Gold-Miner Valuations

The gold miners’ stocks have spent the past half-year mired in a high consolidation. They haven’t been able to break out, but aren’t breaking down either. This technical purgatory is working to slowly bleed off overboughtness and rebalance sentiment. This necessary process to eradicate greed from the last upleg peak is never exciting. But today’s low gold-miner valuations reveal great upside potential in their next upleg.

The world’s leading and dominant gold-stock trading vehicle and benchmark is the GDX VanEck Vectors Gold Miners exchange-traded fund. It commanded $13.2b in net assets in the middle of this week, 2.7x larger than its next-biggest competitor GDXJ. The major gold miners’ stocks included in GDX soared this past summer, blasting higher after gold’s decisive breakout to its bull market’s first new highs in several years.

GDX’s strong 29.0% surge over the next 2.5 months into early September capped a larger 76.2% upleg over 11.8 months. Naturally, last summer’s sharp rally generated much excitement and greed in this small contrarian sector. So the gold stocks needed to correct or consolidate, either selling off deeply enough or drifting sideways long enough to restore sentiment balance. Excessive greed is inherently unsustainable.

So after peaking at a 3.1-year high of $30.95 in early September, GDX initially started correcting with a 15.4% retreat over the next 1.3 months. That’s really small as far as gold-stock corrections go, as this bull’s prior two averaged 35.4% GDX losses over 11.8 months! And this sector as measured by GDX had shown no major technical bottoming signals, like falling back to or under its key 200-day moving average.

But since then that proto-correction morphed into a high consolidation. After that mid-October correction low, GDX spent the next couple months meandering between $26 to $28. Gold breaking out of its own correction downtrend on Christmas Eve unleashed enough gold-stock buying to fuel a parallel breakout by the miners. GDX surged as high as $29.50 on close, and since then has mostly drifted from $28 to there.

This chart shows the past half-year’s correcting and consolidating price action within the context of this broader gold-stock bull. This sector remains in a technical no man’s land, neither correcting far enough nor drifting long enough yet to signal all-clear. This leaves a glass-half-full-or-half-empty thing, with gold-stock outlooks something of a Rorschach Test for traders. This setup can be used to argue their own biases.

(Click on image to enlarge)

The bulls rightfully point to impressively-resilient major gold stocks holding most of last summer’s massive gains. The bears highlight the equally-valid fact GDX has totally stalled out for nearly 5 months, failing to advance despite gold’s recent major new secular highs. Odds are gold is going to prove the arbiter of what this sector does next. The gold stocks are ultimately leveraged plays on gold, amplifying its fortunes.

Gold itself has two dominant primary drivers, speculators’ gold-futures trading and investment buying. In recent weeks I’ve written extensively about both. Specs’ collective positioning in their hyper-leveraged gold futures is effectively all-in. Their long bets are way up at all-time-record highs, while their short-side bets are down near gold-bull lows. Thus their capital firepower for buying more is effectively exhausted.

These influential traders remain far more likely to sell big to unwind these excessively-bullish bets than to buy materially more. Identifiable gold investment demand has been mostly weak on balance too ever since September when gold’s last upleg initially crested. While gold powered to new highs earlier this month on that flaring conflict between the US and Iran, they didn’t hold since specs and investors weren’t buying much.

Whatever gold does next is absolutely critical for gold stocks’ near-term outlook. Over 80% of individual gold-stock price moves are driven by gold’s own trends. Gold is the tide the gold-mining boats rise and fall on as a fleet. Fundamentally-superior gold stocks can outperform their sector when gold is rallying in uplegs, but they still fall with their peers when gold is correcting. Gold stocks need gold buying to advance.

Gold-futures speculators need to somehow keep adding bullish bets even from near-record levels where they are tapped out. Gold investors need to flood back in despite the general stock markets levitating to all-time-record highs spinning off great euphoria. These are both tall orders, with major selling from both key camps much more likely than material additional buying. So it’s prudent to stay wary on gold stocks here.

That caveat understood the major gold miners’ fundamentals look excellent. From a high level this is a simple business financially. The miners wrest all the gold they can from the bowels of the Earth, then sell it at whatever the markets offer. The difference between prevailing gold prices and their total extraction costs is their profits. The more gold they can produce, and the higher they can sell it for, the better their earnings.

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