Gold stocks continue to be universally despised, plagued by extreme bearishness. This has hammered their stock prices to epically-undervalued levels that are truly fundamentally absurd. This whole sector is now trading as if the gold price was less than a third of current levels! This massive disconnect has created vast opportunities for brave contrarians who have forged the mettle to buy low when few others will.
For literally thousands of years around the entire planet, gold has been an indispensable asset. It has been Tolkien’s One Ring of money, ruling over all national currencies ever created. It has been essential for wealth preservation and portfolio diversification, not to mention inflation protection and capital gains. The natural human lust for gold has dramatically reshaped world history, there is simply nothing else like it.
With gold highly-prized and valuable in all places and all times, the companies that painstakingly wrest it from the bowels of the Earth have also been highly valued. Their hard efforts recover a rare, scarce, and finite resource of great value, so investors usually flock to own these companies. Their extreme degree of out-of-favourness among investors today is far from the norm, it is actually a wildly-unprecedented anomaly.
Such incredibly irrational hyper-bearishness has bludgeoned gold-stock prices down to levels so far below fundamental reality that it defies belief. Through all the stock markets, individual stock prices are ultimately a direct function of the profits each underlying company generates. Gold stocks are no different. Like every other sector, they will eventually settle at reasonable multiples of their underlying earnings.
And obviously for the gold-mining industry, the price of gold is the dominant driver by far of its profitability. Building new mines is fantastically capital-intensive, so the costs of recovering the gold from any deposit are largely fixed when its mine is planned and constructed. Thus any increase in the gold price translates directly into higher profits, which grow far faster than gold rallies due to the fixed mining costs leveraging them.
As I discussed in an essay last week about the foolish gold-stock ostrich investors who have shut off their brains to succumb to bearish groupthink, gold stocks are trading at fundamentally-absurd levels. The first time the flagship HUI gold-stock index achieved today’s levels was fully a decade ago, when gold and silver were near just $385 and $5.25. With the precious metals vastly higher now, such levels make zero sense today.
The clearest way to understand this massive fundamental disconnect is to look at gold stocks relative to the price of gold, which drives their profits and hence ultimately stock prices. The HUI/Gold Ratio is the preferred metric for this, something I’ve been writing about for many years now. Like nothing else it visually captures the fundamental absurdity of today’s gold-stock prices and the resulting epic opportunities.
This first chart looks at the HGR in blue superimposed over the raw HUI in red. Out of the countless charts we’ve created at Zeal, this is one of my favourites. Successful investing demands first buying low then later selling high, and today’s gold-stock price levels represent one of the greatest buy-low opportunities I’ve ever seen. No sector is ever cheaper than when nearly everyone expects it to continue falling forever!
Just this week the HUI/Gold Ratio fell to 0.166x. In other words, the flagship HUI gold-stock index was trading at just 16.6% of the price of gold. This was the lowest this ratio has fallen in 12.8 years, even far below the 2008 stock panic’s extreme of 0.207x. Going back 12.8 years takes us to January 2001, when the gold price was languishing near $265 and the secular gold bull wouldn’t even start for a few months!
The implications of this fact for investors are staggering. Gold stocks are as out of favour today as they were at the end of a brutal multi-decade secular bear. Gold stocks are as out of favour today as they were when the HUI was just beginning its epic 1664% bull run between November 2000 and September 2011. Gold stocks have literally never been cheaper in almost the entirety of their wildly-profitable secular bull!
Today prudent contrarian investors can buy gold stocks at the same prices relative to gold last seen in the very first months of an epic 10.8-year bull run where they multiplied capital invested in them by nearly 18 times! Who wouldn’t want to partake in such an opportunity? It’s as if the extreme sentiment anomaly plaguing gold stocks today has unwound the entire secular gold-stock bull, totally resetting stock prices.
This epic pricing anomaly is the result of the most extreme bearishness imaginable. Investors have totally given up on gold stocks, they have convinced themselves gold stocks will never rally again. This has led to a self-feeding vicious circle. Discouraged investors dump gold stocks, driving their prices lower. This ramps popular bearishness even higher, leading even more investors to capitulate and run for the exits.
I certainly understand the brutal psychological pressure this year’s extreme selling has exerted on gold-stock investors. As of this week, the HUI is down 50.6% year-to-date thanks to gold’s own 22.0% loss. And it wasn’t like gold stocks were expensive before 2013’s wildly-unprecedented GLD mass exodus and gold-futures forced liquidations triggered by the Fed’s stock-market levitation arrived, they were cheap then too.
But they got far cheaper as this year’s extreme capitulation selling persisted. It’s funny, as the legions of gold-stock bears who no longer think fundamentals apply to gold stocks use this to beat contrarians over the head. But there is never any shame in buying low. If you offer me a $100 bill for $80, I will buy it immediately. If $100 bills are then going for $50 a few months later, the bargain just gets that much more attractive.
Extreme pricing and sentiment anomalies never last in the financial markets, they are naturally self-limiting. At some point everyone who can be scared into selling has sold, and everyone weak enough to succumb to popular groupthink has already become bearish. There is only a finite amount of selling possible, and a finite amount of traders who can manage to delude themselves to believe a sector will fall forever.
The best example of this is right in the middle of the chart above, 2008’s once-in-a-century stock panic. Gold stocks got sucked into that epic fear superstorm like everything else, and the HUI plummeting a gut-wrenching 71% in a matter of months. It felt like the end of the world, so many investors who had owned gold stocks for many years gave into their own fears and sold right into those extreme lows in panic.
But selling when everyone else is scared and universal bearishness dominates is always the height of folly. Just when things look like they will never get any better is exactly when they can’t get any worse! As I aggressively warned our subscribers at the time, gold stocks were trading as if gold was less than half the levels it hit at worst during 2008’s stock panic. That fundamental anomaly was ridiculous, it couldn’t last.
And it didn’t. Over several years after those extreme hyper-bearish 2008 stock-panic lows, the flagship HUI gold-stock index more than quadrupled. Many of the elite smaller miners we prefer saw far bigger gains than that. Vast fortunes were won by betting on a simple market truth. Extremes of prices and sentiment never last, both stock levels and emotions always mean revert. Markets are forever cyclical.
All prices, along with greed and fear, perpetually flow and ebb. Gold stocks can only fall relative to gold for so long, can only fall out of investor favour for so long, before that trend inevitably reverses. And if you look at this HUI/Gold Ratio chart above, this out-of-favour trend has lasted for a long time. Gold stocks have been slipping on balance relative to gold ever since 2008’s stock panic, which shattered their previous trend.
In the 5-year secular span before that event that sparked the greatest market fear we’ll witness in our lifetimes by far, the HGR averaged 0.511x. The HUI tended to trade at just over half the price of gold. This whole sector naturally oscillated between periods of becoming more liked and less liked by investors. The former sometimes drove the HGR above its 0.56x resistance, the latter occasionally pushed it under 0.46x support.
But the stock panic destroyed that normal secular trend. The majority of gold-stock investors who thought they were contrarians had deceived themselves, they were too weak psychologically to ride out a stock-panic-grade anomaly. So they capitulated and foolishly sold low, and then fled the gold-stock realm to never return. But even without them, the cyclical nature of the markets still decisively reasserted itself.
New investors, real contrarians, saw the extreme gold-stock lows and bearishness plaguing this sector and bought low, eventually driving the HUI to more than quadruple. And now today we find ourselves in a similar anomaly, the HUI’s extreme plunge in the first half of 2013 mirrors its late-2008 one during the stock panic remarkably well. The HUI is down 67% now compared to 71% then, similar catastrophes.
This year’s extreme bearishness hammered the HUI to its worst level in 4.6 years in late June, not too different from 2008’s stock panic which blasted it to a 5.3-year low. Today, just like back in late 2008, the HUI fell to its lowest levels relative to gold of essentially the entire secular gold-stock bull. The parallels are many, despite the gold-stock price and sentiment extremes being far worse at today’s cyclical ebb.
Today’s smug gold-stock bears foolishly ignore market history, they make the assumption that gold stocks (and gold for that matter) will continue falling deeper out of investor favour forever. But this flies in the face of the indisputable truth that markets are cyclical. The HGR has been plunging almost without respite for over 2 years now, since early 2011. At some point this will reverse, gold stocks will start reflecting fundamentals.
This week the HUI slumped to 219, levels first seen way back in October 2003 a decade earlier. But back then gold and silver were merely near $385 and $5.25. This week they were fully 3.4x and 4.2x higher near $1305 and $22.00. Does it make any sense at all for the gold stocks to trade as if the great majority of the secular gold bull never happened? Of course not! Their pricing today is truly fundamentally absurd.
Even if gold does nothing but drift, sooner or later gold-stock prices have to reflect the prevailing gold prices driving their high profitability. This is going to result in one heck of a mean-reversion rally. In the post-panic years between 2009 and 2012, before 2013’s extreme gold-selling anomaly, the HGR averaged 0.346x. To merely mean revert to that low standard would lead the HUI to more than double to 451!
But after price and sentiment extremes inevitably burn themselves out, mean reversions almost never end at averages. Like a released pendulum they don’t magically stop at the centre of their arc, but they overshoot proportionally as the momentum carries them to the opposite extreme. Thus I continue to believe there is a high probability the HUI will at least regain its pre-panic average HGR of 0.511x in the coming few years.
This next chart reveals the staggeringly-bullish implications of such a mean reversion for gold stocks. It looks at the HGR and HUI again in just the post-panic years, but adds a third series in yellow. That shows where the HUI would be trading if it regained its secular pre-panic average HGR of 0.511x. Even at today’s relatively-weak gold prices, gold stocks at normal valuations would more than triple the HUI to 667!
This week and back in late June at the HUI lows, this index was merely trading at 33% of where it would have been at that 5-year pre-panic-average HGR of 0.511x. This was actually far more extreme than during 2008’s stock panic, when the lowest the HUI sunk was 41% of this level. And if the HUI more than quadrupled after that anomaly, why on earth won’t it enjoy even greater mean-reversion gains after this bigger one?
Starting way back in April 2011, gold stocks begin to lose ground relative to gold. This led to the brutal HGR downtrend that persists to this day, only interrupted for several months in 2012 when gold stocks started to regain investors’ favor again. Unfortunately that natural market cycle was artificially derailed when the Federal Reserve’s highly-inflationary QE3 campaign ignited an unnatural levitation in the stock markets.
With general stocks rallying relentlessly on traders’ belief that the Fed wouldn’t let them fall, alternative investments including gold fell deeply out of favor. Gold stocks followed the yellow metal lower and leveraged its losses, ultimately leading to the recent months’ extremes. I’ve been actively trading and studying gold stocks for their entire secular bull, and I’ve never seen them more out of favour than today.
Being a contrarian is never easy, you have to be brave when others are afraid to buy low and later afraid when others are brave to sell high. Mainstream investors who only gain comfort from running with the crowd, selling low near bottoms and buying high near tops like everyone else, always ridicule the black-sheep contrarians. By thinking differently, fighting the herd, we make mainstreamers very uncomfortable.
They don’t want to hear that a deeply-out-of-favour sector is too cheap and on the verge of a massive upleg. They don’t want to hear that levitating stock markets are far too expensive and due to roll over into a new cyclical bear. The history-proven concept that markets are cyclical, that extremes on either side never last and soon mean revert, is heretical. So contrarian thought is mercilessly scorned and attacked.
But who cares? Would you rather be accepted by your friends and peers and fritter away your fortune by selling low and buying high like everyone else does? Or would you rather fight the crowd to buy low when few others will, then later sell high when everyone else realises you were right, and grow wealthy? Decades ago I made this decision myself, being a student of the markets forced me to be a contrarian.
Buying gold stocks low back in the early 2000s or during the 2008 stock panic when everyone thought it was sheer lunacy wasn’t any easier than it is today. Buying out-of-favour stocks in hyper-bearish sectors always makes those around you deride you as a fool. But the vast profits that come out of contrarian investing, becoming millionaires and then multi-millionaires through stock trading, makes all well worth it.
That’s what investing is all about, right? Multiplying your wealth through buying low then selling high. It’s not a popularity contest, it’s not about feeling good or accepted. The worst investors in general feel about any sector, the more bearish they are on it, the lower its prices and hence the better the bargains. There is no sector in all the stock markets today that can even remotely approach the extreme cheapness of gold stocks!
After falling deeper and deeper out of favour for more than a couple years now, gold stocks have effectively never been cheaper relative to gold in this sector’s entire secular bull. Gold stocks are trading at just a third of their pre-panic average levels relative to gold, with the HGR just hitting nearly-13-year lows this week. This anomaly cannot persist, gold stocks can’t mock their own fundamentals and market cycles forever.
If gold does nothing and the HGR merely returns to its post-panic average, the HUI will more than double. If gold does nothing and the HGR mean reverts to its pre-panic average, the HUI will more than triple. And if the HGR overshoots as is highly probable, the gains will be far larger. And if gold rallies too, as is almost a certainty after such an extremely-anomalous selloff, the gold-stock gains will be even greater.
The bottom line is gold stocks are as deeply out of favour as they’ve ever been in their entire secular bull. They’ve never been lower relative to gold, nor suffered popular bearishness so extreme, in nearly 13 years. This has crushed their prices to fundamentally-absurd levels even worse than the stock panic’s. They are trading as if the last decade of the secular gold bull never even happened, which is crazy.
But the silver lining of extreme anomalies in prices and sentiment is they never last. Selling and fear are self-limiting, they eventually burn themselves out. And then the cyclical nature of the markets reasserts itself to drive massive mean reversions, and ultimately overshoots to the opposite extremes. Today’s cheap gold stocks are set up for a colossal mean-reversion rally, maybe the biggest HUI upleg ever witnessed.
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