Gold stocks have been pummeled mercilessly this month, their price action looking almost apocalyptic. The psychological stress spawned by such extreme weakness is intense, breaking the wills of this sector’s few remaining bulls. This week their selling cascaded into a full-blown capitulation, a mass surrender by weary investors. While exceedingly miserable, these events flag major long-term bottoms.
Over the course of gold’s powerful secular bull, the gold stocks have been a sentiment roller coaster. Early on their gains were enormous, gold stocks even rocketed higher while the general stock markets plunged in a brutal cyclical bear. Though they were nearly obliterated in 2008’s once-in-a-lifetime stock panic, as expected they soon soared in a massive recovery. Last autumn they hit new all-time highs.
But since the flagship gold-stock index (HUI) peaked in September, this sector has really fallen out of favor. Selling begets more selling, technical levels are broken, sentiment waxes increasingly bearish, so gold stocks are driven ever lower. In the first couple weeks of May alone, the HUI plunged 15.2%! Relentless selling leading to abysmal new lows eventually shakes out all but a bull’s true believers.
Even though the HUI was already hyper-oversold by its own bull-to-date standards, it plunged another 8.6% over 3 trading days ending this past Tuesday. Such massive selloffs from already-deep lows are a hallmark of capitulation. The frenzied exit of traders throwing in the towel in great frustration leads to selling exhaustion. Everyone susceptible to being scared into selling anytime soon is squeezed out.
But this leaves only buyers, so the nearly total absence of sellers after a capitulation ignites a big surge. This major reversal usually matures into a strong upleg. Thus capitulations, the wholesale abandonment of a sector by traders pushed to their emotional limits, are one of the greatest buy signals. And this week’s intense technical weakness and extreme sentimental distress in gold stocks sure looked like one.
While capitulations are psychological events, collective emotions can’t be measured. But the miserable impact of excessive fear and disgust is readily apparent in price action. So the mass surrender of capitulation is easily identifiable on charts. And the recent cascading selloff from already-low gold-stock levels is perhaps most vividly illustrated across multiple gold-stock measures in indexed terms.
The first is the HUI, long the leading gold-stock index closely followed by investors and speculators. Officially known as the NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index, it currently includes 16 elite major gold miners. But in this increasingly ETF-dominated world, the GDX gold-stock ETF is vying for the HUI’s throne. This Market Vectors Gold Miners ETF was launched in May 2006.
Today GDX has 31 component stocks, but despite its broader reach it still trades very similarly to the HUI due to the way each metric’s major components are similarly weighted. For a variety of reasons beyond the scope of this essay, I suspect GDX will eventually replace the HUI as this sector’s measuring rod of choice. Its little brother, the GDXJ junior-gold-stock ETF, offers the best view of the latest capitulation.
This Market Vectors Junior Gold Miners ETF was launched by Van Eck Global just like GDX, but quite a bit later in November 2009. While GDX focuses on major gold miners, GDXJ offers a valuable window into the volatile world of much-smaller producers and explorers. It currently has a whopping 86 components, dominated by small market-cap companies. Juniors were ground zero for this capitulation.
And of course no look at gold stocks would be properly framed without considering gold. This metal’s price naturally drives the long-term profitability and hence ultimately the stock prices of the companies that produce it. The fact that gold stocks plunged so dramatically relative to gold remaining high and strong greatly enhances the odds for success in this post-capitulation gold-stock buying opportunity.
With 4 data series on 4 different scales, the only way to parse them all at once is by indexing them. This makes them perfectly comparable in percentage terms. I set each individual index to 100 as of the HUI’s recent all-time high in early September 2011. From there a 10% move higher or lower takes any index to 110 or 90 respectively. This first chart establishes some strategic context for identifying capitulations.
Because gold’s fortunes are gold stocks’ only real long-term fundamental driver, I zeroed the vertical axis so this latest capitulation can be understood relative to gold. Gold has had a rough time lately, no doubt. A relentless parade of economic fears out of Europe, Asia, and the US, as well as traders realising the Fed isn’t going to launch a third round of inflationary quantitative easing anytime soon, really hit gold.
Since its latest interim high in late February, gold was down 13.9% as of this week. While that isn’t a trivial selloff, gold was still only dragged back to a 10-month low. Even though gold fell under $1550 and spooked excitable traders, you have to remember that before a year ago such levels had never even been seen before! Technically gold has merely been consolidating high after getting very overbought last August.
But the gold-stock investors and speculators have wildly overreacted to this relatively minor gold selloff in the grand scheme. Over this same short 11-week span, the HUI was pounded 31.5% lower. To give you an idea of how disproportionate this was compared to gold, the HUI hit 27-month lows this week! There is a huge disconnect between gold slumping to 10m lows and its miners being pummeled to 27m ones.
And it gets even worse. This week’s capitulation beat the flagship HUI gold-stock index back down near 375. The first time the HUI exceeded 375 in this secular gold bull was way back in September 2007. Where was gold then? It had just approached $720 for the first time in this bull! So this week, gold stocks were trading as if gold was at $720 when this metal was really 2.1x higher near $1540! Crazy.
As you can see above, the indexed blue HUI line and white GDX line are virtually identical. But the red GDXJ performance is radically different. This premier junior ETF was obliterated this week, falling to the lowest levels it’s ever seen since its birth in November 2009. The highly-speculative juniors are a great weathervane for gold-stock psychology in general, and they were wildly out of favor this week.
During this week’s capitulation, even though many of these stocks were already near major multi-year lows, some plummeted by 10% to 20% on a single trading day with no news! Extreme selling from lows, for no reason, is a capitulation.
And the jaw-dropping magnitude of the recent gold-stock selloff is crystal-clear on this zeroed indexed chart. The gold stocks, big and especially small, have just cascaded lower in a waterfall decline. The psychological angst, pain, and pressure such a brutal selling event spawns are nearly impossible to resist for all but the most battled-hardened contrarians. Gold stocks have just fallen off a cliff lately.
Such immense selling has only been seen one other time before in recent history, during 2008’s epic stock panic. Gold stocks plummeted then, again dramatically outpacing gold’s own decline. They ended up at absurdly-oversold levels that I pointed out at the time were a once-in-a-lifetime buying opportunity. And indeed this sector soon started surging, the HUI more than quadrupling in the next 3 years!
The stock-panic plunge leading into that amazing time to fight the scared herd and buy aggressively is provocatively the only other recent event remotely comparable to this latest gold-stock capitulation. Extreme weakness, shaking out every last trader who can’t withstand the intense pressure of fundamentally-sound positions plunging for emotional reasons, paves the way for enormous rallies.
Could the HUI actually quadruple again in the coming 3 years? Absolutely. As I’ve discussed in many essays since the stock panic, this index had an average ratio to gold of 0.511x in the 5 years before 2008’s stock panic. This week the HUI/Gold Ratio plunged to 0.244x, levels only briefly seen during the panic’s dark heart. If gold merely stays flat near its recent lows, the HUI would have to more than double just to regain its pre-panic HGR!
But given gold’s bullish fundamentals globally, this metal certainly isn’t likely to languish near lows in the coming years. With mine supply growth still heavily constrained and investors including central banks still seriously under-allocated to this unique asset, gold’s secular bull ought to have years left to run yet. And by the time we see that popular-mania parabolic gold-bull climax, the HUI will likely easily more than quadruple.
This next chart zooms in to highlight this latest gold-stock capitulation. The selling in the gold stocks, especially the high-potential juniors, was wildly disproportionate relative to what has happened in gold. Once again the HUI, GDX, GDXJ, and gold are all indexed to 100 as of the day the HUI’s all-time high was achieved last September. The sheer carnage driven by this irrational gold-stock capitulation is unreal.
Since their latest highs, the HUI and GDX plunged by 40.8% and 41.0% as of this week. This is ridiculous given gold was only down 18.8% from its own all-time high a little earlier. But the selling in the major gold miners was dwarfed by the apocalyptic plunge in the juniors. From its latest interim high last April, GDXJ was down a stomach-churning 57.8% as of this week! Juniors are getting obliterated!
These highly-speculative stocks are tasked with the critical mission of discovering and starting to mine new gold deposits to feed the world’s voracious investment demand for this yellow metal. And just like larger miners, the price of gold determines the profitability of these hard labors. And universally in the stock markets, any company’s long-term profits ultimately drive its long-term stock-price levels.
When GDXJ peaked in early April 2011, gold had just hit $1475 for the first time in history. And given this ETF’s ascent into that interim high mirroring but only modestly outperforming the HUI, that valuation of gold-stock prices relative to gold was certainly conservative. But fast-forward to this week, and this basket of elite gold juniors was 58% lower while gold itself actually rose 4% over this same span!
Why is the entire gold industry valued between 40% to 60% less when gold is gradually inching higher even at its recent lows? You have to agree this makes no sense at all fundamentally, it is incredibly illogical and irrational.
In fact besides the lack of investor interest (which makes it very difficult to raise the capital needed to explore and mine), juniors as a whole have no new industry-wide operational problems or impairments. The entire junior-gold rout culminating in this latest capitulation is purely emotional, it has absolutely nothing to do with fundamentals. Gold-stock investors and speculators are simply scared, end of story.
The same is true in the major gold miners, where we’ve done extensive research on their profit margins. In both gross-margin and absolute terms, gold-mining profits continue to rise dramatically thanks to these sustained high gold prices. Late last August heading into the HUI’s all-time high, its components had a market-capitalisation weighted-average price-to-earnings ratio of 23.3x earnings. By the end of April, it had plunged to just 13.2x!
So it’s not like gold miners aren’t earning money anymore with gold near $1500 instead of $1800. They are actually earning profits hand over fist, and are seriously cheap even by general-stock-market standards. 2011 was gold miners’ most profitable year ever by far, when gold averaged $1573 on close. So far this year, despite all the bearish gold hysteria, gold has averaged $1672! This is 6% higher.
Regardless of which angle you choose to view gold stocks from, their steep selloff culminating in this week’s capitulation climax makes zero sense fundamentally. The hard truth is gold stocks have been sold wildly disproportionately to gold’s own weakness merely because investors and speculators succumbed to their own unjustified fears. Capitulations are always irrational, emotional events.
The extreme fear and disgust generated by these exceptional selling climaxes force out every last trader that lacks emotional discipline. Sadly all many investors and speculators can think about is the last couple weeks’ technical action. They can’t be bothered with researching gold-stock fundamentals, or with learning the essential contrarian discipline of keeping their own emotions in check. So they surrender.
The capitulation event itself forces all the weak hands to exit at once, they sell low in their rush to realise huge losses. But once they are gone, the buyers regain control. And with everyone too scared shaken out, sentiment quickly swings back away from extreme fear and disgust. So capitulations nearly always spawn huge rallies and uplegs, major advances are born out of the deck-clearing throes of despair.
And indeed one appears to be starting. As I pen the draft of this essay on Thursday, gold and the gold stocks are surging dramatically out of Tuesday’s and Wednesday’s hyper-oversold lows. Even weak general stock markets weren’t enough to retard early-day gold and HUI rallies on the order of 2.5% and 6.0%! The sharp bounce after a brutal cascading selloff offers confirmation the capitulation is over.
This week’s capitulation certainly isn’t the first time gold stocks have been loathed. Like every other sector, they gradually oscillate from in favor to out of favor and back again. If you can steel yourself to fight the crowd, be brave when others are afraid, you can buy them at incredible bargains occasionally. And today looks like just such a rare opportunity.
The bottom line is gold stocks appear to have just suffered a full-blown capitulation. For no fundamental reason whatsoever, they cascaded sharply lower from major lows. Traders simply let their own fear and anxiety overpower their reason, so all the weak hands rushed for the exits to end the pain. While miserable to suffer through, these rare extreme selling climaxes mark major long-term bottoms.
So if you can keep long-term fundamentals in focus and tame your fear, capitulations are the worst-possible time to sell and an amazing time to buy. Though they feel like hopeless death spirals, this very despair quickly burns itself out. And with buyers greatly outnumbering sellers, prices soon rocket higher to undo the tremendous technical damage of the capitulation. Gold stocks are due to rebound sharply.
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