Gold-Miner Valuations Low

After soaring in a powerful upleg, the gold miners’ stocks have been grinding lower for a couple months now.  This ongoing correction is increasingly draining enthusiasm for this small contrarian sector, working to rebalance sentiment.  Gold-stock price levels relative to gold suggest this necessary and healthy selloff hasn’t fully run its course yet.  But once this passes, current valuations remain very bullish for the gold miners.

Unlike the vast majority of other industries, gold miners’ earnings are almost totally dependent on a single variable.  That’s the price of gold.  The profitability of excavating and selling gold directly levers prevailing gold prices.  The costs of producing this metal are largely fixed, mostly determined during mine-planning stages when engineers decide which gold-bearing ores to mine, how to dig to them, and how to process them.

Because gold prices are dynamic while mining costs are effectively static, prevailing gold levels are the overwhelming driver of corporate profits.  And these earnings compared with stock prices are the only ingredients in valuation analysis.  The classic valuation metric is trailing-twelve-month price-to-earnings ratios, which are current stock prices divided by actual profits earned over the last four reported quarters.

Plenty of major gold miners’ stocks are very cheap per this classic measure!  The popular GDX VanEck Vectors Gold Miners ETF is this sector’s leading benchmark and trading vehicle.  Its components include all of the world’s biggest and best gold miners.  Right after every quarterly earnings season, I do a deep fundamental dive into the elite GDX gold miners’ results.  The latest covering Q2’20 was done in mid-August.

Using conventional TTM P/Es, plenty of massive gold miners were quite cheap.  Newmont and Barrick Gold are GDX’s biggest and dominant components, which then commanded 13.0% and 12.1% of this ETF’s total weighting!  As that last-reported earnings season wrapped up, they were trading at only 14.3x and 16.1x earnings.  This week their valuations are even lower at 12.8x and 10.9x, making for big bargains.

Another major gold miner Kinross Gold sported a similar 13.2x P/E then, which has contracted to 12.0x now due to the subsequent gold-stock correction.  There’s lots of undervaluation in the major gold stocks per normal price-to-earnings multiples.  But given the gold-mining industry’s unique nature of profits being almost totally dependent on prevailing gold prices, other proxies better reflect gold-miner valuation levels.

One I’ve long used in my detailed quarterly analyses of gold-stock fundamentals compares average gold prices with miners’ average costs.  In Q2’20 for example, the top 25 GDX gold miners reported average all-in sustaining costs of $984 per ounce.  That’s what it cost them to both produce gold and replace that depletion.  Deposits are expanded into new areas of gold-bearing ores to ensure gold output is sustainable.

Gold itself averaged a lofty $1714 per ounce in Q2, implying that sector profitability was running way up at $730 per ounce!  That soared a stupendous 66.2% year-over-year from Q2’19’s $439, which resulted from much-lower $1309 average gold prices and $870 average AISCs.  Gold-miner earnings leveraged gold’s 30.9% YoY gains by 2.1x, right in their normal historical range of 2x to 3x.  Gold prices drive profitability.

And all gold-stock speculators and investors should be super-excited for the major gold miners’ upcoming Q3’20 results.  These all-important fundamental reports are generally released between 3 to 6 weeks after quarter-ends.  So I can’t wait to dig into this latest quarter in mid-November, as it is looking utterly spectacular.  Gold averaged a dazzling record $1912 in this just-finished Q3, soaring 11.6% quarter-on-quarter!

Average all-in sustaining costs are likely to decline, as Q2’s were artificially-high due to all the disruptions from national lockdowns to slow the spread of COVID-19.  Gold-mining operations were largely spun back up in late Q2 and early Q3.  And the better mines’ production, the more ounces to spread their big fixed costs across.  Thus increased gold output lowers AISCs, so Q3’s should retreat considerably from Q2’s high.

In Q3’19, the major GDX gold miners averaged $883 AISCs.  Over the past four reported quarters ending in Q2’20, they averaged $933.  So that’s as good of estimate as any for the upcoming Q3’20 results.  That implies the gold miners earned an epic $979 per ounce last quarter!  If proven true, gold-stock earnings yet again rocketed up 65.7% YoY.  No other sector in the stock markets can rival such incredible profits growth.

Rising earnings naturally lower valuations.  So once these Q3’20 numbers drop into the rolling totals from the latest four reported quarters, gold-stock P/E ratios will sink even farther.  Unless prevailing gold-stock prices stage a dramatic rebound before mid-November, some major gold miners will see their TTM P/Es plunge into the single digits!  That is deeply undervalued by any standard, and incredibly cheap for gold stocks.

Wading through dozens of gold miners’ quarterly results, and building big spreadsheets to analyze them over time, is challenging and tedious.  And they can only be updated four times a year, which is a pretty-low-resolution read on gold-miner valuations.  But there’s a great gold-stock-valuation proxy available in real-time.  And it really helps traders better game gold-stock uplegs and corrections to time buying and selling.

It simply looks at the ratio between prevailing gold-stock and gold price levels.  While there are various permutations, the most-relevant one today is the GDX/GLD Ratio.  This GGR divides the daily close of that leading GDX gold-stock ETF by the daily close of the dominant GLD SPDR Gold Shares gold ETF.  When charted and analyzed over time, this ratio reveals whether gold stocks are relatively cheap or expensive.

This GGR chart encompasses gold stocks’ entire secular bull since mid-January 2016.  Between then and this sector’s latest interim peak in early August, GDX has soared 256.7% higher over 4.5 years.  That amplified gold’s 87.7% gain in that same span by 2.9x, yet again confirming the major gold stocks’ great leverage to gold of 2x to 3x.  Despite low gold-stock valuations, the GGR suggests their correction isn’t over yet.

While gold-miner valuations are undoubtedly very low, this GDX/GLD Ratio proxy for them indicates they are likely to head lower still.  The GGR illuminates the swings in gold-stock valuations driven by their bull markets’ normal upleg-correction cycles.  Gold-stock valuations relative to gold naturally rise in uplegs, then retreat in the inevitable subsequent corrections to rebalance sentiment.  So tracking the GGR is essential.

GDX’s last major upleg that climaxed in early August was a monster, rocketing 134.1% higher in just 4.8 months after mid-March’s COVID-19-lockdown-fueled stock panic.  That upleg was born in extreme gold-stock undervaluations relative to gold driven by that epic maelstrom of fear.  When GDX bottomed in mid-March at just $19.00, the GGR had collapsed to just 0.133x!  That was a brutal 4.1-year low in this metric.

In other words, GDX’s share price was trading at only 13.3% of GLD’s share price.  Gold-stock prices hadn’t been lower compared to gold prices since early February 2016 right after this gold-stock bull was born!  And massive mean reversions higher erupt out of extreme anomalous lows in the tight relationship between gold-stock and gold price levels.  I wrote about this extensively during and just after that stock panic.

In my March 20th essay on mid-tier gold miners’ fundamentals when GDX was still way down at $20.55, I concluded at that time, “after this insane COVID-19 stock panic crashed this sector, these stocks are trading at some of their steepest discounts to current fundamentals ever!  That gives them epic potential to mean revert radically higher as fear fades and gold recovers, yielding huge gains to early contrarians.”

We backed up the truck to aggressively deploy capital around those super-cheap and unsustainable lows, buying and recommending dozens of fundamentally-superior gold-stock and silver-stock trades to our newsletter subscribers who keep us in business.  Those blossomed into massive realized gains as this latest gold-stock upleg matured, averaging over +80% absolute and +300% annualized when stopped out!

This is relevant today because gold-stock valuations per this GGR proxy were one of the screaming buy signals triggered by that stock panic.  At a scary time when most gold-stock traders were selling low to flee this burning sector, gold stocks were so radically undervalued relative to gold that huge fast mean-reversion gains were very likely.  This same fantastic timing tool is now warning gold stocks’ correction isn’t over.

Ahead of GDX cresting at $44.48 in early August, the GGR surged to a 4.0-year high of 0.241x.  This gold-stock ETF was trading at 24.1% the price of the leading gold ETF.  That level was very interesting because it was right where this gold-stock bull’s mighty maiden upleg failed in early August 2016.  With huge gains of 151.2% even besting this latest upleg’s 134.1%, a correction was necessary to rebalance sentiment.

Bull-market uplegs in both gold stocks and gold require big capital inflows.  As long as growing ranks of traders are actively deploying increasing amounts of money bidding the precious metals higher, uplegs can persist.  But eventually their fast gains get so large that everyone interested in buying in anytime soon is already in.  That peak greed marks upleg toppings, when near-term buying is exhausted leaving sellers in charge.

In August 2016 that point when major uplegs inevitably have to fail into rebalancing corrections hit as the GGR stretched to 0.244x.  August 2020’s 0.241x peak GGR was right in line with that.  With the gold stocks relatively high compared to gold after soaring in a massive upleg, they really needed to sell off to eradicate all the excessive greed at that major upleg topping.  And that has indeed been happening since.

A month ago I wrote an essay on gold stocks being in correction mode, focusing on their lingering really-overbought technicals.  I won’t rehash that still-valid analysis here, but looking at this sector instead from a valuation angle arrives at that same conclusion.  At worst since early August, GDX has retreated 15.4% as of late September.  That dragged the GGR as low as 0.215x, right about where it still traded this week at 0.216x.

The problem is these GGR levels aren’t low enough, and haven’t fallen far enough, to flag the likely end of this healthy correction.  Today’s correction is the fourth of gold stocks’ secular bull.  During their first three corrections following uplegs, the GGR retreated an average of 0.065x to bottom at an average of 0.155x.  So far in our current correction, this GGR valuation proxy has only slid 0.026x to that 0.215x level.

So based on bull-to-date precedent, only about 40% of the expected gold-stock correction has happened compared to prevailing gold prices.  And the GGR itself is still 39% above the tight average levels that marked correction bottoms birthing new uplegs earlier in this bull.  Even if the GGR doesn’t retreat all the way back to 0.155x, it still needs to head much lower before the last upleg’s residual greed is vanquished.

Over time this GDX/GLD Ratio forms tradable trends, with gold-stock valuations relative to gold moving in sustained patterns.  Since the deep gold-stock lows of September 2018, the GGR has been meandering higher on balance with the big exception of this year’s extreme stock-panic anomaly.  The support line for that gold-stock-valuation uptrend is running just over 0.190x now.  Another interesting level converges there.

Since gold stocks are so incredibly volatile, their bull and bear markets are often considered based on gold’s own.  During the 4.8 years today’s secular gold bull has run, the GGR has averaged 0.190x.  After this gold-stock bull’s second-largest upleg that enjoyed big and fast 134.1% gains, it’s hard to imagine the GGR not at least reverting back to that mean.  The GGR revisiting 0.190x will be a more-favorable time to buy.

Because we humans aren’t very good at parsing small decimals, gold-stock valuations falling from 0.216x to 0.190x in GGR terms doesn’t sound like much.  But it could mean considerably more downside before this correction gives up its ghost.  The major gold stocks’ 2x-to-3x leverage to gold is a double-edged sword, working in both directions.  So weaker gold prices forcing GLD lower will exacerbate this GDX selloff.

A few weeks ago I wrote an essay on gold’s own correction, which certainly wasn’t over due to festering overboughtness since its own parabolic early-August peak.  That analysis revealed gold would likely have to correct back down to its 200-day moving average.  While this critical technical support zone for bull-market corrections continues to rise, this week it is still way down near $1735.  That’s another 8.1% lower!

Expressed in GLD-share-price terms, a 200dma approach implies $163.18.  Applying that 0.190x GGR multiple to that yields a GDX-share-price downside target of $31.00.  While still relatively high by this gold-stock bull’s standards, that is still another 19.2% lower from this week’s levels!  So even if the major gold stocks bottom at higher valuations compared to gold, they could still have considerable selling to go.

Interestingly this correction scenario would extend GDX’s total selloff to 30.3%.  That is more in line with this bull’s correction precedent averaging 36.5% losses.  At any rate, buying gold stocks today won’t be prudent if they have another 10%-to-20% downside left in this correction.  Patient gold-stock traders who watch valuations should have plenty of opportunities to add positions at lower prices in the near future.

As I discussed in another essay a couple weeks ago, the gold stocks are now in their biggest seasonal selloff of the year.  That could exacerbate and compress their necessary correction over the next few weeks or so.  This gold-stock selloff needs to run until greed and euphoria are eradicated.  And plenty of these topping emotions lingered after gold stocks peaked, because they consolidated high for weeks after that.

But while this immediate GGR outlook is short-term bearish for gold stocks, from a longer perspective these valuation-proxy levels are wildly bullish for the gold miners!  As secular bulls mature making both speculators and investors more comfortable with holding gold stocks, their price levels relative to gold climb on balance.  So we can expect this GDX/GLD Ratio to continue rising way above this bull’s precedent.

The last secular gold-stock bull peaked when GDX hit $66.63 in September 2011.  During the two years leading up to that climax, the GGR averaged 0.419x.  That implies much-higher gold-stock prices are probable in coming years as more bull-market uplegs march higher.  Imagine gold at $2250, a lowballed conservative outlook just 19.2% above this week’s levels.  In GLD terms that works out to roughly $211.

At that 0.419x late-bull-average GGR, $211 GLD would catapult GDX up over $88 per share!  That’s 131% higher than this week’s levels.  So if you can weather a 30%ish correction psychologically, and be brave enough to buy back in low when most others are too scared to, you should be able to ride the major gold stocks’ third doubling-plus upleg of this bull.  From a longer perspective, gold-stock valuations are cheap.

The key to multiplying your wealth in gold stocks is to trade with bull markets’ inevitable upleg-correction cycles instead of fighting them.  Buy relatively low late in corrections, then sell relatively high late in uplegs!  GGR levels help flag both key conditions.  When considered along with other technical measures of oversoldness and overboughtness, this gold-stock valuation proxy is an excellent buy-sell timing tool.

At Zeal we started aggressively buying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscription newsletters back in mid-March right after the stock-panic lows.  We layered into dozens of new positions before gold stocks grew too overbought, which were stopped out recently at huge realized gains running as high as +199%!  Our subscribers multiplied their wealth within months.

To profitably trade high-potential gold stocks, you need to stay informed about their technicals, sentiment, and fundamentals.  And what is moving gold, their dominant primary driver.  Our popular newsletters are a great way.  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.  Subscribe today and take advantage of our 20%-off sale!  Corrections are the time to do your gold-stock homework, preparing to redeploy as they pass.

The bottom line is gold-stock valuations remain low.  These companies are earning profits hand over fist with such high prevailing gold prices, forcing down their conventional valuations.  Huge stock-price gains in future uplegs are fully justified by the epic profits growth this contrarian sector is achieving.  But before this gold-stock bull’s next major upleg, real-time gold-stock valuation proxies suggest this correction isn’t over yet.

Since their last monster upleg peaked in early August, the gold stocks still haven’t retreated far enough to rebalance sentiment.  The leading gold-stock ETF hasn’t given up enough ground relative to prevailing gold prices to signal a high-probability correction-bottoming.  Short-term valuation analysis implies major gold stocks still have another 10%-to-20% downside to go before their next big bull upleg can get underway.

Adam Hamilton, CPA

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