Gold stocks were so overwhelmingly out-of-favor and left-for-dead in late July that they challenged the most-extreme market fear event we’ll likely ever…
by Adam Hamilton of Zeal LLC
The gold miners’ stocks have been hammered to deeply-undervalued levels in recent months. Slammed by heavy gold-futures selling driven by an extreme parabolic US-dollar surge, the gold stocks have been largely abandoned. That left their stock prices anomalously low relative to gold, which overwhelmingly drives their earnings. This portends a massive mean-reversion higher to normalize gold-stock levels to gold.
Traders would be hard-pressed to find a sector more out-of-favor these days than the gold miners! That is evident in the dreadful price action of their leading sector benchmark and trading vehicle. Between mid-April to late July, the GDX VanEck Gold Miners ETF cratered a bullishness-slaying 39.8%! Since sentiment is driven by performance, that brutal walloping has left gold stocks mired in universal bearishness.
Big stock-price swings are generally assumed to be fundamentally-righteous, that recent newsflows must have justified them. But endless waves of herd greed and fear often temporarily distort prices away from normal valuations based on underlying corporate earnings. Imagine fair-value as a straight line, with actual stock prices oscillating around that like a sine wave. Gold stocks are now in a fear-driven trough.
This unsustainable anomaly was fueled by gold plunging 14.3% between mid-April to mid-July. That in turn was driven by a monster 8.8% US-Dollar-Index rally within that span, on the Fed’s most-extreme hawkish pivot in its entire century-plus history! That unleashed enormous gold-futures dumping, leaving speculators’ positioning at anomalous extremes after their capital firepower available for selling was spent.
As this unprecedented deviation from market norms unfolded in recent months, I wrote multiple essays on the US dollar’s parabolic spike and the resulting extreme gold-futures selling. But our focus today is the deeply-undervalued gold stocks left in that exceedingly-unusual event’s wake. Normally the major gold stocks of GDX amplify material gold moves by 2x to 3x, which is exactly what happened since mid-April.
That 39.8% GDX plummeting leveraged gold’s parallel 14.3% plunge by 2.8x, which is on the higher side of that usual historic range. This relationship between gold stocks and the metal they mine is driven by ironclad fundamentals. Gold miners’ profits magnify underlying moves in gold. Those are the difference between prevailing gold prices and mining costs, which are best considered in all-in-sustaining-cost terms.
That extreme gold-futures selling climaxed on July 20th, pummeling gold as low as $1,695 on close. As the major gold miners dominating GDX haven’t all reported their new Q2’22 results yet, the latest sector-wide AISC data remains Q1’s. During that previous quarter, the top-25 GDX gold miners averaged AISCs of $1,133 per ounce. Those would’ve yielded correction-trough sector earnings of $562 per ounce.
With gold rallying sharply since, that looks like a major bottoming. Gold’s current secular bull was born back in mid-December 2015. Since then there have been six uplegs, averaging hefty gains of 27.6% each. If this gold bull’s likely-underway seventh upleg merely clocks in at this precedent, gold would power up to $2,163. The GDX gold miners’ AISCs probably wouldn’t change much as gold’s gains mounted.
That’s because mining costs are largely fixed during planning stages, with nameplate ore-processing capacities that don’t change quarter-to-quarter. They require similar levels of infrastructure, equipment, and employees to keep running regardless of prevailing gold prices. So after another average gold upleg, the major gold miners’ unit profits could hit $1,030 per ounce. That’s soaring 83.3% on a 27.6% gold surge!
The GDX gold miners’ earnings would leverage this bog-standard gold advance around 3.0x. That’s why their stock prices similarly amplifying gold’s price swings is totally righteous fundamentally. Because the gold stocks’ profits are so closely intertwined with gold’s fortunes, the ratio between gold-stock prices to gold’s is a great proxy for sector valuation. One measure compares GDX with the dominant gold ETF.
That of course is the mighty American GLD SPDR Gold Shares. According to the latest data from the World Gold Council, at the end of Q2 GLD commanded a whopping 27.7% of all the gold held by all the world’s physically-backed gold ETFs! That dwarfed the 13.5% second place held by another American giant, the IAU iShares Gold Trust. Together their capital flows dominate global gold investment demand.
Simply dividing daily GDX closes by GLD ones yields the GDX/GLD ratio or GGR. When charted over time, that reveals when gold stocks are undervalued and overvalued compared to prevailing gold prices. Again if gold-stock fair-value is linear, the GGR captures those sentiment-driven oscillations around that baseline. As this chart shows, gold-stock valuations have just been bludgeoned to deeply-undervalued levels.
GDX apparently bottomed at $24.59 on July 25th, capping that miserable 39.8% selloff over 3.2 months. That day the battered gold-stock prices were so darned low that the GGR collapsed to 0.153x! In other words, GDX’s closing price that day was just 15.3% of GLD’s. That was the most-extreme undervaluation gold stocks had suffered relative to their metal since during March 2020’s pandemic-lockdown stock panic.
Defined as stock markets plummeting 20% in two weeks or less, these violent maelstroms of selling are exceedingly-rare. In March 2020, the world was trying to figure out how dangerous the new COVID-19 virus was. Unsure of mortality rates, governments mandated lockdowns to try and slow that virus’s spread. Those threatened to drastically slow the US economy, potentially even forcing it into a full-blown depression.
With the extreme uncertainty of a potential pandemic, the flagship US S&P 500 stock index collapsed a staggering 33.9% in just over a month! A 22.8% cratering during two weeks within it qualified as a stock panic. Naturally fear was off-the-charts, as traders didn’t know what to expect with corporate earnings, the US economy, or even their own families’ safety. So they aggressively dumped stocks and fled to cash.
In less than a couple weeks, the US Dollar Index skyrocketed a breathtaking 8.2% on safe-haven buying. That unleashed epic gold-futures selling bashing the metal 12.1% lower in that short span. That sounds familiar, eh? So in just several weeks, GDX crashed a horrific 38.8%! The major gold stocks amplified gold’s downside, pummeling the GGR all the way down to 0.133x. I warned then that extreme wasn’t sustainable.
Remember how unsettled you felt in March 2020 as lockdowns went into effect? Because it wasn’t just a markets or economic crisis but a potentially-lethal health one, that was the most-extreme fear event of our lifetimes. No one knew how that pandemic would play out, how many people would lose their lives or health to the scourge of COVID-19 and governments’ heavy-handed responses to it. That episode was crazy.
Unbelievably, those recent deeply-undervalued gold-stock levels relative to gold in late July 2022 almost rivaled those of March 2020! Let that sink in. Gold stocks were so overwhelmingly out-of-favor and left-for-dead that they challenged the most-extreme market fear event we’ll likely ever witness. Throughout that entire pandemic-lockdown stock panic, the GDX/GLD ratio only closed under 0.153x on five trading days!
So it is utterly absurd the GGR cratered to 0.153x in late July 2022. Today we aren’t facing a looming pandemic, we haven’t seen a stock panic, and the US economy isn’t threatening to roll over into a new depression. Instead all that has happened is a few months of heavy gold-futures selling spawned by a monster parabolic US-dollar surge on the Fed’s most-extreme hawkish pivot ever. Now all that’s behind us.
After the Federal Open Market Committee’s massive 50-basis-point, 75bp, and 75bp federal-funds-rate hikes at its last three meetings, this fierce rate-hike cycle’s shock-value has passed. After these big-and-fast hikes and Fed officials’ hawkish jawboning previously ignited big US-dollar buying and crushing gold-futures selling, that is exhausted. The wildly-overcrowded long-dollar and short-gold trades ran out of steam.
In three days starting with the Fed’s huge late-July hike, the US Dollar Index fell 1.2% while gold surged 2.7%! Speculators’ gold-futures positioning had grown so crazy-bearish that they had run out of capital firepower to keep dumping longs and adding shorts. The lopsided situations in US-dollar futures and opposing euro futures are similar. So the dollar peaked in mid-July while gold bottomed four trading days later.
Since then the US Dollar Index has retreated 2.6% at worst while gold has surged 4.5% at best. At its normal historical leverage to gold of 2x to 3x, GDX should’ve rallied between 9% to 14% with gold mean-reverting higher. Yet as of the middle of this week, the battered major gold stocks had merely recovered 6.8% at best. The gold miners have lagged gold’s young V-bounce, languishing at deeply-undervalued levels.
So far the GGR has only regained 0.160x at best, still exceedingly low based on gold-bull precedent. In that terrifying pandemic-lockdown stock panic, the GGR only closed at or under 0.160x on ten trading days! These recent crushed gold-stock prices relative to gold are ridiculous and unsustainable. The gold stocks have blasted far higher in massive mean-reversion rallies out of past episodes of excessive fear.
That last time GGR levels collapsed so low is a great example. After March 2020’s stock-panic anomaly, GDX skyrocketed 134.1% higher over the next 4.8 months! That proved a textbook mean-reversion and overshoot out of radically-oversold levels. The major gold stocks could easily more than double again in this next upleg out of their latest deeply-undervalued extremes. There’s lots of precedent supporting big gains.
That can start with this GDX/GLD-ratio valuation proxy itself. Since 2020 which includes that stock panic and recent capitulation, the GGR averaged 0.200x. If this gold bull’s likely-underway seventh upleg again reaches the previous six’s 27.6% average gains, GLD shares would power up near $201.66. At recent years’ skewed-low average GGR, GDX would hit $40.33 which would make for strong 64% gold-stock gains.
But like those sentiment-fueled valuation sine waves oscillating around that linear baseline, GGR mean-reversions after extremes tend to keep running towards the opposite ones. So as gold stocks surge high enough to eventually fuel popular greed, traders chasing big upside should catapult the GGR way above its average. It peaked at 0.241x in late July 2020, overshooting after that pandemic-lockdown stock panic.
Plug that into an average gold upleg in GLD terms and it yields a $48.60 GDX target, which would make for fantastic 98% upleg gains! That’s in-line with precedent during this secular gold bull, as GDX’s six previous uplegs paralleling gold’s have averaged rich 77.7% gains. And those are skewed low by the last couple, which were prematurely truncated by heavy gold-futures selling as Fed hawkishness drove up the dollar.
And major-gold-stock gains out of these recent deeply-undervalued levels could grow far larger. All that extreme gold-futures selling since mid-April made investors forget gold has proven the ultimate inflation hedge. Thanks to this profligate Fed effectively more than doubling the US monetary base by ballooning its balance sheet 115.6% higher in just 25.5 months into mid-April, a terrible inflation super-spike is underway.
Relatively-far-more money chasing and bidding up the prices on relatively-way-less goods and services is fueling general-price surges unlike anything seen since the 1970s. That decade’s monetary excesses forced the last two inflation super-spikes. Gold skyrocketed during both on soaring investment demand, as raging inflation ravaged stock prices and investors’ purchasing power. Diversifying into gold was essential.
During that first inflation super-spike into the mid-1970s, monthly-average gold prices soared 196.6% higher in 30 months from trough to peak US Consumer-Price-Index inflation reads! Then during the second in the late 1970s, this same conservative gold measure rocketed 322.4% higher in 40 months! With inflation raging again at 1970s levels, gold’s next upleg has high odds of seeing gains far above average.
Plug in 50%+ gold gains and a resulting bigger GGR mean-reversion overshoot as traders rush back to chase soaring gold stocks, and their upside potential is breathtaking. Interestingly after gold itself was pummeled to radically-oversold levels in March 2020’s stock panic, its rebound upleg clocked in at huge 40.0% gains! And that was with no meaningful inflation, nothing but upside momentum to attract back investors.
The gold miners’ improving operating fundamentals could accelerate their next upleg too. While plenty are suffering higher consumables costs driven by this furious inflation, many are still forecasting rising production in the second half of this year. Better ores yielding more ounces to spread the mining costs across could actually lower average all-in sustaining costs despite inflation! That would boost profits leverage.
Gold-stock valuations relative to gold meander in cycles, and this GGR chart reveals gold-stock prices have been losing ground for a couple years. But this GGR downtrend is overdue to reverse, ushering in a glorious multi-year stretch of gold stocks outperforming gold! And the fundamentally-superior mid-tiers and juniors better able to consistently grow their outputs will see gains trouncing those of the GDX majors.
It’s certainly hard being contrarian, fighting the herd to buy low when sectors are seriously out-of-favor and deeply-undervalued. But that’s the surest way to multiply capital in the markets, buying really low then later selling much higher. After the last time gold stocks were pummeled to such crazy-low levels relative to gold during March 2020’s stock panic, GDX soared 134.1% in 4.8 months in a mean-reversion overshoot!
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The bottom line is gold stocks are deeply-undervalued today relative to the metal they mine. They were pummeled relentlessly lower in recent months, as extreme gold-futures selling slammed gold. That left this sector the cheapest and most-oversold it has been since March 2020’s pandemic-lockdown stock panic! But with futures speculators’ capital firepower for selling exhausted, gold is starting to mean-revert higher.
Emerging from unsustainable lows fueled by anomalous fear, gold stocks’ upside potential is huge. After that last similar episode a couple years ago, GDX skyrocketed 134% in less than 5 months in a massive mean-reversion-overshoot upleg. And with inflation now raging in its first super-spike since the 1970s, gold’s coming upleg gains ought to prove way bigger than their 40% last time around. So gold stocks should fly!
Adam Hamilton, CPA