Gold Stocks’ Massive Correction

Gold stocks have suffered a terrible month, plunging in a serious selloff.  The resulting carnage has left investors and speculators shaken, wondering if this red-hot sector’s blistering new bull this year has already run out of steam.  These fears are misplaced, as massive corrections are common in major gold-stock bulls.  They create bulls’ best buying opportunities in sentimental, technical, and fundamental terms.

It’s easy to understand why gold-stock sentiment is so bearish today, as this sector has been trashed since early August.  In less than a month the gold miners went from 2016’s overwhelmingly-dominant top-performing sector to bear-market-grade losses!  Falling from heroes to zeroes in such a short span of time is enough to test the resolve of even the most-hardened contrarians.  It’s a tough turn of events to weather.

The leading gold-stock benchmark is the NYSE Arca Gold BUGS Index, better known by its symbol HUI.  Its performance is nearly identical to that of the flagship GDX VanEck Vectors Gold Miners ETF, which is the most-popular gold-stock investment vehicle by far.  Comprised of many of the same elite gold miners, both benchmarks suffered enormous losses over the past month.  This year’s HUI chart tells the sordid tale.

Just a month ago in early August, the HUI had been enjoying an epic year as gold stocks grew more popular with investors and speculators.  This leading gold-stock index closed at a 3.2-year high of 284.1 on August 4th, and the gold miners were increasingly lauded even in the mainstream financial media including CNBC.  Back in early July I’d warned about a coming correction, but this sector had defied the odds.

Gold stocks indeed suffered a sizable pullback in mid-July, retreating 8.6% at worst.  Remember that in conventional stock-market terms, a selloff under 10% in a bull trend is considered a pullback.  But these selloffs can balloon into full-blown corrections, total retreats of 10% to 20% on a closing basis.  Once the 20% threshold is crossed, the selloff is considered a new bear market.  Gold stocks merely pulled back.

In late July that pullback was quickly aborted as gold itself surged higher in the wake of the newest Fed policy meeting.  In the FOMC’s statement released the afternoon of July 27th, no hints were made about a rate hike imminent at the Fed’s next meeting coming September 21st.  Traders considered this quite dovish, so gold surged 1.6% right after that FOMC statement which blasted the HUI 4.7% higher in sympathy.

Remember that the Fed’s first rate hike in 9.5 years came last December.  And in the FOMC statement from the meeting immediately preceding that one, late October’s, the Fed had directly warned of a likely rate hike at its next meeting.  So the fact the Fed didn’t even allude to a coming hike almost certainly meant one wasn’t likely at all in late September.  Gold-futures speculators, who irrationally fear rate hikes rejoiced.

That late-summer rally was able to push the HUI marginally higher into early August.  But the inevitable selling was still due, and it began rather innocuously.  While the gold stocks drifted back down to their early-July levels in the middle couple weeks of August, there was only one significant down day.  But that started changing in late August, ignited by the 19th’s sizable 0.9% gold selloff despite no relevant news.

The HUI lost 2.2% that Friday, extended by another 2.2% the following Monday, and then 2.0% more on the subsequent Tuesday.  This series of sizable down days really weighed on the psychology of gold-stock traders, especially the recent buyers.  They had chased gold stocks’ record summer rally, which I warned at the time wasn’t prudent.  Healthy corrections in bull markets are necessary and unavoidable.

The next day on Wednesday the 24th, the excrement really hit the whirling metal blades.  Gold itself got slammed early on by a massive futures sell order of 10k+ contracts in a single minute!  That was a short attack, a blatantly-manipulative trade designed and executed to try and force cascading selling by running the stop losses of the legions of long speculators.  While gold weathered it relatively well, the gold stocks didn’t.

Nerves already frayed from 3 consecutive trading days of substantial selling, the weak-handed newer gold-stock investors and speculators panicked.  While gold only fell 1.0% that day, pretty modest in light of that big and fast short attack, the HUI plummeted 7.8%!  Weak-handed traders were fleeing in terror, dumping everything in their scramble for the exits.  This was extreme capitulation-grade gold-stock selling.

In less than 3 weeks the gold stocks as measured by the benchmark HUI had plunged 16.5% to a mere 2.6% gold drop.  Since the gold price drives gold-mining profits, miners’ stocks naturally leverage its moves.  Usually that’s on the order of 2x to 3x, the HUI doubling or tripling gold rallies or selloffs.  But during that mid-August span, the downside leverage of gold stocks to gold had soared to an anomalously-high 6.3x!

So the odds really favored that gold-stock correction being over on that serious capitulation down day, which was the HUI’s worst by far since late in its last correction in May.  But unfortunately the sellers weren’t done yet, with more weak hands nervously biding their time.  While there was a few-trading-day respite, gold’s next material daily selloff arrived on August 30th.  Gold fell 0.9% that day to $1311, a new 9-week low.

That was more than some of the already-frazzled gold-stock traders could bear, so they again scrambled to get out of Dodge just 4 trading days after that capitulation.  This pummeled the HUI lower by another 5.6%!  And that selling persisted into the next trading day, August’s last, as the HUI lost 2.2% more.  The resulting carnage was breathtaking.  In just 19 trading days, less than a month, the HUI had plunged 22.0%!

Remember in the general stock markets, a 20%+ fall from a bull’s recent high is not a correction but a new bear market.  So the gold stocks had formally collapsed right back into bear-market territory!  That naturally led to a deluge of hyper-bearish commentary on this wounded sector.  As usual after a sharp fall, most analysts jumped on the momentum bandwagon and called for more gold-stock selling to come.

Not me though.  As a battle-hardened contrarian who has spent decades actively trading this sector, I’ve learned a hundred times over that sharp selloffs in strong bull markets are great buying opportunities.  The bigger the selloff, the better the buys!  So I explained much of the stuff in the rest of this essay to our newsletter subscribers, and aggressively added new gold-stock and silver-stock trades on those lows.

In our weekly newsletter published on August 30th, which was gold stocks’ second big capitulation day, I recommended 4 new gold-stock and silver-stock trades.  That was on top of 6 others added earlier in August as gold stocks’ selloff accelerated.  The very next day in our monthly newsletter, I recommended 5 new stock trades for our subscribers.  We also added new gold-stock-ETF call options to leverage the next upleg.

Buying low is never easy.  When selloffs snowball to major levels, there’s always a chance they will cascade even lower.  So it’s very challenging psychologically to fight the thundering herd and buy when everyone else is selling.  It feels terrible buying into capitulation selloffs, almost nauseating.  The only way to build the fortitude necessary to do it is to stay exceptionally informed, which helps frame selloffs in context.

Yes, the gold stocks have just plunged into a bear-market-grade drop.  But that was immediately after the HUI had skyrocketed 182.2% higher in just 6.5 months!  From those fundamentally-absurd 13.5-year secular lows of mid-January that I warned at the time were an epic buying opportunity, the gold-stock sector had nearly tripled by early August.  The bigger a bull upleg, the bigger the subsequent correction necessary.

Bull-market corrections exist for one reason, to rebalance sentiment.  After strong uplegs, greed grows excessive with everyone far too euphoric about a sector.  They rush to buy high, betting the strong upside momentum will persist.  But soon the soaring popular greed sucks in all the available near-term buyers.  That leaves nothing but sellers, so that overheated sector soon corrects hard.  Like gold stocks in August.

Big and fast corrections frighten away the weak-handed investors and speculators who bought in late and high in the preceding upleg.  Corrections rapidly ramp fear, which eradicates greed and leads to more and more selling.  By the time the correction has run its course, all traders susceptible to being scared into selling relatively low have already exited.  That leaves only buyers, so the next bull-market upleg is born.

There’s no doubt gold-stock sentiment was getting too frothy in early August, as evidenced by even CNBC commentators gushing over gold stocks’ near-term upside.  But that enthusiasm was soon turned into universal worry as gold stocks corrected hard.  By late August, no one in the mainstream world and even few contrarians wanted anything to do with gold stocks.  They were damaged goods psychologically.

Yet technically, the massive correction last month didn’t wreak havoc at all.  While the HUI broke below its uptrend’s support line, that’s not uncommon in sharp corrections.  Merely battered back down to late-April levels again, the gold stocks’ mighty young bull market was overwhelmingly intact.  About a third of its progress had been temporarily erased at the recent correction low, leaving a commanding 2/3rds still standing.

While August’s correction was very large, it wasn’t even this bull’s first correction.  Traders have already forgotten that back in May the HUI plunged 14.8% in less than a month.  But far from being a warning of a failing bull market, those fearful correction lows heralded another imminent upleg that would push this sector 42.9% higher despite its weak summer season (  https://www.gold-eagle.com/article/gold-summer-doldrums-risk). Corrections are bull markets’ best buying opportunities!

And despite gold stocks nearly tripling in just over a half-year leading into this latest massive correction, they were still quite low in the grand scheme.  This next chart zooms out to the past 9 years or so to put this year’s bull in proper context.  There’s virtually no threat of a young new bull giving up its ghost until it has run for years and major new record highs are reached.  That certainly wasn’t the case in early August.

This year’s near-tripling in gold stocks merely left them at mid-2013 levels at best.  That’s just a 3.2-year high, nothing to write home about.  Gold stocks’ gains have seemed so extreme, growing so large so fast this year, simply because the levels that birthed their new bull were so extreme.  All we’ve witnessed so far is a still-relatively-minor mean reversion out of January’s fundamentally-absurd 13.5-year secular low.

And even ignoring that, gold stocks’ current bull is way too young and way too small to be at risk of rolling over into a new bear market.  The last gold-stock bull emerging out of also-fundamentally-absurd but far-less-extreme secular lows from 2008’s wild stock panic powered 319.0% higher over 2.9 years in HUI terms.  Gold stocks more than quadrupled out of those last extreme lows, boosting the HUI to record highs!

Our current anemic little bull has only run 182.2% higher at best in 6.5 months, which truly remains in the infant stage by past gold-stock-bull standards.  If gold stocks had nearly tripled in a half-year leading into new record highs after a multi-year bull, the risks of a major new bear emerging would indeed be high and ominous.  But that same performance out of extreme lows leaving gold stocks still low is nothing to fear.

Nevertheless, August’s serious 20%+ bear-market-grade massive correction has given many gold-stock investors and speculators serious pause.  Can a gold-stock bull market even hope to keep on powering higher after suffering such a sentiment-damaging selloff?  Provocatively 20%+ corrections are actually par for the course in the super-volatile gold miners’ realm!  This next chart zooms into their last bull market.

While 20%+ selloffs from bull markets in major broad-market stock indexes like the S&P 500 are definitely bear markets, gold stocks are a very different beast.  On their way to more than quadruple out of late 2008’s extreme stock-panic lows, the gold stocks suffered no fewer than two 20%+ corrections!  A 21.4% one over 1.2 months in mid-2009 was followed by a huge 27.6% specimen over 2.1 months leading into 2010.

So early in gold stocks’ last mighty bull market, 20%+ corrections were seen as well!  Realize the gold miners are a small sector compared to the general stock markets.  So when capital floods back in as investors return after major secular lows, gold stocks launch violently higher.  These enormous early-bull uplegs necessitate proportionally-large subsequent corrections to bleed off the excessive greed spawned.

Thus in the gold-stock realm, that conventional 20%-selloff bear-market threshold isn’t valid.  So I call 20%+ bull selloffs in the HUI or GDX “massive corrections”.  They are very unlikely to be new bears until a bull market has run for years and propelled gold stocks to new record highs.  And provocatively, these massive corrections within ongoing gold-stock bulls are far more common than most traders would imagine.

That last cyclical gold-stock bull that more than quadrupled gold-stock prices between October 2008 and September 2011 was actually the final component of a much-larger secular gold-stock bull.  During the 10.8 years between November 2000 and September 2011, the HUI skyrocketed an epic 1664.4% higher!  That radically dwarfed the S&P 500’s 14.2% loss over this span, greatly multiplying the wealth of smart contrarians.

Back in January 2012 soon after that secular bull ended, I did an analysis of the gold-stock upleg cycles throughout its entire span.  Excluding that extreme anomaly in 2008 driven by the first stock panic in a century, the average major gold-stock correction in HUI terms during this mighty secular bull ran way up at 26.1%!  4 of those 12 major corrections actually exceeded 30%, running as high as a staggering 35.7%.

So if you’re not psychologically prepared to weather 30%+ massive corrections in gold stocks, there’s little chance you’ll be able to ride gold stocks’ next secular bull higher.  And after a brutal 4.4-year secular bear market exacerbated by the Fed’s extreme market distortions of recent years, I suspect a new secular bull is exactly what’s beginning.  It’s hard to imagine 13.5-year secular lows spawning a mere cyclical bull.

All these sentimental and technical arguments for why gold stocks’ young bull market remains alive and well and ready to surge higher again are joined by strong fundamental ones.  While gold stocks were correcting hard in August, I spent long weeks wading through the latest quarterly results from the elite miners of that GDX ETF and the elite juniors of its GDXJ VanEck Vectors Junior Gold Miners ETF cohort.

Gold-stock bull markets don’t fail until the miners’ fundamentals really start to deteriorate, and just the opposite is true now.  In 2016’s second quarter, the elite gold miners of GDX reported excellent average all-in sustaining costs of just $886 per ounce.  That makes today’s prevailing $1300s gold levels already very profitable.  This fueled a huge 32.3% quarter-on-quarter surge in these miners’ operating cash flows in Q2’16.

And the elite junior gold miners of GDXJ fared even better per this leading metric of current operating profitability.  Their operating cash flows soared an incredible 51.1% higher quarter-on-quarter in Q2’16 on a mere 6.5% gain in the average gold price!  They are already really profitable as well, thanks to low average all-in sustaining costs of $887 per ounce.  The gold-mining sector is already thriving fundamentally!

And these operating profits will only soar as gold keeps mean reverting higher in its own young bull market.  Gold stocks’ next major upleg is going to be fueled by investment capital surging back into gold, driving it higher.  As today’s artificial and totally-fake Fed-levitated stock markets inevitably roll over, gold investment demand for prudent portfolio diversification will soar.  That will amplify gold’s autumn strong season.

As gold’s own new bull accelerates again in its next major upleg, the profitability of mining this metal will again really leverage gold’s own gains.  And much-higher gold-mining profits will naturally translate into much-higher gold-stock prices.  Far from being a threat, the massive correction the gold stocks suffered in August is a major buying opportunity.  Corrections offer the best entry points seen within ongoing bulls!

While you can certainly ride the next gold-stock upleg in GDX and GDXJ, the gains in these ETFs will be trounced by those of the best individual miners with superior fundamentals.  While many of these elite gold miners are included in the dominant ETFs, those also hold many inferior companies’ stocks that will retard overall ETF gains.  As always, the greatest bull-market gains will come from the best individual stocks.

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The bottom line is gold stocks’ sharp August selloff is an incredible mid-bull buying opportunity.  The gold stocks are a volatile sector, with enormous uplegs leading to oversized selloffs.  This often results in massive corrections so big they’d be considered bear markets in other sectors.  But such major selloffs are healthy and necessary for gold-stock bulls, rebalancing sentiment to pave the way for subsequent uplegs.

These big corrections batter gold stocks technically and shred sentiment, flaming widespread fears for further selling.  Yet they actually improve fundamentals, forcing stock prices lower relative to underlying gold-miner operating profitability.  So if you can fight the thundering herd to buy low when few others will, you’ll enjoy the best buying opportunities ever seen within ongoing bull markets.  Corrections are a boon!

Adam Hamilton, CPA

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