Gold miner valuations low (2)

But this technical confirmation of a young gold-stock upleg certainly isn’t the only reason the miners look so bullish today. Their underlying fundamentals are incredibly strong with gold remaining relatively-high. About a month ago I dove into the latest quarterly results from the top 25 gold miners in GDX, which were Q4’20’s. They were super-impressive, yet widely-overlooked since gold stocks were deeply out of favor then.

Herd sentiment in the markets is a direct function of recent price action. When something has surged, traders greedily anticipate further momentum gains. But falling prices leave deep bearishness in their wakes, which scare traders into expecting more losses. So they quickly lose interest after significant price weakness, moving on to the next hot thing. GDX had just suffered a major correction, slaying bullishness.

Between early August to early March, GDX fell a serious 30.5% over 6.4 months! That healthy correction accomplished its mission of rebalancing sentiment, eradicating the euphoria surrounding gold stocks’ last upleg topping. And that was really extreme after GDX had skyrocketed 134.1% higher in just 4.8 months! But that sentiment pendulum had swung back to fear by early March, so gold miners’ Q4’20 results were ignored.

Yet despite mostly correcting that quarter, the GDX-top-25 gold miners reported record revenues, adjusted earnings, operating cash flows, and cash treasuries. In year-over-year terms, those surged about 18%, 165%, 54%, and 83%! This incredible stock-market-leading performance was driven by higher prevailing gold prices. Averaging $1,876 per ounce in Q4’20, gold was 26.5% higher from where it traded in Q4’19.

Conventional trailing-twelve-month price-to-earnings ratios in this sector were among the lowest I’ve ever seen. Excluding one outlier, the GDX top 25 averaged P/Es of 23.4x. Four of them had amazingly-cheap valuations in the single-digits, while another six were trading in the teens! Another great sector valuation proxy compares the GDX top 25’s average reported all-in sustaining costs to that quarter’s average gold prices.

With that GDX Q4’20 AISC read at $1,038 per ounce, these major gold miners were earning about $838 per ounce in profits. That had soared 50.3% YoY from Q4’19! And that was just the latest in a six-quarter streak of phenomenal earnings growth. The GDX top 25’s overall profitability by this measure rocketed up 53.5%, 57.8%, 55.5%, 66.2%, 49.7%, and 50.3% year-over-year during that super-impressive span!

And this epic gold-miner earnings growth will persist through Q1’21, which will be reported over the next month or so. While gold spent most of last quarter correcting, it still averaged $1,793. That remains the third-highest on record, only behind the preceding couple quarters. And that is still up a hefty 13.4% YoY from Q1’20. And the GDX top 25’s AISCs last quarter will probably come in around their past-year’s average.

That was $996 per ounce, implying big sector profitability of $797 in Q1’21. That would still be up a strong 22.8% YoY during a tough quarter where gold corrected hard! The gold miners’ fundamentals continue to be outstanding, despite traders’ bearish outlook on this sector spawned by its recent extended correction. Gold-stock psychology won’t turn really bullish again until their stock prices have rebounded much higher.

But the huge gains to be won by buying in relatively-low early on will dwarf those available to momentum players who wait too long to return. This gold-stock bull’s four previous uplegs averaged enormous 99.2% GDX gains over 7.6 months! Another doubling from early March’s deep correction low wouldn’t be a surprise at all. The hard part is mustering enough courage to be contrarian before this upleg grows big.

All the hard valuation data I’ve shared so far requires lots of expertise and time to amass. It is a full-time job to track and analyze this stuff, relentless and demanding. But there’s another alternative valuation proxy that anyone can casually follow in real-time, the ratio of gold-stock price levels to gold. It works because gold is the dominant primary driver of miners’ earnings, and profits ultimately determine stock prices.

Of course GDX is the best gold-stock index to put in the numerator of this ratio. That matches well with the leading and dominant GLD SPDR Gold Shares gold ETF in its denominator. Dividing the daily GDX closes by the daily GLD closes and charting the results over time shows how gold-stock prices are trending relative to gold. This GDX/GLD Ratio or GGR aids trade timing, revealing under- and overvaluation.

While our famous Zeal charts are all custom, you can track this ratio yourself at StockCharts.com by entering the symbol GDX:GLD including that colon. The GGR shows that gold stocks are just coming off a major bottoming in valuation terms, starting to regain ground relative to gold. This is normal, as the major gold stocks of GDX tend to amplify material gold upside by 2x to 3x. This GGR behavior portends big upside.

Back in early March when gold stocks bottomed after GDX corrected 30.5%, this GDX/GLD Ratio sunk to 0.191x. In other words, this leading gold-stock benchmark’s price was trading at 19.1% of the price of the dominant gold exchange-traded fund. That was the lowest gold-stock valuation relative to gold since emerging from last March’s brutal stock panic, which battered the GGR way back down to just 0.133x.

That extreme-anomalous 4.1-year low wasn’t far above the 0.120x seen when this gold-stock bull was born back in mid-January 2016, and was wildly-unsustainable. So the GGR quicky recovered as gold stocks far-outperformed their metal, mean-reverting sharply higher out of that stock panic. After that epic-yet-short-lived deviation in this fundamental relationship, the GGR soon returned to its multi-year bull uptrend.

That is rendered in this chart, revealing gold stocks’ usual bull pattern of flowing and ebbing compared to gold. Gold-stock gains again amplify gold’s on the order of 2x to 3x during bull-market uplegs, forcing this ratio higher. That last massive 134.1% GDX upleg across the middle of 2020 was fueled by gold’s own huge 40.0% one, making for outsized 3.4x upside leverage. Gold stocks’ relationship with gold works both ways.

GDX’s 30.5% correction into early March 2021 was directly driven by gold’s own 18.5% one, which was really-mild 1.7x downside leverage. When gold itself is correcting, the gold stocks amplify its losses due to their innate profits leverage to it. Thus gold outperforms its miners’ stocks by falling less, driving this GGR lower. So this ratio’s meanderings can be used to game GDX upleg toppings and correction bottomings.

When that last mighty gold-stock upleg peaked in August, the GDX/GLD Ratio at 0.241x was well above its bull uptrend’s resistance. That was another warning sign that gold stocks had surged up to overvalued levels compared to gold. And indeed the gold stocks soon rolled over into a correction driven by gold’s parallel one. They fell faster than their metal like usual, which dragged the GGR back down to uptrend support.

With gold-stock price levels relative to gold bottoming in recent months, that implied sector selling was finally exhausting. And indeed over the past six weeks or so gold stocks have resumed rallying on balance with gold. The miners’ stocks outperforming their metal has forced the GGR higher again, to a decisive breakout above its recent correction’s upper-resistance line! That is more new-upleg confirmation.

And once gold and gold-stock uplegs get underway, they tend to run for at least a half-year or so. Again this bull’s prior four GDX uplegs averaged those awesome 99.2% gains over 7.6 months. Gold stocks rally faster than gold on balance throughout those spans, pushing the GGR higher. Gold-stock uplegs aren’t likely to fail into corrections or consolidations until the GDX/GLD Ratio climbs near upper resistance.

That is running way up around 0.241x today, incidentally right where the last gold-stock upleg peaked. This GGR resistance line will continue rising though, probably being closer to 0.250x about a half-year after GDX’s early-March bottoming. That probable relative-valuation topping level is interesting since it implies gold-stock upside targets. Extracting them is a little more complicated since we’re using GLD for gold.

Managing a colossal gold ETF backed by real physical gold bullion moving into and out of vaults certainly isn’t cheap. So GLD charges its shareholders a 0.4% annual expense ratio to cover all those operating costs. That has accumulated since GLD’s birth way back in November 2004, growing into a GLD-share-price discount to gold of around 6.3% today. GLD’s share price is also based off 1/10th of an ounce of gold.

So in the middle of this week, GLD’s $162.69 close times ten was 93.7% of gold’s own close near $1,737. So at today’s prevailing gold prices around $1,750, that implies a GLD-share price of $163.98. If the gold-stock valuations relative to gold marched back up to a 0.241x GGR, that targets GDX hitting $39.52. That would require another 15.3% GDX rally from midweek, extending its total upleg gains to a really-anemic +27.9%.

That isn’t much, and probably isn’t worth the significant risks gold stocks bear. But gold stocks can’t rally in a vacuum, they need gold uplegs to amplify their underlying metal’s gains. Gold’s own young upleg is also just getting underway, with potential for much more upside. As of the middle of this week, gold had merely climbed 4.5% at best from its own early-March low. GDX’s 12.4% gains leveraged that by 2.7x.

Gold stocks’ four earlier uplegs in this bull have naturally been driven by gold’s own previous uplegs, which averaged strong 33.3% gains over 10.9 months. If gold’s latest upleg ultimately sees it power up by that same third, we’d be looking at a topping up near $2,241. That’s not extreme by any stretch of the imagination, gold’s last 40.0% upleg peaked at $2,062 in early August. $2,241 is merely about 9% higher.

In GLD-share-price terms to plug into this GDX/GLD Ratio, $2,241 gold translates into about $210. And again the GGR upper-resistance line is rising, so this next gold-stock upleg will probably push the GGR over 0.25x. That implies a GDX target of $52.50, which would represent a 70% total upleg gain from this ETF’s early-March correction low. That’s a lot closer to sector precedent, big enough to be well worth riding.

That GGR-implied GDX-upleg target is conservative though. Both gold and gold stocks can run longer and higher when speculators and investors get excited and greedy. Given the epic central-bank money printing over this past year, gold’s upside potential is far greater than normal. Since last March’s stock panic, the Fed’s balance sheet ballooned 78.8% or $3,397b higher! Other central banks have panicked too.

So plug in higher gold prices to the GGR, and the gold-stock upside potential rises accordingly. A 0.25x GGR certainly isn’t a hard top either. The last secular gold-stock bull peaked in September 2011. During the last several years of that colossal bull run, the GDX/GLD Ratio actually averaged 0.406x! So if gold stocks return to favor in a big way stoking greedy herd participation, their potential gains are much greater.

Still relatively-conservative $2,500 gold and a 0.35x GGR would make for GDX trading near $82, 165% higher from early March’s latest correction low! Specific price targets don’t really matter, the point is the gold stocks still have vast room to power higher from here. They remain really undervalued compared to prevailing gold prices, enjoying great fundamental strength from a wide variety of measures and proxies.

And the major gold miners that dominate GDX actually well-underperform the smaller mid-tier and junior gold miners. They have superior fundamentals, smaller gold production and market capitalizations which make it much easier to grow both. Those are the high-potential gold stocks we’ve actively traded through decades of gold uplegs and corrections now. And we’re fully deployed in great ones for gold’s newest upleg.

Over recent months we’ve gradually layered in twenty and ten new gold-stock trades in our weekly and monthly newsletters. As I explained in my technical GDX-young-upleg essay last week, exact correction bottomings are never obvious in real-time. Thus new trades must be added at relatively-low gold-stock prices across probable bottomings. That requires lots of hard research work and courage to fight the herd.

While fundamentally-superior gold-stock prices are already surging, the great majority of their gains are still yet to come since this sector upleg remains so young. But the window to get deployed relatively-low to reap the lion’s share of this next gold-stock upleg’s gains is increasingly closing. So if you expect gold to head higher on balance in coming months, there’s no point tarrying too long on shifting capital into miners.

The bottom line is gold stocks remain undervalued, relative to both their underlying profits and prevailing gold prices. Despite gold’s recent correction, the gold miners are still earning money hand over fist with strong double-digits profits growth. And those great fundamentals will only improve as this gold bull’s next upleg continues powering higher. Gold miners’ stock-price gains will amplify their metal’s advance like usual.

That is already happening, as is apparent in the ratio of gold-stock prices to gold’s own. After their recent bottoming relative to gold, gold-stock valuations have started marching higher again. That new upleg has already broken out way above correction resistance, confirming its authenticity and staying power. These undervalued gold-stock prices have a long ways to run higher yet before they get expensive compared to gold.

(By Adam Hamilton)