False Gold-Stock Panic

By Adam Hamilton, CPA

2022.09.23

The left-for-dead gold miners’ stocks are literally trading at stock-panic levels today!  But they’ve been slammed to extreme lows in recent months on a false premise.  Traders assume gold’s parallel plunge must be fundamentally-righteous.  But that was driven by enormous gold-futures selling on anomalous market events.  As these unsustainable extremes inevitably reverse hard, the battered gold stocks will soar.

Without any doubt, the most-contrarian sector in the markets today is the despised gold stocks.  They’ve been long-forgotten by mainstream traders, and they’re pretty loathed even by contrarians who ought to like buying low.  It’s hard to imagine anything more deeply-out-of-favor than the gold miners, as there is virtually zero interest in them.  That has left them languishing at exceedingly-oversold stock-panic levels.

The leading gold-stock benchmark and trading vehicle remains the GDX VanEck Gold Miners ETF.  Its dreadful recent technical action sure illuminates why gold stocks have been abandoned.  From mid-April to early September, GDX was thrashed a brutal 43.5% lower in just 4.5 months!  This sector won’t win any fans with that kind of miserable performance, which left sentiment overwhelmingly-bearish to apathetic.

The gold stocks just suffered their worst summer performance of all modern gold-bull-market years since 2001.  During June, July, and August, GDX cratered 25.0%!  That is painfully evident in this updated chart from my latest gold-summer-doldrums essay.  It uses the older HUI gold-stock index since GDX’s history is insufficient for such longer-term analysis, but these two sector indices are functionally-interchangeable.

Ouch right?  Entering September, the gold stocks have never suffered such a massive bearish deviation from their average seasonal performances!  That 26.6% plummeting compares to them normally exiting market summers up 5.6%.  So it’s no wonder even the hardest-core contrarians’ enthusiasm for this high-potential sector has all but vanished.  Price action drives herd sentiment, and both have proven terrible recently.

GDX’s latest sharp plunge to major secular lows happened in late August, after the Fed chair’s short-and-blunt hawkish speech at Jackson Hole.  Jerome Powell used only eight minutes of his half-hour time slot to emphatically declare the Fed must keep tightening aggressively “until the job is done” of slaying this raging inflation.  In five trading days starting with that uber-hawkish war cry, GDX plummeted 11.7% to $23.08.

That proved gold stocks’ lowest levels since late March 2020, when they were just emerging from the extreme pandemic-lockdown stock panic.  Battered to that deep 2.4-year secular low just a few weeks ago, the gold stocks were literally trading at stock-panic levels!  So why not join the herd in abandoning them?  Massive uplegs are born from extreme lows, GDX rocketed up 134.1% in 4.8 months after that panic!

Contrarian trading is based on the core market truth that the worse any sector looks and feels, the greater its upside potential.  The vast majority of traders are momentum-chasers, they will only buy after sectors have already powered much higher stoking popular greed.  But once they’ve rallied big-enough and long-enough to start attracting mainstream traders, the lion’s share of the upleg gains have already been won.

So buying low as massive gold-stock uplegs are being born requires fighting the herd.  Capital needs to be deployed when it feels bad as popular fear, bearishness, and apathy abound.  Excessive negativity is the telltale sign major bottomings are underway.  That’s certainly the case in gold stocks today, which are trading at stock-panic levels under false premise.  They’ll mean revert way higher before traders figure this out.

Gold miners’ earnings are highly leveraged to prevailing gold prices, so their stocks mirror and amplify whatever is happening in gold.  Powell’s Jackson-Hole warning that the Fed will accept forcing the US economy into a recession if necessary to combat inflation also hammered the yellow metal.  It fell 3.5% over those same subsequent five trading days where GDX plunged 11.7%, making for 3.3x downside leverage.

That’s on the high side, as the major gold stocks dominating GDX typically exaggerate gold’s material trends by 2x to 3x.  And that’s what happened since mid-April when all this carnage started.  Plummeting that 43.5% at worst, that amplified gold’s own 15.8% drop from mid-April to late September by 2.8x.  So understanding why gold stocks have been brutalized and why they are overdue to soar requires looking at gold.

The overwhelming reason gold just had such a tough 5.3 months is extreme gold-futures selling.  I wrote a whole essay on futures still dogging gold a couple weeks ago analyzing that in depth.  Futures have an outsized impact on gold prices due to the staggering leverage inherent in them, which usually exceeds 25x!  That makes futures trading exceedingly-risky, forcing those speculators to have ultra-myopic time horizons.

They take their primary trading cues from the US dollar’s fortunes, doing the opposite.  Gold futures are sold when the dollar rallies.  And boy has the benchmark US Dollar Index skyrocketed since mid-April.  In just 5.3 months into the middle of this week, it blasted an astounding-for-a-major-currency 11.4% higher!  That is one of the biggest parabolic USDX spikes ever, catapulting it to an extreme 20.3-year secular peak!

The US dollar in turn soared on the Fed’s most-extreme hawkish pivot ever.  The tightening executed by the Fed’s Federal Open Market Committee since mid-March has been radically unprecedented.  It hiked the federal-funds rate at five consecutive FOMC meetings, by 25 basis points, 50bp, 75bp, 75bp, and yet another 75bp this week!  That was its first 50bp hike since May 2000 and its first 75bp since November 1994.

The FOMC hasn’t blasted its FFR higher so fast in six months since March 1981!  Exactly a year ago, top Fed officials projected the FFR would end 2022 at just 0.38%.  In their newest dot plot just released this week, these same policymakers are now projecting 4.38% exiting this year!  The FFR has already shot from 0.13% to 3.13% since mid-March.  And violent rate hikes aren’t the Fed’s only tightening underway.

The FOMC also recently birthed its second quantitative-tightening campaign and accelerated it to terminal velocity shortly after.  QT2 is necessary to start unwinding the colossal quantitative-easing money printing following March 2020’s pandemic-lockdown stock panic.  The Fed mushroomed its balance sheet an insane 115.6% or $4,807b in just 25.5 months into April 2022!  That more than doubled the US money supply.

That’s the overwhelmingly-dominant reason inflation is raging out of control, which is why Fed officials are panicking.  Relatively-much-more money is chasing and bidding up the prices on relatively-less goods and services.  QT2 was launched at $47.5b per month of monetary destruction in mid-June, then quickly ramped to $95b monthly in September!  That dwarfed QT1’s $50b target pace which took an entire year to hit.

This radically-extreme Fed tightening is why the US dollar shot parabolic pummeling gold.  The FOMC is hiking rates at its fastest pace in 41.5 years while destroying QE-conjured money at the greatest velocity ever attempted!  That has blasted the USDX way higher as other major central banks were initially slow to follow the Fed.  While that is changing, the dollar opened up big positive yield differentials over competitors.

That epic dollar strength triggered enormous gold-futures selling.  Between mid-April to last Tuesday’s latest data, speculators dumped 126.9k gold-futures long contracts and added another 50.2k short ones.  That is the equivalent of 551.0 metric tons of gold selling in just 5.1 months, far too much too fast for global markets to absorb!  And extended to early March’s gold geopolitical spike, the selling was even bigger.

At worst within that span, specs liquidated 154.1k longs while short selling another 85.3k.  That adds up to 744.7t of gold supply vomited out in just 6.2 months!  With that extreme degree of selling intensity, gold has actually proven relatively resilient.  Its total selloff since soon after Russia invaded Ukraine is running 18.8% mid-week.  Using that total correction, GDX’s downside leverage was actually milder too at 2.3x.

That brutal gold plunge hammering its miners’ stocks lower wasn’t fundamentally-righteous though, it was a futures-driven anomaly.  That’s why I say it happened under false premise.  Because of the extreme risk inherent in hyper-leveraged futures trading, there aren’t many speculators playing in that realm.  And their capital firepower is small compared to the greater gold markets.  So they can only do so much total selling.

And as explained in my gold-futures essay a couple weeks ago, specs’ gold-futures selling firepower is essentially exhausted.  In mid-September’s latest data, total spec longs slumped to a fresh 3.3-year low.  And total spec shorts weren’t far from late July’s 3.7-year high.  Speculators have already shot their wad, done virtually all the selling they are able to.  That has left their overall futures positioning exceedingly-bearish.

After similar past episodes of incredibly-lopsided gold-futures trading, massive mean-reversion buying soon erupted to normalize their collective bets.  The last time spec gold futures were similar to today came in May 2019.  These traders were convinced gold was doomed, so they had jettisoned huge amounts of longs while ramping their shorts.  They soon resumed buying, catapulting gold 21.5% higher in just 3.3 months!

Speculators are legally required to buy gold futures to cover and close out their shorts, and they love jumping in on the long side to chase the resulting sharp gold rallies out of major lows.  Their strong mean-reversion buying fuels big-and-fast gold uplegs, which work wonders for gold stocks.  During that same short mid-2019 span, GDX rocketed 51.6% higher!  That was solid 2.4x upside leverage to gold’s big surge.

If spec gold-futures selling didn’t look spent by historical standards, if these traders could keep on selling at extreme levels, the near-term outlook for gold and gold stocks would indeed be bearish.  But since they have done about all the selling they are likely able to do, massive mean-reversion buying to normalize their crazy-lopsided positions is imminent.  When that arrives, gold and its miners’ stocks will power way higher.

That recent extreme-but-exhausted gold-futures selling wasn’t justified fundamentally, it has to soon reverse.  But unfortunately the resulting distorted gold prices really impacted gold investor psychology, which sucked in more selling.  I analyzed that in depth in last week’s essay on gold investment bleeding.  The recent gold carnage wrought by those gold-futures speculators left gold investors bearish, apathetic, and wary.

While comprehensive global gold investment data is only available quarterly, a great high-resolution proxy is found in the combined holdings of the world’s largest gold exchange-traded funds.  These of course are the American GLD SPDR Gold Shares and IAU iShares Gold Trust.  In plenty of quarters, changes in their holdings alone account for the great majority of changes in overall global gold investment demand!

While they control vastly more capital than gold-futures speculators, gold investors are momentum-chasers.  Most only want to buy when gold is rallying on balance, portending more gains to come.  With gold plunging on that extreme anomalous gold-futures selling since mid-April, investors increasingly fled.  They assumed gold’s battered prices were fundamentally-righteous instead of the actual temporary anomaly.

So GLD+IAU holdings plunged 11.3% or 183.5t between late April to mid-week, adding to the downside pressure on gold.  That identifiable gold investment selling clocked in at about a third of the gold-futures puking, or a quarter of the combined total.  Similar to specs’ unsustainably-bearish positioning in futures, that pummeled American stock investors’ gold holdings to deep secular lows.  That too needs to reverse.

At just 1,442.3t of gold bullion held between these two mighty gold ETFs mid-week, their holdings hadn’t been lower since mid-April 2020.  That was 2.4 years ago as gold and gold stocks were screaming out of that pandemic-lockdown stock panic.  Gold ultimately rocketed 40.0% higher in just 4.6 months out of that extreme selling anomaly!  That massive upleg was initially fueled by futures buying, but investment took over.

After despising gold in that stock panic’s depths much like today, investors quickly flipped to loving it as it soared.  So they rushed to flood back into GLD and IAU, catapulting their holdings up 35.3% or 460.5t in that short span!  Big gold investment demand will quickly return again once gold powers decisively higher on inevitable massive gold-futures mean-reversion buying.  That truly is way overdue to ignite any day now.

Despite the extreme Fed hawkishness, the extraordinarily-overbought US dollar is running out of steam.  In the past month the USDX only rallied 2.1% at best despite the Fed chair’s Jackson-Hole hawknado and top Fed officials’ aggressive rate-hike outlook this week.  In the initial month of this parabolic dollar surge into mid-May, the USDX blasted 4.9% higher.  The long-dollar trade that has vexed gold has grown wildly-overcrowded.

Now other major central banks are increasingly rushing to catch up with the Fed, executing their own monster rate hikes.  That is closing the yield differentials between the US dollar and five of the six major currencies included in the US Dollar Index.  Together they account for nearly 7/8ths of its weighting.  So this way-overextended US dollar is on the verge of rolling over hard as other currencies rally on big rate hikes.

A weaker USDX will ignite big gold-futures short-covering buying.  That will propel gold high-enough for long-enough to attract back long-side gold-futures specs, who trade about 2.7x more contracts.  Their buying will greatly accelerate gold’s rally, eventually attracting back investors with their massive pools of capital.  That will fuel gold’s next major upleg, on which the battered gold stocks will soar amplifying its gains.

And gold stocks have huge room to run, as this next chart shows.  It looks at a construct called Relativity, how GDX is trading relative to its 200-day moving average.  This multiple reveals how absurdly oversold the gold miners’ stocks are today.  They literally haven’t been this brutalized technically since the depths of that March 2020 pandemic-lockdown stock panic!  Just like back then, this false anomaly won’t last long.

When GDX itself collapsed to that brutal 2.4-year secular low in early September, as a multiple of its own 200dma the Relative GDX plunged to 0.727x.  That proved a deep 2.5-year low not seen since the worst depths of that stock panic.  This degree of gold-stock oversoldness is so darned extreme that it was only exceeded on two trading days as that stock panic bottomed!  Gold stocks are literally panic-level oversold.

After actively speculating and investing in gold stocks and writing popular financial newsletters about that full-time for almost 23 years now, I’ve learned some key truths about panic-level prices.  They never last long, as extreme bearish sentiment soon sucks in all available sellers.  That leaves only buyers, who soon return with snowballing capital inflows quickly catapulting gold stocks sharply higher out of anomalous lows.

During and soon after March 2020’s pandemic-lockdown stock panic I was writing similar contrarian analysis.  I warned those extreme gold and gold-stock prices couldn’t last and were birthing enormous mean-reversion uplegs.  Indeed that hardcore contrarian stance soon proved correct, as gold and GDX skyrocketed 40.0% and 134.1% higher over the next 4.6 and 4.8 months!  This time should prove bigger.

Why?  Thanks to the Fed’s extreme QE4 money printing, inflation is raging out of control.  Since the US dollar started shooting parabolic in mid-April, the monthly headline Consumer Price Index inflation read has run red-hot up 8.3%, 8.6%, 9.1%, 8.5%, and 8.3% year-over-year.  June’s high-water mark was the worst witnessed since November 1981, a 40.6-year high!  We’re in the first inflation super-spike since the 1970s.

Gold skyrocketed during the last similar inflation super-spikes that decade.  In the first the CPI blasted from +2.7% YoY to +12.3% over 30 months into December 1974.  Gold’s monthly-average prices from trough to peak CPI months launched 196.6% higher!  During the second the CPI exploded from +4.9% YoY to +14.8% in 40 months climaxing in March 1980.  Gold’s monthly-average prices were a moonshot, up 322.4%!

Sooner or later gold-futures speculators and gold investors are going to realize the US dollar can’t keep soaring indefinitely, especially with raging inflation relentlessly eroding its purchasing power.  They will come to realize ultra-aggressive Fed rate hikes aren’t slaying inflation, that requires the FOMC to unwind the majority of its QE4 money printing.  And they will fear this Fed-fueled major stock-market bear deepening.

They will remember gold has proven the ultimate inflation hedge for centuries.  Speculators will flood back into gold futures with a vengeance as the inflation-debased US dollar mean reverts way lower.  Investors will aggressively boost their meager portfolio allocations to gold as it surges with general stocks burning all around from the Fed’s scorched-earth tightening.  As gold runs, battered gold stocks will soar multiples higher.

The bottom line is battered gold stocks are literally trading at panic levels today!  They haven’t been lower or more oversold since March 2020’s pandemic-lockdown stock panic, after which they violently mean reverted massively higher.  Today’s extreme lows are just as anomalous and unsustainable, based on a false premise that recent months’ big gold selloff was fundamentally-righteous.  But that simply isn’t true.

Gold-futures speculators fled unleashing enormous selling as the US dollar soared parabolic on the Fed’s most-extreme hawkish pivot ever.  That tainted gold psychology, leaving investors bearish enough to join in the selling.  But all that has mostly been spent, with speculators’ gold-futures positioning and investors’ gold-ETF holdings at major multi-year lows.  As all that reverses, gold will soar launching gold stocks way higher.

Adam Hamilton, CPA