Gold-Stock Breakout 2

By: Adam Hamilton | Fri, Feb 14, 2014
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Gold stocks just surged to a major technical breakout, a very bullish omen. Investors are actually starting to redeploy capital in this battered sector, catapulting gold stocks into the early lead as 2014's best performers! This year is shaping up to be the polar opposite of last year's epic carnage, with gold stocks mean reverting back up to fundamentally-reasonable levels. The vast majority of the buying is still yet to come.

Exiting last year, gold stocks were inarguably the most hated sector in all the stock markets. And it is easy to understand why. In a stupendous year when the benchmark S&P 500 stock index blasted 29.6% higher, the flagship HUI gold-stock index collapsed 55.5% lower! It is hard to imagine a greater performance gap, which led investors to flee as gold stocks were crushed with gold. It was a total disaster.

But naturally such brutal losses drove sentiment to hyper-bearish extremes. Virtually everyone assumed gold stocks were doomed, never to rise again. They were wholesale abandoned, there was truly blood in the streets. Plagued by peak despair, gold-stock prices plummeted to levels that were fundamentally-absurd. Many elite gold stocks were trading at trailing P/E ratios under 10x, radically undervalued by any standard.

In late December, the leading HUI gold-stock index slumped to 190. As I was pounding the table about at the time, those levels were fundamentally absurd. The first time the HUI traded at 190 in this secular gold bull was over a decade earlier in August 2003. But back then gold, the dominating driver of gold-mining profits and hence gold-stock prices, was merely around $365! In December 2014 it was $1200.

With gold almost 3.3x higher, did it make any sense at all for gold stocks to trade at decade-earlier prices? Were the widespread single-digit P/Es justified? Hell no! Gold stocks weren't ridiculously cheap because there was any fundamental justification for those prices, but because investors had capitulated on this sector and abandoned it. But extreme bearishness, fear, and despair can never persist for long.

All anomalous sentiment extremes soon burn themselves out. Once everyone who is susceptible to being scared into selling low has already dumped their shares, only buyers remain. Then fundamentally-cheap abandoned sectors start rallying out of the ashes. That's what has happened so far this year in gold stocks. As of its latest interim high this past Tuesday, the HUI has powered 18.8% higher in 2014.

This compares to the S&P 500 down 1.5%, and gold itself only up 7.1%. Gold stocks as measured by the HUI have leveraged gold by over 2.6x in this young new year! And the smaller high-potential gold and silver miners we prefer have seen gains far outpace the HUI's. Once this phenomenon of gold-stock outperformance starts, it rarely stops until gold stocks soar radically higher as investors flock back in.

Just this week, the HUI enjoyed a major upside technical breakout. This is a very bullish harbinger of much more to come. This first chart looks at this flagship gold-stock index over the past year or so, superimposed over a trading construct called the Relative HUI. Relativity trading looks at prices as multiples of their 200-day moving averages. They tend to form horizontal trading ranges that help time entries and exits.

HUI Technicals 2013-2014

2013 was catastrophically bad for gold stocks, there's no doubt. The HUI started falling right out of the gates, dragged down by gold. Gold got hit due to epic record mass liquidations from the flagship GLD gold ETF. This flood of supply was the result of stock traders dumping their GLD shares to redeploy that capital into the Fed-driven stock-market levitation. So gold stocks just plummeted, it was nauseating.

The worst of this carnage came in two specific episodes. Last April, gold plummeted 13.8% in just 2 trading days in a panic-like selloff. When heavy differential GLD selling pressure pushed gold under key long-term support at $1550, futures speculators were forced to dump their longs in a massive forced liquidation. That wildly-anomalous event drove a quarter of the HUI's 2013 losses in just 4 trading days.

And then in mid-June, gold plunged again after Fed chairman Ben Bernanke outlined the Fed's best-case timeline for tapering its QE3 debt monetizations following an FOMC meeting. Over the subsequent week, the HUI suffered another fifth of its full-year losses. Together these massive April and June selloffs, along with early-year selling, conspired to force the HUI into the free-fall downtrend rendered above.

In 2013's first half, this index had plummeted 54.1%! That was essentially where it ended the year, so all the losses were front-loaded. The bearishness and despair in gold and gold stocks in late June was just insanely high. There were only a handful of hardcore contrarians bullish on this loathed sector, with the vast majority of analysts and investors predicting big additional losses. This consensus proved dead wrong.

In July just when all hoped seemed lost, the HUI surged dramatically. It soon broke out of early 2013's free-fall downtrend on a sharp short-covering rally. While this trend change was very welcome, like all short-covering rallies the buying was short-lived. Short sellers buy fast and then they are all done, so if investors don't return that momentum soon peters out. And indeed the gold stocks started drifting lower again.

Investors didn't return because gold continued to experience pressure from heavy differential GLD selling thanks to the Fed-driven stock-market levitation. And without gold advancing, the gold stocks can almost never rally materially. The HUI settled into a new and much-shallower consolidation downtrend. The additional selling was marginal compared to the first half of 2013's, but it was still relentless.

The HUI finally bottomed in late December, just 2 trading days after the Fed's surprise decision to start tapering its QE3 bond monetizations at that month's FOMC meeting. This was very interesting. After both gold and gold stocks plummeted in June on the mere threat of the QE3 taper, they weren't too much lower when the actual event arrived. Gold only fell another 0.8%, and the HUI was 8.1% lower at worst.

All year long the groupthink-blinded gold bears argued that gold and therefore the entire precious-metals complex would just be crushed when the Fed started slowing QE3. A full-blown QE3-taper hysteria arose surrounding gold, it was crazy. But once the taper arrived and gold didn't collapse on cue, buyers started to return. And that tentative rally has grown into the great gold-stock strength in 2014.

The HUI is up 23.6% in the past 1.7 months, which is the longest it has rallied in 17 months! This new buying is gradual and sustained, the kind of advance seen when real investment capital starts returning to a sector. This is a big contrast to the sharp short-covering rallies last summer and autumn, which quickly burned themselves out. Slow and steady wins the race, as it gradually entices in more and more buyers.

The reason I'm writing this essay this week is a major technical breakout. Note above that just in this past week, the HUI broke out decisively above its consolidation downtrend's upper resistance line! This zone had trapped the HUI for several weeks, but the gold stocks finally powered through. And shortly after, this flagship gold-stock index regained its 200dma for the first time since the first trading day of 2013.

Crossing back over a 200dma from below after a long downtrend is a very bullish sign. That gives sidelined investors the necessary confidence to start returning. The HUI's 50dma has also turned up again in February too. As long as gold stocks keep rallying on balance, within a few months this 50dma will cross the 200dma from below. This is the fabled "golden cross", one of the strongest technical buy signals.

And the HUI still has vast room to run higher. Merely to return to end-of-2012 levels before 2013's once-in-a-lifetime gold anomaly, the HUI would have to soar 95% from this week's levels! And if the HUI doubles, the best of the smaller gold miners we own and recommend will see their stocks quadruple. And there is little danger of the HUI getting overbought and correcting before it exceeds 1.40x its 200dma.

That Relative HUI metric has marked past gold-stock toppings, and is up around 327 based on today's 200dma. And this baseline HUI 200dma will soon start trending higher again as investors continue to gradually return to the fundamental-bargain gold stocks. So later this year and early next, this same 1.40x rHUI overbought metric will be considerably higher in HUI-level terms than it happens to be today.

Within days of that HUI bottom in mid-December, I wrote an essay called contrarian gold stocks. It explained how fundamentally absurd it was to have gold stocks trading at the same prices they were at a decade earlier when gold was just $365. At $1200 gold and single-digit P/Es, shouldn't they be a heck of a lot higher? It was a no-brainer investment thesis, fighting the crowd to buy low when few others would.

But most traders hate to use their brains. They desperately want to believe whatever is popular, they so fear sticking out from the herd. They want to assume that a price move that has already run to extremes is going to continue indefinitely. So I got a ton of criticism and flak from traders all over the world for daring to buy low in peak despair. But when everyone believes the same thing, that trend is already ending.

Brave contrarians multiply their wealth dramatically by buying low when no one wants to. In our weekly newsletter we added new gold-stock and silver-stock trades in mid-December and mid-January. As of the middle of this week, they were already up 41%, 28%, and 29%! In our monthly newsletter, our three newest trades launched in early November, January, and February are already up 96%, 32%, and 28%!

If you are not a Zeal subscriber riding this young new gold-stock upleg, you are robbing yourself. 2013's leaders are definitely not going to lead the markets this year, the odds are radically higher it will instead be 2013's laggards. Sadly most investors and speculators won't figure this out until too late, they lack the necessary contrarian background and ongoing research to discern the major trend changes in real-time.

Even more important than the HUI's absolute gains are its advances relative to the primary driver of gold-mining profits, the gold price. This next chart looks at the HUI/Gold Ratio which distills down this critical relationship over time. With the gold stocks also climbing relative to gold in recent months, the strength and staying power of their young upleg is far more potent. This is an even more bullish omen.

HUI/Gold Ratio 2013-2014

The HGR saw similar downtrends and breakouts over this past year as the raw HUI. It not only experienced an upside breakout from its consolidation downtrend this week, but it tentatively broke out above its 200dma as well. Its 50dma has also turned positive, setting up another golden cross in the coming months. The gold stocks haven't outperformed gold for this long in 17 months, which proves things are changing.

Back in early December when everyone had given up on and abandoned gold stocks, the HUI/Gold Ratio fell to a jaw-dropping 12.9-year low. Gold stocks had never traded at lower prices relative to gold in their entire secular bull, not even during 2008's brutal once-in-a-lifetime stock panic! Gold stocks had never been so unpopular, which was a sure indicator that their popularity and hence prices had to recover.

While the HGR still looks low today even on this short-term chart, that certainly doesn't tell the whole story. In the secular 5-year span before 2008's stock panic, the HGR averaged 0.511x. The HUI gold-stock index tended to trade just above half the prevailing gold price. If the HUI returned to those levels, it would trade at the yellow line rendered above. This gives the HUI a 660 target, nearly triple today's levels!

Most investors and speculators are so down on gold stocks that they believe they will never return to pre-stock-panic price levels relative to gold. I strongly disagree, as the markets are forever cyclical and gold stocks will return to favor again. But nevertheless, there is a much more conservative HGR target. That is the post-stock-panic average of this ratio between 2009 and 2012, before 2013's anomalous gold carnage.

That turns out to be 0.346x, which is vastly higher than this week's still-pathetic 0.177x. To merely regain those post-panic levels relative to gold, the HUI would have to soar 96% from here to 447! With gold stocks still so radically undervalued relative to the metal that drives their profits, they have vast room to run higher from here. This means the young gold-stock upleg in early 2014 is likely just the very beginning.

And any HGR analysis is remiss without considering gold. As I discussed a few weeks ago in another essay, gold itself has bottomed. It has very high odds of enjoying a massive mean-reversion recovery upleg this year. It's hard to believe after 2013's slaughter, but gold actually exited 2012 way up at $1675. There is no reason it can't return to those levels relatively soon as the GLD capital outflows reverse into inflows in 2014.

At far-more-normal $1675 gold levels, the HUI mean reverting back to its post-panic-average HGR of 0.346x implies this index near 580. That is 154% higher than today's levels! And if it can actually regain its secular pre-panic average relative to gold, we are looking at a staggering 856. That is 275% above current levels, or nearly a quadruple! Make no mistake, gold stocks have a long ways to run higher yet.

The new major upside technical breakouts in both HUI and HGR terms are merely the bullish vanguards of much more gold-stock buying to come. Hedge funds are already starting to salivate at the extreme upside opportunities in gold stocks created by the hyper-bearish sentiment last year. And since this sector remains very small relative to the broader markets, it doesn't take a lot of new capital to catapult it higher.

After 2013's epic record carnage, the odds are overwhelming that gold stocks will enjoy one of their best years ever in 2014. The smart contrarian investors and speculators who get in early have the potential to literally double to quadruple their fortunes in a single year! How often does that happen? If you want to ride these mean reversions and understand what is going on in this forgotten sector, join us at Zeal.

We've been actively studying the stock markets and gold full-time, and trading gold and silver stocks, for over 14 years now. After these countless thousands of hours on task, our expertise is unparalleled and super-valuable. All 664 stock trades recommended in our newsletters since 2001 have averaged stellar annualized realized gains of +25.7%! And that includes all the losses as well, even last year's misery.

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There is no better way to stay informed on the markets from a critical contrarian perspective that you won't get in the mainstream media than through investment newsletters. We have long published popular weekly and monthly ones. In them I draw on our hard-won experience, knowledge, wisdom, and ongoing research to explain what is going on in the markets and why. And we recommend specific stock trades as appropriate. For just $10 an issue, you can't afford not to subscribe. Join us today and prosper!

The bottom line is the battered gold stocks just experienced a major upside breakout. This is a very bullish portent that marks a radical departure from last year's dismal carnage. Investors are just starting to understand the extreme bargains littering this sector, and are buying low. This has driven enough gradual and sustained buying to make gold stocks the best-performing stock-market sector of 2014 so far.

And these early gains are just the beginning. Gold stocks were hammered to such fundamentally-absurd levels relative to gold that they have vast room to run from here. The major gold stocks could double and still be cheap by all historic metrics, and the smaller high-potential ones are likely to at least quadruple in the coming year. The brave contrarians willing to fight the crowd are going to win massive gains.

 


 

Adam Hamilton

Author: Adam Hamilton

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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