Gold stocks V-bounce

The trading books of our newsletters are full of these fundamentally-superior smaller gold miners, which are better able to consistently grow their production. Being a contrarian speculator for decades now, I’ve witnessed countless times how buying low when sectors are deeply out of favor is the best way to multiply wealth. During that gold-stock V-bounce week, many of our open trades skyrocketed about a third higher!

That was sure fun, but it’s only a start on unwinding gold stocks’ worst summer performance in modern gold-bull history. GDX was flying high earlier this year, soaring 39.5% in just 2.6 months into mid-April. Then that solid young upleg had its legs kicked out from under it by an exceedingly-anomalous event. The Fed embarked on the most-extreme hawkish pivot it has ever attempted, catapulting the US dollar parabolic.

Fed officials not only promised monster rate hikes and unprecedented quantitative-tightening monetary destruction to fight raging inflation, but they actually delivered. In five consecutive FOMC meetings they lifted their federal-funds rate by 25 basis points, 50bp, 75bp, 75bp, and 75bp! That was the most-extreme rate-hike tightening the Fed has done in such a short span since the early 1980s, with pledges of more to come.

Simultaneously the Fed aggressively ramped up QT2 which dwarfs QT1 in every way. QT2 surged to full-speed which is nearly double QT1’s terminal pace in only a quarter the time! Just six months ago, either such a big-and-fast Fed-rate-hike cycle or forceful QT kickoff would have seemed impossible, yet here we are. The Fed has never before shocked the markets like that, and probably never will be able to again.

With other major central banks dragging their feet on tightening hard to combat fast-rising general prices, the US dollar’s yield-differential lead soared. So between mid-April to late September, the benchmark US Dollar Index skyrocketed an epic 14.3% to an extreme new 20.4-year secular high! That was truly a crazy market anomaly, as the world’s major currencies usually meander with all the sound and fury of a glacier.

Unfortunately the hyper-leveraged gold-futures speculators who dominate gold’s short-term price action watch the dollar’s fortunes as their main trading cue. So during that mighty USDX rally’s same short 5.5-month span, gold collapsed a proportional 17.9%. That gold-futures selling, both long-side liquidations and massive shorting, was off the charts. I dove in deeper on the futures still dogging gold a month ago.

With their metal that overwhelmingly drives their profits hammered so brutally lower by that incredible dollar mania, the gold stocks were crushed. GDX plummeted a jaw-dropping 46.5% in that span, just obliterating any remaining bullishness. Sector bearishness was so extreme that we were getting to the point where you could count high-profile gold bulls on your fingers. Gold stocks were assumed to be doomed.

Interestingly their downside leverage to gold during that supremely-unusual dollar anomaly was normal. GDX amplified gold’s dollar-induced futures-fueled selloff by 2.6x, near the middle of the usual range. But still the sentimental and technical damage was catastrophic. While mainstream traders totally forgot about gold stocks, contrarians increasingly hated them. This chart helps illuminate the sheer depths of misery.

The abandoned and despised gold stocks had been bludgeoned back down to literal stock-panic levels in late September! As that euphoric US-dollar mania peaked, gold plunged to $1,623 which hammered GDX down to $21.87. Both were deep 2.5-year lows not seen since the dark heart of March 2020’s infamous and brutal pandemic-lockdown stock panic! Prevailing fear then was stellar on the epic uncertainty.

In just over a month, the broad benchmark S&P 500 stock index plummeted 33.9%! Its VIX fear gauge skyrocketed up to a mind-blowing 82.7! Safe-haven capital flows into the dollar were so gargantuan that the USDX soared 8.2% in just nine trading days. That in turn crushed gold a dreadful 11.2% lower in that same short span, on that same leveraged-gold-futures-trading dynamic. The markets looked apocalyptic then.

Yet during that most-extreme fear event of our lifetimes, GDX closed under late-September-2022’s $21.87 low on only four trading days! So gold stocks’ recent nadir was extreme and anomalous beyond all belief. GDX was bashed to just 0.703x its 200-day moving average, exceedingly-oversold levels. Only a single day during March 2020’s savage stock panic saw a slightly-more-oversold reading running 0.694x!

So make no mistake, the recent terribly-low gold-stock prices were literally stock-panic-grade extreme. They weren’t sustainable, not only fundamentally-absurd but smothered in peak fear that couldn’t persist for long. That’s why gold and its miners’ stocks erupted in these violent and exciting V-bounces. Odds are they are just getting started. So far GDX has only recovered about a fifth of recent months’ ugly selloff.

Arguments for more massive mean-reversion-overshoot gold-stock gains coming are legion. Technically something new is underway. Both gold and GDX just enjoyed their biggest up days by far since this incredibly-anomalous USDX parabolic spike ignited in mid-April, with huge 2.3% and 7.1% gains! That is similar price action to the last blistering V-bounce out of March 2020’s stock panic, which soon snowballed.

Inevitably after extreme technical lows driven by unsustainable extreme popular fear, the herd-sentiment pendulum swings in the opposite direction. Peak bearishness at panic bottoms sucks in all-available sellers, traders stampede for the exits who lack the mental toughness to buy low or at least hold on when sectors are deeply out of favor. But their mass exodus leaves only buyers, who soon flood in fueling V-bounces.

Over the next 4.6 months after gold’s extreme stock-panic low in mid-March 2020, it rocketed 40.0% higher! That huge upleg ignited as those leveraged gold-futures speculators were forced to cover their shorts. This same gold dynamic is playing out again today. As gold surges sharply on short-covering buying, the larger long-side futures traders soon return to chase its upside. That amplifies gold’s young upleg.

Eventually gold rallies high-enough for long-enough to convince the vastly-larger investors to return. They love chasing upside momentum, and only grow interested in gold when a major upleg looks to be decisively getting underway. Gold investment bleeds heading into extreme lows as investors capitulate, but comes roaring back with a vengeance as gold’s subsequent V-bounce gathers steam strengthening gains.

The panic-battered gold stocks greatly leveraged gold’s powerful post-panic upleg in mid-2020, as GDX skyrocketed 134.1% higher in just 4.8 months! That 3.4x upside leverage was way better than normal, reflecting the mounting enthusiasm for gold stocks as they recovered. Mean-reversion uplegs born in extreme unsustainable lows have the best potential to grow into massive ones. Today’s setup is phenomenal.

Back in mid-2020 as gold blasted out of its last panic lows, inflation was tame and stock markets were soaring. The headline Consumer-Price-Index inflation measure averaged mere 1.2% year-over-year gains in 2020. And propelled higher by a biblical deluge of Fed money printing, the S&P 500 rocketed 67.9% into year-end out of late March’s capitulation climax! So there wasn’t a strong investment case for gold.

Gold has been the ultimate inflation hedge for millennia, powering higher to outpace falling purchasing power in debasing currencies. Investors had little inflation reason to buy gold in mid-2020, yet they flooded in all the same to chase its strong upside momentum. That quickly becomes self-feeding, buying begets buying as prices surge. And with stock markets soaring higher, there was little need to diversify portfolios.

So with little going for it other than upside momentum, gold still soared 40.0% higher out of its previous stock-panic lows. Today’s fundamental case for gold is radically more bullish, giving it much-greater ultimate upside potential. Inflation is raging out of control now thanks to the Fed’s extreme money printing after that pandemic-lockdown panic. In just 25.5 months, the Fed ballooned its balance sheet a crazy 115.6%!

That effectively more than doubled the US-dollar monetary base, which is why even lowballed monthly headline CPI inflation has averaged shocking 8.3%-YoY surges so far this year. The CPI’s recent 9.1% peak in June was its hottest inflation seen since way back in November 1981, a staggering 40.6-year high! The biggest inflation super-spike since the 1970s is now underway, which is astoundingly bullish for gold.

Gold utterly skyrocketed during those last similar inflation super-spikes. In the first the CPI blasted from +2.7% YoY to +12.3% over 30 months into December 1974. Gold’s monthly-average prices from trough to peak CPI months launched 196.6% higher! During the second the CPI exploded from +4.9% YoY to +14.8% in 40 months climaxing in March 1980. Gold’s monthly-average prices were a moonshot, up 322.4%!

Because gold hasn’t reacted yet to this raging inflation, traders assume it is broken. But gold’s necessary reflection of relentlessly-rising general price levels has only been temporarily delayed by that extreme US-dollar anomaly. Serious inflation is incredibly bearish for currencies historically, since it rapidly erodes their purchasing power. Investors soon tire of the relentless real losses in cash, and increasingly flock to gold.

Severe inflation also fuels major bear markets in stocks, ravaging corporate earnings. Companies face plunging profit margins as their input costs soar. But they can’t raise their selling prices enough to offset their costs because that will impair their sales. Rising general prices force customers to cut back on their spending. And indeed the S&P 500 rolled over into a bear market this year, falling 25.2% by late September!

Burning general stock markets really boost gold investment demand. As bear maulings gradually worsen, investors grow increasingly frustrated with the mounting losses in their stock-heavy portfolios. So they feel compelled to diversify, upping their meager gold allocations. Those were trivial when the S&P 500 was trading at all-time record highs entering this year, and remain far too low today given these conditions.

The value of the world-leading GLD and IAU gold ETFs’ bullion holdings divided by the S&P 500’s entire market capitalization is a great proxy for American investors’ gold allocations. Entering 2022 as the stock markets peaked, GLD and IAU were worth just 0.20% of large-cap US stocks. Exiting September at fresh bear lows, that ratio had only slightly improved to 0.23%. Investment in gold today remains effectively zero!

As this long-overdue stock bear exceeds 30%, 40%, or even 50% like the last couple secular bears, what if gold allocations grow to 1% or 5%? Gold prices would soar in similar mighty gains to those seen during those last 1970s inflation super-spikes. And as gold powers dramatically higher, the major gold stocks of GDX will continue leveraging its gains by 2x to 3x. If gold merely doubles, GDX would triple or quadruple!

Given this raging-inflationary backdrop and gold’s historical precedent of far-bigger gains in such times, a doubling near $3,250 out of recent panic lows is conservative. A move of that magnitude would take a few years like during those 1970s inflation super-spikes, but is easily doable. If gold returning to favor in such a big way seems crazy, think about the extreme market dislocations that have happened recently.

In early January as the S&P 500 soared to all-time record highs, virtually no one believed a bear market was imminent. Contrarians like me calling for a serious bear in late 2021 were ridiculed. In the year after that pandemic-lockdown stock panic when headline CPI inflation averaged tiny 1.2%-YoY increases, few feared the Fed’s extreme money printing would fuel serious inflation. Yet history was vindicated again.

We humans are notorious for making linear assumptions in a nonlinear world. We extrapolate whatever is happening in markets today out into the indefinite future! So traders figure gold and its miners’ stocks have fallen out of favor forever. That kind of thinking didn’t work so well in energy stocks after oil prices collapsed following that stock panic. They soared becoming some of subsequent years’ best performers.

It’s always foolish to assume extreme stock-panic lows fueled by extreme unsustainable fear can persist, they never do. They always spawn massive proportional mean-reversion-overshoot rallies to rebalance sentiment. And assuming gold and gold stocks are doomed with inflation raging out of control and a new stock bear gathering steam is the height of folly. They are going to soar to reflect super-bullish fundamentals.

So this gold-stock V-bounce is almost certainly only getting started. As the radically-overcrowded US dollar rolls over hard on inflationary debasement, speculators will flood back into gold futures catapulting the yellow metal higher. That will motivate investors to chase gold’s upside momentum, accelerating it. And the battered gold stocks will be off to the races, rocketing higher in a massive upleg besting 2020’s.

The bottom line is gold stocks just soared in a mighty V-bounce. That erupted off extreme lows last seen briefly in the dark heart of March 2020’s pandemic-lockdown stock panic. That last similar unsustainable anomaly birthed a massive upleg where gold stocks more than doubled in a matter of months. Another mighty mean-reversion-overshoot upleg is likely just getting underway now, which should grow to huge gains.

Gold is the overwhelmingly-dominant driver of its miners stocks’ fortunes. Gold is surging out of its own deep stock-panic-level lows as this year’s extreme parabolic US-dollar spike rolls over. As gold-futures speculators and gold investors return, upside momentum should increasingly become self-feeding. The biggest beneficiaries of gold powering decisively higher in a major new upleg are the beaten-down gold stocks.

(By Adam Hamilton)