand scheme. Over this same short 11-week span, the HUI was pounded 31.5% lower. To give you an idea of how disproportionate this was compared to gold, the HUI hit 27-month lows this week! There is a huge disconnect between gold slumping to 10m lows and its miners being pummeled to 27m ones.

And it gets even worse. This week’s capitulation beat the flagship HUI gold-stock index back down near 375. The first time the HUI exceeded 375 in this secular gold bull was way back in September 2007. Where was gold then? It had just approached $720 for the first time in this bull! So this week, gold stocks were trading as if gold was at $720 when this metal was really 2.1x higher near $1540! Crazy.

As you can see above, the indexed blue HUI line and white GDX line are virtually identical. But the red GDXJ performance is radically different. This premier junior ETF was obliterated this week, falling to the lowest levels it’s ever seen since its birth in November 2009. The highly-speculative juniors are a great weathervane for gold-stock psychology in general, and they were wildly out of favor this week.

Gold juniors have long been our specialty at Zeal, and we own plenty of them thanks to gold stocks languishing at stock-panic levels relative to gold in recent months. During this week’s capitulation, even though many of these stocks were already near major multi-year lows, some plummeted by 10% to 20% on a single trading day with no news! Extreme selling from lows, for no reason, is a capitulation.

And the jaw-dropping magnitude of the recent gold-stock selloff is crystal-clear on this zeroed indexed chart. The gold stocks, big and especially small, have just cascaded lower in a waterfall decline. The psychological angst, pain, and pressure such a brutal selling event spawns are nearly impossible to resist for all but the most battled-hardened contrarians. Gold stocks have just fallen off a cliff lately.

Such immense selling has only been seen one other time before in recent history, during 2008’s epic stock panic. Gold stocks plummeted then, again dramatically outpacing gold’s own decline. They ended up at absurdly-oversold levels that I pointed out at the time were a once-in-a-lifetime buying opportunity. And indeed this sector soon started surging, the HUI more than quadrupling in the next 3 years!

The stock-panic plunge leading into that amazing time to fight the scared herd and buy aggressively is provocatively the only other recent event remotely comparable to this latest gold-stock capitulation. Extreme weakness, shaking out every last trader who can’t withstand the intense pressure of fundamentally-sound positions plunging for emotional reasons, paves the way for enormous rallies.

Could the HUI actually quadruple again in the coming 3 years? Absolutely. As I’ve discussed in many essays since the stock panic, this index had an average ratio to gold of 0.511x in the 5 years before 2008’s stock panic. This week the HUI/Gold Ratio plunged to 0.244x, levels only briefly seen during the panic’s dark heart. If gold merely stays flat near its recent lows, the HUI would have to more than double just to regain its pre-panic HGR!

But given gold’s bullish fundamentals globally, this metal certainly isn’t likely to languish near lows in the coming years. With mine supply growth still heavily constrained and investors including central banks still seriously under-allocated to this unique asset, gold’s secular bull ought to have years left to run yet. And by the time we see that popular-mania parabolic gold-bull climax, the HUI will likely easily more than quadruple.

This next chart zooms in to highlight this latest gold-stock capitulation. The selling in the gold stocks, especially the high-potential juniors, was wildly disproportionate relative to what has happened in gold. Once again the HUI, GDX, GDXJ, and gold are all indexed to 100 as of the day the HUI’s all-time high was achieved last September. The sheer carnage driven by this irrational gold-stock capitulation is unreal.

index, chart, technical analysis, gold

Since their latest highs, the HUI and GDX plunged by 40.8% and 41.0% as of this week. This is ridiculous given gold was only down 18.8% from its own all-time high a little earlier. But the selling in the major gold miners was dwarfed by the apocalyptic plunge in the juniors. From its latest interim high last April, GDXJ was down a stomach-churning 57.8% as of this week! Juniors are getting obliterated!

These highly-speculative stocks are tasked with the critical mission of discovering and starting to mine new gold deposits to feed the world’s voracious investment demand for this yellow metal. And just like larger miners, the price of gold determines the profitability of these hard labors. And universally in the stock markets, any company’s long-term profits ultimately drive its long-term stock-price levels.

When GDXJ peaked in early April 2011, gold had just hit $1475 for the first time in history. And given this ETF’s ascent into that interim high mirroring but only modestly outperforming the HUI, that valuation of gold-stock prices relative to gold was certainly conservative. But fast-forward to this week, and this basket of elite gold juniors was 58% lower while gold itself actually rose 4% over this same span!

Why is the entire gold industry valued between 40% to 60% less when gold is gradually inching higher even at its recent lows? You have to agree this makes no sense at all fundamentally, it is incredibly illogical and irrational. We continue to do extensive research into gold juniors at Zeal, and they continue to find excellent new deposits and bring great new mines online just like they always have.

In fact besides the lack of investor interest (which makes it very difficult to raise the capital needed to explore and mine), juniors as a whole have no new industry-wide operational problems or impairments. The entire junior-gold rout culminating in this latest capitulation is purely emotional, it has absolutely nothing to do with fundamentals. Gold-stock investors and speculators are simply scared, end of story.

The same is true in the major gold miners, where we’ve done extensive research on their profit margins. In both gross-margin and absolute terms, gold-mining profits continue to rise dramatically thanks to these sustained high gold prices. Late last August heading into the HUI’s all-time high, its components had a market-capitalization weighted-average price-to-earnings ratio of 23.3x earnings. By the end of April, it had plunged to just 13.2x!

So it’s not like gold miners aren’t earning money anymore with gold near $1500 instead of $1800. They are actually earning profits hand over fist, and are seriously cheap even by general-stock-market standards. 2011 was gold miners’ most profitable year ever by far, when gold averaged $1573 on close. So far this year, despite all the bearish gold hysteria, gold has averaged $1672! This is 6% higher.

Regardless of which angle you choose to view gold stocks from, their steep selloff culminating in this week’s capitulation climax makes zero sense fundamentally. The hard truth is gold stocks have been sold wildly disproportionately to gold’s own weakness merely because investors and speculators succumbed to their own unjustified fears. Capitulations are always irrational, emotional events.

The extreme fear and disgust generated by these exceptional selling climaxes force out every last trader that lacks emotional discipline. Sadly all many investors and speculators can think about is the last couple weeks’ technical action. They can’t be bothered with researching gold-stock fundamentals, or with learning the essential contrarian discipline of keeping their own emotions in check. So they surrender.

The capitulation event itself forces all the weak hands to exit at once, they sell low in their rush to realize huge losses. But once they are gone, the buyers regain control. And with everyone too scared shaken out, sentiment quickly swings back away from extreme fear and disgust. So capitulations nearly always spawn huge rallies and uplegs, major advances are born out of the deck-clearing throes of despair.

And indeed one appears to be starting. As I pen the draft of this essay on Thursday, gold and the gold stocks are surging dramatically out of Tuesday’s and Wednesday’s hyper-oversold lows. Even weak general stock markets weren’t enough to retard early-day gold and HUI rallies on the order of 2.5% and 6.0%! The sharp bounce after a brutal cascading selloff offers confirmation the capitulation is over.

At Zeal we’ve been actively trading gold stocks for over a decade, earning a fortune through every kind of extreme sentiment condition you can imagine. This week’s capitulation certainly isn’t the first time gold stocks have been loathed. Like every other sector, they gradually oscillate from in favor to out of favor and back again. If you can steel yourself to fight the crowd, be brave when others are afraid, you can buy them at incredible bargains occasionally. And today looks like just such a rare opportunity.

The bottom line is gold stocks appear to have just suffered a full-blown capitulation. For no fundamental reason whatsoever, they cascaded sharply lower from major lows. Traders simply let their own fear and anxiety overpower their reason, so all the weak hands rushed for the exits to end the pain. While miserable to suffer through, these rare extreme selling climaxes mark major long-term bottoms.

So if you can keep long-term fundamentals in focus and tame your fear, capitulations are the worst-possible time to sell and an amazing time to buy. Though they feel like hopeless death spirals, this very despair quickly burns itself out. And with buyers greatly outnumbering sellers, prices soon rocket higher to undo the tremendous technical damage of the capitulation. Gold stocks are due to rebound sharply.

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