Gold Stocks Upside Huge 2018 / Commodities / Gold and Silver Stocks 2018

The gold miners’ stockshave huge upside potential in 2018, likely the best among stock-marketsectors.  They really lagged gold lastyear, so a major mean-reversion catch-up rally is coming.  The gold miners are universally ignored anddeeply undervalued relative to the metal which drives their profits.  And gold itself is likely to powerdramatically higher this year as euphoric record-high stock markets inevitablystart to falter.

Gold has always beenthe leading contrarian investment, tending to move counter to stockmarkets.  So not surprisingly investmentdemand stalled last year as the extreme taxphoria-fueled stock surge blastedrelentlessly higher.  When stock marketsapparently do nothing but rally indefinitely, investors feel no need toprudently diversify their portfolios with theanti-stock trade gold.  So theyignored the yellow metal in 2017.

That was certainlyevident in the leading proxy for gold investment demand, the flagship AmericanGLD SPDR Gold Shares gold ETF.  Itsphysical gold bullion held in trust for shareholders merely grew 1.9% or 15.3metric tons in 2017.  That was a colossalslowdown from 2016’s massive 28.0% or 179.8t growth!  Given the weak gold investment demand lastyear, it’s rather impressive how well gold managed to perform.

Big up-years in thestock markets sometimes drive big down-years in gold, and 2013 was a key casein point.  That year extreme Fed easing catapulted the benchmark S&P 500 broad-market stock index (SPX) an amazing29.6% higher.  Exuberant investors wantednothing to do with gold, and dumped it in droves.  So the gold price plummeted 27.9% in 2013,leaving deep psychological damage that persists to this day.

In 2017 the SPX soared19.4% on hopes for big tax cuts soonfrom the newly-Republican-controlled US government.  Extreme complacency, greed, euphoria, andeven hubris ran rampant among investors. It was a perfect scenario to see gold crushed again on a mass exodus ofinvestor capital.  Yet despite the stockmarkets enjoying their best year since 2013, gold was still able to achieve astrong 13.2% gain in 2017!

Nevertheless, thewildly-optimistic stock-market sentiment drowned out everything else sopsychology in precious metals remained exceptionally weak.  The leading indicators for gold sentiment arethis metal’s peripheral leveraged plays of silver and gold miners’ stocks.  Both typically amplify gold’s upside by 2x to 3x.  But oddly in 2017 despite gold’s big rally,silver and the main gold-stock index only climbed 6.4% and 5.5%.

That index is of coursethe NYSE Arca Gold BUGS Index, better known by its symbol HUI.  It is closely mirrored by the dominantgold-stock ETF, the GDX VanEck Vectors Gold Miners ETF.  The composition of these gold-stock trackers is very similar bynecessity, as the universe of major gold miners to pick from when buildingindexes is small.  Without scales, it’simpossible to tell the difference between HUI and GDX charts.

In a 13.2% gold up-yearlike 2017, the HUI really should’ve leveraged that by 2x to 3x to enjoy solidannual gains of 26.4% to 39.7%.  Yetbecause investors weren’t interested in either gold or its miners’ stocks, theHUI languished with that miserable 5.5% gain last year.  That made for terrible 0.4x leverage to gold,which is wildly unacceptable.  Goldminers must generate greater returns thangold to be viable investments.

Owning gold miners ismuch riskier than simply owning gold itself. On top of all the price risks that gold faces, the miners heap manyadditional operational, geological, and geopolitical challenges.  They must compensate investors for these considerableadded risks relative to owning gold outright, or there is truly no point inowning them at all.  2017 was a rareanomaly where they dramatically lagged gold’s solid rally.

That’s very unlikely topersist into 2018, as we’re already seeing. Since the Fed’s 5thrate hike of this cycle in mid-December, gold and the HUI have rallied 5.5%and 12.8% as of the middle of this week. That makes for solid 2.3x upside leverage, already a vast improvementover last year’s 0.4x.  Thus investors arealready returning to gold stocks in a meaningful way, and this young trendshould accelerate.

The gold miners’ stocksare radically undervalued fundamentallyafter so horribly underperforming gold last year.  Gold mining is a simple business from aprofits standpoint.  Miners painstakinglywrest gold from the bowels of the Earth, then sell it at prevailing marketprices.  So their earnings are thedifferences between current gold prices and mining costs.  Gold-mining profitability was actually fairlystrong in 2017.

Right after quarterlyearnings seasons, I dig into the newest reports from the world’s top gold minersincluded in that leading GDX gold-stock ETF. In their latest-reportedquarter of Q3’17, the top 34 GDX component gold miners averaged all-insustaining costs of $868 per ounce.  AISCs are this industry’s main profitabilitymeasure, accounting for not only mining but maintaining production byreplenishing reserves.

One of the primary attributesthat makes gold stocks so attractive to investors is the fact these costs don’t change much regardless ofprevailing gold prices.  Over the past 7quarters ending in Q3’17, GDX’s top-34 gold miners reported average AISC of$833, $886, $855, $875, $878, $867, and $868. That makes for a tight variance, despite gold trading as low as $1074and as high as $1365 during this same span.

These quarterlymajor-gold-miner average AISCs within this gold bull have their own mean of$866, so let’s assume this industry can operate at $865 all-in sustainingcosts.  In 2017 gold averaged $1258 perounce, so the major gold miners were collectively earning profits of $393 per ounce.  That equates to hefty 31% profit margins,levels most industries would die for.  Yetgold-mining stocks certainly didn’t reflect this!

The HUI averaged just196.0 in 2017, incredibly-low levels. This leading gold-stock index first hit 196 in September 2003 when goldwas only trading near $375.  Back thenthe major gold miners were far less profitable in both absolute and percentageterms.  In 2004 the HUI averaged 212.2,considerably better than 2017 levels despite gold’s super-low average price of$409 that year.  Today’s gold-stockprices are absurd!

In 2010 the gold priceaveraged $1228, a bit below 2017’s $1258. Yet the HUI averaged 471.5, or a whopping 141% higher than last year’sridiculous levels.  The gold miners’stocks are now priced as if this industry was operating at massive cashflowlosses with its very future viability called into question.  Yet obviously that isn’t the case, as thegold miners are generating big positive cashflows and profits today.

The only explanationfor this epic fundamental anomaly is extremesentiment, which never lasts for long. Because the stock markets soared in taxphoria last year, investorsshunned gold and everything related to it. Thus the gold stocks fell deeply out of favor, universally ignored ifnot scorned.  When that weird psychologyinevitably shifts, the beaten-down gold stocks are going to stage a massivecatch-up upleg.

There’s plenty ofprecedent for that.  Back in early 2016when the general stock markets suffered their last correction, gold investment demand exploded for prudently diversifying stock-heavy portfolios.  The SPX only fell 13.3% over 3.3 months, buteven that minor correction was enough to rekindle big gold buying.  That catapulted gold 29.9% higher in 6.7months, birthing its first new bullmarket since 2011!

Like today, gold stockswere neglected and anomalously-cheap before that last stock-selloff-driven goldupleg.  Then in roughly that samefirst-half-of-2016 span, the HUI skyrocketed 182.2% higher in just 6.5months!  That made for amazing 6.1xupside leverage to gold.  When goldstocks have underperformed their metal, their catch-up rallies are huge and greatlyamplify gold’s gains.  2018’s actionshould echo 2016’s.

Gold stocks certainlyhave the potential today to see similar fast gains this year to their near-triplein a half-year on gold powering less than a third higher a couple years ago!  The lead-in to 2018 was very similar to thatlead-in to 2016, with gold stocks deeply out of favor and thus languishing at fundamentally-absurd pricelevels relative to their profits.  Butthe vast majority of traders haven’t figured this out yet.

Investment is all aboutbuying low then selling high, andthat requires buying when assets are unpopular and thus underpriced.  Unfortunately most investors ultimatelyperform poorly because they reverse this. They instead wait to buy until assets are adored, which forces them tobuy really high.  Then once those assetsinevitably mean revert to much-lower levels, investors succumb to popular fearand sell low for big losses.

In late 2015 just likein late 2017, the contrarian gold-stock sector was despised.  Few investors were even aware of it, and mostof those didn’t want to touch it with a ten-foot pole.  Yet in 2016, the gold stocks were the best-performing stock-marketsector.  The HUI rocketed 64.0% higherthat year on a mere 8.5% gold rally, trouncing the SPX’s 9.5% gain!  Fighting the crowd to buy low reallymultiplies wealth.

There’s a high probabilitythe gold miners’ stocks will once again prove the best-performing stock-marketsector in 2018.  There’s virtuallynothing else deeply out of favor and radically undervalued in these entiretaxphoria-inflated stock markets!  Everythingelse has already been bid dramatically higher, and thus is susceptible tosuffering sharp selloffs as the stock markets roll over.  Gold stocks are the only bargains left.

Since prevailing goldprices directly drive gold-mining profitability and hence ultimately stock prices,the HUI/Gold Ratio is a great valuation proxy for this sector.  It simply divides the daily HUI close by thedaily gold close.  When charted overtime, this core fundamental relationship reveals when gold stocks areovervalued or undervalued relative togold.  And there’s no doubt thelatter is true in spades heading into 2018.

Despite the goldminers’ nice post-FOMC-meeting rally in recent weeks, they left 2017 trading atan HGR of just 0.148x.  In other words,the HUI was trading at just under 15% of the gold price.  This ratio means nothing in isolation, butyears of history shows when gold stocks are high or low compared to gold.  And they almost couldn’t be lower today, ormore undervalued.  Essentially only 2015saw worse gold-stock prices.

That happened to be theclimaxing stretch of a major gold bearthat ran 6.1 years leading into the Fed’s first rate hike of this cycle in December2015.  The HGR slumped to all-time lowsnear 0.09x late that year, extreme and unsustainable.  And indeed the gold stocks rallied sharplyout of that anomaly, again nearly tripling in a half-year.  Gold-stock prices remain super-low, overdueto mean revert dramatically higher.

This long-term HGRchart encompasses a 15-year secular span that included every conceivable marketcondition for gold and its miners’ stocks. The HGR averaged 0.341xthrough all of it, or fully 2.3x higher than today’s extreme lows.  That means the gold stocks as measured by theHUI ought to be trading at least 127% higher than today’s levels!  And that’s assuming gold just stalls outinstead of rallying further.

Instead 2018 is almostcertain to see gold surge dramatically higher in its next major bull-market upleg. That leaves the gold stocks with early-2016-like potential to skyrocketagain, greatly outperforming gold until their stock prices catch up or morelikely overshoot to the upside.  Thedriver will once again be these euphoric stock markets rolling over into theirnext correction or more likely the long-overdue bear market.

Despite the extremestock euphoria as 2018 dawns, today’s stock markets are hyper-risky.  They have powered higher for years now onextreme central-bank easing before the recent taxphoria.  But that has forced them toexceedingly-dangerous bubble valuations.  The SPX left 2017 with its elite componentstocks sporting an average trailing-twelve-month price-to-earnings ratio of30.7x, above the 28x bubble threshold!

The SPX has now gone1.9 years without a 10%+ correction, and such selloffs tend to happen at leastonce a year in healthy bull markets.  Nowthat the highly-anticipated Republican corporate tax cuts have indeed come topass, 2017’s taxphoria will naturally fade. The more-optimistic Wall Street estimates are for those tax cuts toboost corporate earnings by 10% in 2018, which still won’t justify today’s lofty stock prices.

If this year sees SPXearnings indeed grow 10%, that still leaves its components’ average P/E ratioway up at a near-bubble 27.6x!  Stockvaluations are so extreme after an extraordinary 8.8-year 301.0% SPX bullmarket that the biggest US corporate tax cuts ever will barely put a dent inbubble valuations.  That leaves stockmarkets at risk for their first correction-grade selloff since early 2016,which is great news for gold.

But the real coup de grâceto these euphoric record stock markets will be this year’s enormous central-bank tightening radically unprecedented inhistory.  The Fed’s newquantitative-tightening campaign is ramping up in 2018, starting to unwindyears of epic quantitative easing.  Andthe European Central Bank is sharply tapering its own QE bond buying byslashing it in half.  Together this will stranglethis stock bull.

There is nothing moreimportant to the global markets this year than this unparalleled tightening byboth the Fed and ECB.  I wrote a wholeessay analyzing it in depth back in late October, which everyinvestor needs to understand! Compared to 2017, 2018 and 2019 will respectively see $950b and $1450bmore tightening and less easing from the Fed and ECB!  Nothing remotely like this has ever beforebeen witnessed.

When thesecentral-bank-easing-inflated record stock markets face the biggest central-banktightening in world history, while trading at bubble valuations no less, theonly possible outcome is a seriousselloff.  At best it will be a majorcorrection approaching 20% in the SPX, but far more likely a new bearmarket.  Those tend to run near 50%losses over a couple years, annihilating wealth of investors who get trapped inthem.

Just like in early2016, the long-overdue next major stock-market selloff will quickly rekindlemajor gold investment demand.  Investorswill remember gold when their stock-heavy portfolios start tanking, and rush todiversify into it.  The reason goldrallied 29.9% in roughly the first half of 2016 is investors flooded back intogold following the last SPX correction.  That was led by American investors heavilybuying GLD shares.

This dominant globalgold ETF saw its holdings skyrocket 55.7% or 351.1t over that same short span!  That was just after a 13.3% SPXcorrection.  Imagine the gold investmentdemand if we approach 20% or go beyond into the inevitable next bear.  The differential GLD-share buying forcingstock-market capital into physical gold bullion could very well beunprecedented.  That’s exceedinglybullish for gold stocks!

When thisgold-demand-killing stock euphoria inescapably breaks, gold could easily poweranother 30% higher in 2018.  But let’s beconservative and look for a 20% upleg, which would leave gold near $1563.  That’s still well below gold’s all-time highof $1894 in August 2011, not extreme by any measure.  Gold was above $1550 almost continuously for1.8 years between July 2011 to April 2013, we’ve seen it before.

At $1565 gold and thosetop-34 GDX gold miners’ average all-in sustaining costs of $865 during this goldbull, their profits would soar to $700 per ounce!  That’s 78% above 2017 levels.  There’s nowhere else in all the stock marketswhere such huge earnings growth is even possible, let alone probable.  Such a big surge in profits coupled withexcessively-low gold-stock prices would lead to huge fundamentally-driven gains.

At $1565 gold and that15-year-average 0.341x HGR, that implies the HUI fair value is around 534.  That is 170% above this week’s gold-stocklevels.  Thus much like early 2016, thegold stocks truly have the potential tonearly triple again in 2018 on higher gold prices!  Even better, after being excessively low thegold stocks tend to not just mean revert but overshoot to overvaluations.  So their upside potential is huge.

The gold stocks arereally a coiled spring today, ready to explode higher in 2018 and trounce everything else.  They are deeply out of favor, incrediblyundervalued, and one of the only sectors that can rally sharply when generalstock markets sell off.  If you want tomultiply your wealth this year by fighting the crowd to buy low then sell high,this small and forgotten contrarian sector is the place to be.  Nothing else rivals it.

While investors and speculators alike cancertainly play gold stocks’ coming powerful upleg with the major ETFs like GDX,the best gains by far will be won in individual gold stocks with superiorfundamentals.  Their upside will farexceed the ETFs, which are burdened by over-diversification and underperforminggold stocks.  A carefully-handpickedportfolio of elite gold and silver miners will generate much-greater wealthcreation.

At Zeal we’ve literally spent tens of thousands of hours researchingindividual gold stocks and markets, so we can better decide what to trade andwhen.  As of the end of Q3, this hasresulted in 967 stock trades recommended in real-time to our newslettersubscribers since 2001.  Fighting thecrowd to buy low and sell high is very profitable, as all these trades averagedstellar annualized realized gains of +19.9%!

The key to this success is staying informed and beingcontrarian.  That means buying low beforeothers figure it out, before undervalued gold stocks soar much higher.  An easy way to keep abreast is through ouracclaimed weekly and monthly newsletters.  They draw on my vast experience, knowledge,wisdom, and ongoing research to explain what’s going on in the markets, why,and how to trade them with specific stocks. For only $12 per issue, you can learn to think, trade, and thrive likecontrarians.  Subscribe today, and getdeployed in the great gold and silver stocks in our full trading books!

The bottom line isgold-stock upside potential is huge in 2018. The gold miners really lagged gold last year due to the extreme stockeuphoria gutting gold sentiment.  Thatleft gold stocks deeply out of favor and exceedingly cheap relative to themetal which drives their profits.  Thisextreme anomaly won’t last for long, as investors will flood back into thesefundamental bargains as gold starts powering higher again.

Gold investment demand isset to surge again when these euphoric stock markets inevitably roll over intotheir next major selloff.  The likelytrigger will be massive central-bank tightening at wildly-unprecedented levels.  The last time stock markets corrected, goldshot up almost a third while gold stocks nearly tripled in merely ahalf-year!  2018 is perfectly set up fora similar scenario, portending massive gold-stock gains.

Adam Hamilton, CPA

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