Another gold stock upleg

While gold averaged $1,876 per ounce in the recently-reported Q4’20, the big GDX gold miners reported average all-in sustaining costs of $1,038 per ounce. That implied stellar $838-per-ounce profit margins! That fantastic profitability fueled record revenues, adjusted earnings, operating cash flows, and treasuries at the GDX-top-25 gold miners. That was their sixth quarter in a row of soaring mid-double-digit earnings growth!

But you sure wouldn’t know the gold miners are thriving mightily by looking at GDX’s technical action in recent months. Traders wanted nothing to do with gold stocks in January and February, leaving them for dead. This dirt-cheap high-potential contrarian sector was hated, choked by overpowering universal bearishness. This GDX chart over the past couple years or so highlights this sector’s wild and violent ride.

Last March’s brutal stock panic on economic fears from government lockdowns to slow COVID-19 slammed gold stocks to radically-oversold levels. GDX’s mean-reversion rebound out of that extreme anomaly was neck-snappingly sharp, ultimately growing into a huge upleg. Over just 4.8 months into early August, GDX skyrocketed 134.1% higher! That parabolic surge left gold stocks extremely overbought.

So a healthy correction was necessary to rebalance sentiment, and that’s exactly what happened. Over the next 3.6 months into late November, GDX fell 24.9%. That was a sizable retreat, and this key sector benchmark knifed well under its 200-day moving average. Those usually prove strong support zones in ongoing bull markets. Gold-stock technicals and sentiment looked to be bottoming ahead of a new upleg.

Gold’s own situation buttressed that thesis, green-lighting more gold-stock upside. Since gold miners’ earnings are highly leveraged to prevailing gold levels, their stock prices act like leveraged plays on gold. The major gold miners of GDX tend to amplify material gold moves by 2x to 3x. And by late November, gold itself had corrected 13.9% over 3.8 months. That was right in line with this bull’s prior corrections’ average.

Gold’s three earlier corrections in recent years averaged 14.3% losses over 4.1 months. And gold was also oversold below its own 200dma, dogged by widespread bearishness. That was a great setup for a new bull-market upleg, and indeed one soon got underway. Over the next 1.3 months into early January, GDX powered 15.2% higher in a textbook-perfect series of higher lows and higher highs defining a young upleg.

That even surged to decisive major upside breakouts above both GDX’s 50-day moving average and its correction-downtrend resistance! That young gold-stock upleg looked rock-solid, set up beautifully to keep rallying on balance. But then the markets threw a spanner into the works, ultimately causing gold stocks’ young upleg to fail. While that was a strange low-probability event, it devastated sector psychology.

Gold stocks were nicely consolidating high during 2021’s opening week, until Friday January 8th. Gold plummeted 3.5% out of the blue that day when gold-futures selling cascaded after the key technical level of $1,900 failed overnight. GDX collapsed 4.8% that day, weathering gold’s plunge relatively well at just 1.4x downside leverage. But that day’s extreme selling started inexorably eroding precious-metals sentiment.

The major gold stocks drifted lower throughout January into mid-February, keeping their young upleg intact with a high consolidation. But when heavy gold selling flared again in mid-February as $1,800 gold failed, gold-stock traders fled hammering GDX to new correction lows. That young gold-stock upleg that looked so promising in December, that had been as technically-confirmed as uplegs ever get, gave up its ghost.

That shattered any remaining gold-stock bullishness, and GDX plunged sharply into early March in a fierce capitulation climax. By March 1st, GDX’s correction had extended to 30.5% over 6.4 months. That was much closer to this gold-stock bull’s first three corrections’ average of 36.5% losses in 8.0 months. The resulting deep new correction low left GDX extremely oversold, falling to just 0.825x its 200dma.

For a variety of reasons, I remained very bullish on gold stocks during that extended-correction swoon. They are earning money hand over fist with these high prevailing gold prices, leaving their stocks super-cheap fundamentally. With this sector despised and abandoned, and technicals so deeply oversold, odds really favored a major rebound rally that could grow into this bull’s next upleg. And gold also looked very bullish.

So as gold stocks slid and psychology worsened, I kept adding fundamentally-superior gold-stock and silver-stock trades in our subscription newsletters. I was trying to get their trading books fully-deployed while this sector languished so seriously out of favor. We took some lumps with some of those trades getting stopped out, but the pain of redeploying was well worth it given the vast upside opportunities.

Correction bottomings are never obvious in real-time, but only in hindsight. So they can only be gamed by layering in trades gradually when bottomings are increasingly probable. That approach straddles the ultimate correction lows, adding trades at relatively-low prices both before and after. And sure enough when all hope looked lost for this forsaken sector in early March, GDX was actually carving a major bottom!

While gold stocks were drowning in bearishness and extremely oversold, those certainly weren’t the only reasons they looked so bullish surrounding that apparent correction nadir. Again the dominant primary driver of gold miners’ fortunes and thus stock prices is gold, and it too was extremely oversold and riddled with fear. And the drivers of gold’s own extended correction that forced gold stocks’ looked to be exhausting.

Gold’s own price action mostly results from the interplay of speculators’ gold-futures trading combined with investment-capital flows. The latter is ultimately much more important than the former, but because of the extreme leverage inherent in gold-futures trading it often proves the tail wagging the gold-price dog. This week speculators were only required to keep $10,000 cash in their accounts for each contract traded.

Yet controlling 100 troy ounces of gold each, those were worth $173,720 at mid-week gold prices. That implied gold-futures specs could run maximum leverage up to 17.4x! Way up there, every $1 bet on gold has the same price impact as $17 of outright buying or selling. But such crazy leverage comes with crazy risks. At 17.4x, a mere 5.7% gold move against traders’ positions would wipe out 100% of their capital deployed.

That naturally compresses gold-futures speculators’ time horizons to be exceedingly short-term, just days to weeks on the outside. These influential traders are momentum players by necessity, as that is the only way they can survive. So when gold starts materially sliding, gold-futures selling flares, then snowballs, then becomes self-feeding. The more contracts specs dump, the faster gold falls triggering even more selling.

Back in early January when GDX’s young upleg was strong and breaking out, speculators held 411.7k gold-futures long contracts. That’s on the high side historically. Starting with gold’s plummeting in early January on that technical breakdown under $1,900, these guys started unwinding these leveraged bets. By mid-March they had dumped a gargantuan 104.9k contracts, the equivalent of 326.2 metric tons of gold!

That is a staggering amount over just 10 weeks, explaining why gold fell 11.2% over that span. As spec gold-futures positioning is only reported weekly current to Tuesday closes, that doesn’t exactly coincide with gold’s extended correction. But over that same gold-futures-mass-exodus timeframe, GDX only fell 13.0%. That was just 1.2x downside leverage, incredibly resilient compared to the 2x-to-3x normal range.

While speculators puked out gold-futures contracts like they were radioactive, the resulting weakness in gold scared investors. Gold investment data is only available quarterly from the World Gold Council, but a great real-time proxy representing it is reported daily. That is the holdings of the world’s biggest gold exchange-traded funds, which dominate their space. They are the American GLD and IAU gold ETFs.

With gold falling, American stock traders fled these two behemoths. When gold-stock-ETF shares are sold faster than gold itself, that forces these ETFs to sell some of their physical gold bullion. That finances buying back enough of their shares to keep their prices tracking gold. So GLD and IAU draws reveal investment-capital outflows from gold. They added up to another 157.1t of selling during that same span.

Most gold-ETF shareholders aren’t leveraged, and if they are the maximum possible in the stock markets is just 2x. So their selling is nowhere near as frantic as the gold-futures speculators’. It also tends to lag gold’s corrections a bit. So between early January to this week, GLD+IAU holdings actually fell 181.7t at worst. That makes the total identifiable gold liquidation in recent months a colossal 507.9 metric tons!

It’s no wonder gold wilted on that heavy momentum selloff, and gold stocks had no choice but to follow their metal lower. But the great thing about gold corrections driven by major selling is that is finite and soon exhausts itself. Eventually all traders susceptible to being scared into selling have already sold, leaving only buyers. While this dynamic applies to both gold futures and gold ETFs, it is clearest in the former.

After GDX then gold bottomed in early March at extremely-oversold levels, gold-futures selling lingered into mid-March. Total spec longs fell as low as 306.8k contracts, the lowest they had been since back in mid-June 2019. While they can go lower, spec selling is exhausting around 300k. And once all those hyper-leveraged traders who were forced to sell are out, gold decisively bottoms with that selling pressure gone.

In just 2.8 months after that last spec-longs-300k approach, gold rocketed 17.2% higher as these traders flooded back into longs to reestablish normal positions. That sharp mean-reversion gold rally catapulted GDX 37.0% higher in that same short span! Both spec gold-futures positioning and gold-ETF holdings are far more bullish for gold now than they were in late November at its original apparent correction bottoming.

Back then total spec longs and shorts were clocking in at 379.8k and 86.5k contracts, compared to that 306.8k and 118.7k in recent weeks. Total spec longs and shorts are now running 5% and 100% up into their past-year trading ranges. The most-bullish-possible near-term setup for gold is 0% longs and 100% shorts, indicating selling exhaustion leaving room to only buy. In late November that ran 40% and 59%.

GLD+IAU holdings were 1,722.7t then compared to 1,532.1t in the middle of this week, leaving way less potential additional selling with most of the weak hands already shaken out. That makes a new gold-bull upleg increasingly likely. And as that powers higher, the gold stocks will amplify its gains like usual. This is already apparent in GDX, with its technicals in the last five weeks arguing another upleg is underway.

Since bottoming at $30.90 on March 1st, GDX has carved another series of higher lows and higher highs. The former were that $30.90 and then $31.83 in late March, while the latter were $34.21 in mid-March and $34.28 earlier this week. GDX was trading higher still this Thursday when I penned this essay, rallying to a $34.73 close. This is another textbook-perfect uptrend unfolding over a sufficiently-long time.

While countertrend rallies are common in corrections, they are compressed into much-shorter and much-sharper surges. Slower more-deliberate rebounds unfolding over longer periods of time are new-upleg behaviors, not correction ones. And given the bombed-out gold-stock technicals and psychology at GDX’s latest extended-correction low, this upleg has excellent potential to power up to massive size.

This gold-stock bull’s prior four uplegs averaged huge 99.2% GDX gains over 7.6 months! At best so far, the current young upleg is only up 12.4% on close. That leaves vast room to run higher yet, which is fully justified fundamentally by the gold miners’ incredibly-strong operating and financial results. Another nice tailwind is this sector’s strong spring seasonals, which I analyzed in another essay back in late February.

This chart from there indexes gold-stock performances in all modern gold-bull years, using the older HUI gold-stock index which was around long before GDX. For our purposes today, note the major gold stocks as a sector have averaged strong spring rallies of 13.2% between mid-March to early June. April and May in particular have proven the gold stocks’ fourth- and first-strongest months of the year seasonally!

While seasonals are merely a secondary gold and gold-stock driver after sentiment, technicals, and fundamentals, having them align offers a nice boost to in-progress uplegs. This is a heck of a bullish setup for the gold stocks, boosting the odds that a major new upleg is indeed underway. And this time, unlike December’s young upleg, the potential gold selling available to sabotage it is way more limited.

So if you’re not sufficiently deployed in high-potential fundamentally-superior gold stocks, the window to buy in relatively-low is certainly closing. As gold itself powers higher on astoundingly-extreme levels of money printing by major central banks, the gold stocks will amplify its gains like usual. Given this super-bullish setup, another doubling in GDX out of early March’s lows over the coming months wouldn’t be surprising.

While it wasn’t easy psychologically, we gradually filled up the trading books in our newsletters into and since GDX’s March 1st correction bottoming. Now our weekly and monthly have 20 and 10 open gold-stock and silver-stock trades respectively. These hand-picked fundamentally-superior companies offering excellent production-growth potential still have relatively-low stock prices, but they are rallying fast as gold recovers.

The bottom line is another young gold-stock upleg is underway. GDX has carved a lovely series of higher lows and higher highs in the 5+ weeks since bottoming in early March. This nascent uptrend looks very different technically from the short-and-sharp countertrend rallies within corrections. It is very young-bull-upleg-like, arguing that the latest one is indeed marching. This bull’s prior four soon doubled on average.

While another young gold-stock upleg in December subsequently prematurely failed, that anomaly was fueled by heavy gold selling. But that massive gold-futures selling is largely spent, looking increasingly exhausted. And the resulting big differential gold-ETF-share selling is really slowing with gold bouncing. So unlike the previous one, gold stocks’ latest young upleg is far less likely to be derailed by big gold selling.

(By Adam Hamilton)