Guest Post by Adam Hamilton at Zeal LLC:
The gold miners’ stocks are soaring again, just blasting to new upleg highs this week! They are following their metal higher and amplifying its gains like usual. Yet despite their dramatic surges in recent weeks, both gold and gold stocks have lots of room to keep running. Sentiment is improving on this accelerating upside momentum, attracting in more capital. And normal gold-upleg-fueling buying is far from tapped out.
Gold stocks are ultimately leveraged plays on gold, because their earnings multiply material gold moves. A miner producing the yellow metal for $1,225 per ounce earns $375 per ounce at $1,600 gold. But as gold rallies 25% to $2,000, those all-in sustaining costs generally don’t change much. So mining profits just explode to $775, more than doubling at a 107% gain! That fuels gold stocks’ big upside leverage to gold.
These numbers aren’t hypothetical either. Gold carved a major secular bottom way down at $1,623 in late September 2022. That birthed a strong new upleg, which has soared as high as $2,020 on close as of the middle of this holiday-shortened week. And the famed GDXJ gold-stock ETF’s top 25 mid-tier gold miners excluding three extreme outliers averaged $1,223 AISCs in Q4’22. Thus miners’ earnings are soaring!
And so are their stock prices. The leading sector benchmark is GDXJ’s big-brother GDX VanEck Gold Miners ETF, which tracks larger major gold miners. It was slammed with gold last summer to deep 2.5-year lows in late September paralleling gold’s. Those left-for-dead gold-stock prices were literally stock-panic levels, not seen since the dark heart of March 2020’s brutal pandemic-lockdown stock panic.
The trading day before GDX bottomed in late September 2022, I published an essay explaining why that was a false gold-stock panic. Gold had been crushed by an extreme US dollar parabolic moonshot to extreme multi-decade highs on the Fed’s most-extreme tightening cycle ever. That’s a lot of extremes, and none are ever sustainable! That was an incredible contrarian buying opportunity, as I argued then.
Indeed both gold and its miners’ stocks have soared since, as the factors driving mid-2022’s extremely-anomalous gold plunge unwound. After four monster 75-basis-point rate hikes in a row, the Fed’s ability to shock the dollar and gold was ending. An early November essay analyzed that in depth, concluding “The battered gold stocks will soar with gold, winning fortunes for contrarian traders.” And that’s what happened.
Between late September 2022 to early February 2023, gold blasted 20.2% higher to $1,951 reentering formal bull-market territory after last year’s anomalous drubbing. GDX rocketed 52.1% higher in that 4.0-month span, amplifying gold’s young upleg by 2.6x. Normally the major gold stocks dominating GDX leverage material gold moves by 2x to 3x. So everything was looking good, with gold-stock prices soaring.
Price action fuels herd sentiment, and that was really starting to improve with higher gold and gold-stock levels. But then gold suffered a sharp pullback catalyzed by a European Central Bank dovish surprise, and a record-seasonal-adjustment-driven eight-standard-deviation headline beat in monthly US jobs! So in February gold plunged 7.2% in several weeks, ultimately hammering GDX 19.8% lower for 2.8x leverage.
Like many of gold’s larger short-term swings, all that was driven by leveraged gold-futures trading. In February, those speculators expended much of their capital firepower available for selling. That left gold ready to mean revert swiftly higher, which accelerating dramatically during March’s banking crisis. Thus as of mid-week, gold has V-bounced 11.5% higher to that $2,020 close. GDX naturally amplified that surge.
This leading gold-stock sector benchmark blasted 28.1% higher in a similar span to $34.17 this week, a new upleg high! That made for healthy 2.4x upside leverage. Since gold remained far from falling into bear territory in late February, technically all this is one upleg between late September to early April. Gold’s total gains have grown to 24.5%, while GDX’s extended to 56.2% in that span amplifying gold by 2.3x.
These 25% and 56% surges in just 6.2 months should be celebrated, trouncing the flagship S&P 500’s mere 12% gain. But neither are large yet by major gold and gold-stock upleg standards. In 2020 for example, two mighty gold uplegs soared 42.7% and 40.0% higher fueling massive parallel GDX gains of 76.7% and 134.1%! Sector uplegs grow huge when upside momentum and bullish sentiment become self-feeding.
Today’s young gold and gold-stock uplegs have lots of potential to grow much larger before they give up their ghosts. As this chart shows, GDX remains relatively low by recent years’ standards, still rebounding out of last year’s extreme-Fed-rate-hike-driven anomaly. Just to recover to mid-April-2022 levels near $41 before all that, GDX would have to rally another 19.6% catapulting its total upleg to hefty 86.9% gains!
Despite their powerful surge since late September’s extreme lows, the major gold stocks per GDX have only just returned to normal levels over the past couple years. They aren’t particularly overbought, they generally remain quite undervalued relative to their underlying earnings, and sector sentiment is still far from euphoric. So there are no technical or sentimental signs that this mounting upleg has largely run its course.
Gold stocks’ fortunes depend on gold’s, so their stock prices will dutifully leverage whatever their metal does next. And gold’s upleg still looking young is the most-bullish argument for this gold-stock upleg ultimately powering much higher. In the last couple months I’ve written five separate essays analyzing gold’s performance and drivers from various key angles. Gold stocks can only be understood through gold.
Major gold uplegs are fueled by three sequential stages, with the first two igniting the subsequent two. Uplegs are born in deep lows as speculators rush to buy to cover gold-futures short contracts. That burns out fast, lasting a couple months at best. But that legally-required buying forces gold high enough for long enough to attract back other long-side gold-futures speculators. Their voluntary buying is much larger.
On average over the past year, total spec longs have exceeded total spec shorts by 2.3x. Thus they are proportionally more important for fueling major gold uplegs. Stage-one gold-futures short covering soon gives way to stage-two gold-futures long buying, which can run three to six months. That drives gold higher still, soon attracting back investors with their vast pools of capital dwarfing gold-futures specs’.
Eventually all that stage-one gold-futures short covering and stage-two gold-futures long buying drives gold high enough for long enough to ignite far-bigger stage-three investment buying. That lags major gold bottomings, because investors love chasing upside momentum and wait until uplegs are well-established before piling in. In today’s gold upleg, stage one has been spent but most of stage two and three still remain.
I dug into the first couple stages’ leveraged gold-futures trading in depth a couple weeks ago on gold’s upleg rocketing back. Speculators’ gold-futures buying and selling bullies around gold prices because of the extreme leverage inherent in it. This week each 100-ounce contract controlled $202k worth of gold. Yet traders are only required to keep $8k cash margins in their accounts for each contract they are trading.
That yields extreme maximum leverage of 25.3x! Each dollar deployed in gold futures at those limits has 25x the price impact on gold as a dollar invested outright. So these speculators punch way above their weights in driving short-term gold trends. It was mostly their stage-one short-covering buying and bigger stage-two long buying that propelled gold 24.5% higher over the past 6.2 months, fueling its young upleg.
While spec gold-futures trading is complex, there’s a quick proxy I use in our subscription newsletters to distill it all down into a couple numbers. It simply looks at where speculators’ total gold-futures long and short contracts are within their past-year trading ranges. The most-bullish near-term setup for gold is 0% longs and 100% shorts, indicating specs have exhausted their likely capital firepower available for selling.
That screaming buy signal heralding major gold uplegs was last seen in late September 2022 right when today’s upleg was born! I analyzed mid-2022’s gold-futures puking stalling back then. Conversely the most-bearish near-term setup for gold is the opposite 100% longs and 0% shorts, revealing specs have done all their probable buying. These handy metrics can be used to estimate stage-one and stage-two progress.
As of the latest weekly Commitments of Traders report current to Tuesday March 28th when gold closed at $1,973, total spec longs and shorts were running 33% and 0% up into their past-year trading ranges. That implies this gold upleg’s initial stage-one gold-futures short-covering buying is probably finished, but only a third of its stage-two gold-futures long buying is done. That means fully two-thirds of that remains!
Major gold uplegs don’t often fail until total spec longs challenge 100%, but the highest they have been during this entire young upleg is just that latest 33%. That makes for a high degree of confidence that this gold upleg has a long ways higher to run yet. And the higher gold goes, not only will gold stocks amplify it but their gains will accelerate as sector sentiment grows more greedy. This dynamic is building steam.
But it’s not just speculators’ positioning in gold futures that remains very bullish for gold and its miners’ stocks. The far-larger stage-three gold investment buying dwarfing the first two stages’ gold-futures buying has barely even started. Investors command vastly more capital than that hyper-risky gold-futures realm, but without any leverage they’re in no hurry to shift it into gold. Gold has to first win their respect.
That is accomplished by sustained upside momentum, as investors love to chase gains. The longer and higher gold runs, the more investment capital is allocated to it. That big buying is necessary to fuel the largest uplegs like 2020’s back-to-back 40%+ monsters. While comprehensive global gold investment demand is only published quarterly, there is a great daily high-resolution proxy that tends to closely track it.
That’s the combined holdings of the dominant GLD and IAU gold ETFs, which are the best indication of stage-three gold investment buying. Rising holdings in these mighty gold ETFs reveal American stock-market capital flowing into gold, bidding up its price. This stage-three dynamic fueled those huge 42.7% and 40.0% gold uplegs back in 2020, with GLD+IAU holdings soaring dramatically during both of them.
During the first GLD and IAU enjoyed a huge 314.2 metric-ton or 30.4% holdings build, while the second saw an even-bigger 460.5t or 35.3% surge! This essential stage-three investment buying in today’s gold upleg is virtually nonexistent, arguing that it remains young. Measured over this upleg’s entire lifespan like those previous major ones, GLD+IAU holdings actually remain down 54.7t or 3.8% since late September!
Considered another way, at worst during today’s gold upleg GLD+IAU holdings slumped to a stock-panic-grade 3.0-year secular low in mid-March. Investors capitulated after gold’s sharp February selloff. From those extreme unsustainable lows, as of midweek the physical gold bullion held by these dominant ETFs is only up 34.0t or 2.5%. So this upleg’s identifiable stage-three investment buying has barely even started!
And there are certainly big fundamental reasons why investors should want to up their meager portfolio allocations to gold, upside momentum aside. American stock investors’ percentage of capital deployed in gold can be inferred by looking at the value of GLD+IAU holdings relative to the total market capitalization of all 500 stocks in the S&P 500. Exiting March, that remained vanishingly small only running a trivial 0.24%!
So gold investment is virtually zero with a bear market in stocks underway. When these awaken from bubble valuations above 28x earnings, they tend to at least cut stock prices in half before hibernating. At worst in mid-October, the S&P 500 had only fallen 25.4%. And with its elite stocks’ average trailing-twelve-month price-to-earnings ratios still running 27.1x leaving that month, this bear had much work left to do.
They were even higher at 27.8x as this month dawned, still just shy of bubble territory! Major bear markets usually maul valuations under historical fair value at 14x, and sometimes down to half that at 7x! Gold is the ultimate portfolio diversifier, tending to rally on capital inflows as general stock markets weaken. An even-bigger argument for a renaissance of gold investment is the ongoing high inflation still raging.
From just before March 2020’s pandemic-lockdown stock panic to mid-April 2022, the Fed ballooned its balance sheet an astounding 115.6% or $4,807b in just 25.5 months! That essentially doubled the US money supply in just a couple years. As of the latest weekly Fed-balance-sheet data, only 1/20th of that extreme money printing has been reversed. So we are suffering the biggest inflation super-spike since the 1970s.
Even though the Fed has hiked interest rates an exceedingly-extreme 475 basis points off zero over the past year ending mid-March, headline monthly US Consumer Price Index inflation over that span has still averaged red-hot 7.8% year-over-year surges! Rate hikes aren’t slaying inflation fueled by a still-existing doubling of the US money supply. As investors increasingly realize that, they will likely flock back to gold.
During those last two inflation super-spikes of the 1970s, monthly-average gold prices from trough-to-peak CPI-inflation months just skyrocketed. They nearly tripled with 196.6% gains over 30 months during the first, then more than quadrupled during the second soaring 322.4% over 40 months! So a doubling seems reasonable this time with the US money supply still doubled, and other major currencies also way inflated.
The bigger gold’s upleg and larger bull grow and the longer they run, the more investors will shift capital back into gold. And the higher gold ultimately goes to reflect vastly-larger fiat money supplies around the world, the more gold stocks will soar. Again the major gold stocks of GDX tend to amplify material gold moves by 2x to 3x. But the smaller fundamentally-superior mid-tier and junior miners really outperform that.
Trading those is the realm we’ve specialized in for a quarter-century now at Zeal. Our trading books are currently full of great smaller gold and silver miners really starting to soar. This week the unrealized gains in recent trades are already running as high as +101%! Achieving that requires being contrarian, staying informed about the markets even when sectors are deeply out of favor like gold and gold stocks recently.
While the fantastic opportunities to buy really low that I pounded the table about since late last summer have passed, the gold stocks still have lots of rallying left to do. So it isn’t too late to carve out some decent portfolio allocations to gold and gold stocks. The GDX gains in today’s young upleg could double from here if gold’s own upleg grows really large. And all signs are pointing to that being increasingly likely.
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The bottom line is gold stocks are soaring again, powering higher with gold. Despite February’s sharp selloff, their young upleg is alive and well after just surging to new highs this week. Since gold miners’ earnings amplify gold price trends, gold stocks are ultimately leveraged plays on gold. And the yellow metal’s own driving upleg looks to still have a long ways to run yet, with most of the usual buying still coming.
Speculators’ initial gold-futures short covering is mostly done, but their larger secondary long buying is only about a third finished. And the ultimate far-bigger investment buying necessary to fuel major gold uplegs has barely even started. With a stock bear and inflation super-spike underway, investors have great fundamental reasons to up their portfolio allocations to gold. That ought to propel gold stocks way higher.