Gold-Stock Valuation Anomaly

Adam Hamilton, CPA

The gold miners’ stock prices have largely decoupled from their metal, which overwhelmingly drives their profits.  This fundamental disconnect has spawned a shocking valuation anomaly, with gold stocks far too low relative to gold.  But this aberration won’t last, as markets abhor extreme deviations from precedent.  Mean reversions and proportional overshoots soon follow, so gold stocks will soar to reflect their record earnings.

Across stock markets throughout history, stock prices ultimately gravitate towards reasonable multiples of their underlying corporate profits.  Those valuations vary with sectors, and herd sentiment can force them away from averages for some time.  But eventually they always normalize, with mean reversions being an immutable market force.  Visualize sector valuations like sine waves oscillating around long-term averages.

From a high-level valuation perspective, gold mining is a simple business.  Miners excavate, haul, and crush gold-bearing ores, process them to recover the gold, then sell it usually at prevailing market prices.  Profits are the difference between those and the costs of bringing that gold to market.  While the metal can surge fast as this past year’s monster upleg proved again, mining costs lag way behind climbing slowly.

That’s because they are largely fixed when mines are being engineered, well before construction.  The mills processing ores have limited throughput capacities, costing about the same to run quarter after quarter.  All-in sustaining costs are gold miners’ primary way of measuring overall operating expenses.  Interestingly mines’ average AISCs over their entire lives are forecast ahead of those mine-builds starting.

Most gold miners report full financial results quarterly, including their AISCs and profits.  Averaging the former from the world’s leading gold miners then subtracting that from quarterly-average gold prices is an excellent proxy for sector unit earnings.  For the past 34 quarters I’ve been doing that with the top-25 gold miners in the dominant GDX gold-stock ETF.  They haven’t reported Q4’24 yet, so Q3’24 is the latest data.

That quarter the GDX-top-25 gold miners averaged all-in sustaining costs of $1,431 per ounce.  With gold averaging $2,477 on close, that made for near-record sector unit profits of $1,046.  Those soared 74.0% year-over-year from Q3’23’s levels, amplifying the big 28.6% average-gold-price gains in that same span by 2.6x!  Over the last four reported quarters, that profits leverage to gold has run 3.0x, 3.7x, 4.6x, and 2.6x.

Gold-stock prices have long mirrored this inherent leveraged relationship between gold prices and gold-mining earnings.  The major gold stocks of GDX normally see their stock prices amplify material gold moves by 2x to 3x.  That not only reflects underlying profits growth, but compensates investors for gold stocks’ big additional operational, geological, and geopolitical risks heaped on top of gold price trends.

Just breaking out again to new record highs, gold’s monster upleg has grown to huge 57.3% gains over 16.1 months!  This is an extraordinarily-large and -long upleg.  Based on that historical 2x-to-3x leverage of GDX to gold, it should’ve soared 115% to 172% in that span.  In the quarters since this gold upleg was born in early October 2023, GDX-top-25 implied unit profits have skyrocketed 42%, 35%, 84%, and 74% YoY!

Yet dumbfoundingly, GDX was merely up 58.4% midweek for no upside leverage at all.  If gold stocks can’t outperform their metal, they’re not worth owning since they are much riskier.  Even at best within this monster gold upleg in late October, GDX was only up 70.2% to gold’s 51.0% then making for 1.4x leverage.  Gold stocks have lagged way behind their metal, spawning a shocking valuation anomaly still in force.

This sector-valuation-proxy chart illustrates that gaping disconnect.  It looks at GDX’s prices divided by the leading-and-dominant GLD gold ETF’s.  Gold-stock-to-gold ratios distill down valuation trends over time, making them very useful for analyses.  Here the blue GDX/GLD-ratio line is superimposed over the raw GDX in red.  Juxtaposing these in recent years reveals the extreme valuation anomaly over this past year.

For well over a decade now, I’ve periodically updated this GGR chart and analyzed it in essays.  Across the great majority of that span, GGR multiples closely tracked the underlying GDX.  The blue and red lines mostly meandered tightly together like in 2022 and 2023.  But late that year as gold’s current upleg began marching, a fundamental disconnect started opening.  It gaped to crazy-anomalous proportions since!

Arguably the last quasi-normal market years were 2019 to 2021, where the GGR averaged 0.199x which may as well be rounded to 0.20x.  2022 was crazy, witnessing the Fed’s most-violent hiking cycle in its entire century-plus history.  It raised its federal-funds rate an extreme 350 basis points in just 6.0 months!  That fueled an epic 16.7% moonshot in the benchmark US Dollar Index to an extreme 20.4-year secular high!

That parabolic dollar slammed gold a proportional 20.9% lower on heavy gold-futures selling.  That in turn crushed gold stocks to extreme stock-panic-level lows in late September.  While both gold and the miners rebounded strongly from that anomaly, those wild markets were far from normal.  At worst the GGR fell to 0.145x in its dark heart.  Nothing like that had been seen since March 2020’s pandemic-lockdown stock panic.

You probably remember fear was off the charts during that event.  No one yet knew how lethal COVID-19 would prove, and the lockdowns risked spawning a full-blown depression.  Astoundingly then in just over a month, the flagship US S&P 500 stock index plummeted 33.9%!  Gold stocks get sucked into extreme selloffs, and at worst the GGR plunged to 0.133x then which was a 4.1-year low.  Keep that nadir in mind.

Fast-forward to late 2023, as gold’s current upleg started powering higher.  Gold stocks leveraged their metal’s gains initially, then increasingly fell behind.  After achieving its first record close in 3.3 years in early December, gold consolidated before slumping back in early 2024.  That freaked-out gold-stock traders, who did enough selling to slam the GGR way down to 0.137x in late February in a stock-panic-grade anomaly!

GDX rebounded sharply out of those extremes, rocketing up 71.0% by late October.  But those gains still seriously lagged gold’s monster upleg.  It had grown extremely-overbought and speculators’ gold-futures positioning was exceedingly-overextended, so a rebalancing selloff was inevitable.  Gold indeed pulled back 8.0% at worst into mid-November, less than 10%+ correction territory that would’ve slain its upleg.

Despite gold’s mild selloff given that bearish setup and a parallel massive surge in the US Dollar Index, gold-stock traders panicked again.  GDX plunged 23.4% by late December, again slamming the GGR way down to a stock-panic-grade 0.140x!  Relative to their metal, gold stocks were cheaper than late September 2022’s secular bottoming.  March 2020’s panic only saw a slightly-lower GGR on a single trading day!

Such dismal gold-stock levels were fundamentally-absurd with gold at record highs.  Again in those last four reported quarters ending Q3’24, the GDX top 25’s implied unit profits skyrocketed 42%, 35%, 84%, and 74% YoY to $659, $795, $1,099, and $1,046 per ounce!  And once reported, Q4’24 will prove gold miners’ best quarter ever.  I wrote a whole essay a couple weeks ago laying out the detailed case for that.

Gold averaged a dazzling record $2,661 on close last quarter.  Conservatively the GDX top 25’s average AISCs should come in under $1,350, as analyzed in that essay.  That implies the major gold miners will report stunning record earnings of $1,311 per ounce in Q4!  That would soar another 99% YoY from Q4’23 levels, doubling!  Certainly no other stock-market sector has enjoyed such massive, sustained profits growth.

So GDX needs to mean revert much higher for gold stocks to trade at reasonable multiples of their huge underlying earnings.  That process got underway in January, but as of midweek the GGR was still down at just 0.155x.  Just to mean revert to that 0.20x last-few-normal-years average, GDX would have to surge another 29% from here.  A proportional upside mean-reversion overshoot would more than double that.

That might not sound spectacular, but it sure could be.  The reason gold stocks decoupled from gold over the past year or so in that extreme valuation anomaly was purely psychological.  Enthralled by the AI stock bubble, distracted speculators and investors mostly ignored gold’s monster upleg.  And gold stocks largely remained way off their radars, long-forgotten.  That apathetic herd sentiment starved this sector of capital.

Gold-stock inflows were anomalously-anemic last year, way insufficient to keep their prices leveraging gold’s upside like normal.  But gold stocks’ mounting gains were starting to command some interest in October.  Late that month GDX surged to a 4.2-year secular high of $44.09, which was merely 0.9% shy of achieving an attention-grabbing 11.8-year one!  A decisive breakout would’ve fueled mounting bullishness.

The financial media loves covering new record highs, growing awareness among traders who love chasing them.  Had gold stocks shot higher into major record territory, interest and capital inflows would’ve almost certainly accelerated.  Unfortunately two events delayed that secular breakout, starting with the world’s biggest gold miner reporting worse-than-expected higher AISCs in Q3 which I analyzed with GDX-top-25 results.

As Newmont’s mining costs surged in the first half of 2024, it maintained solid AISC guidance forecasting a turnaround.  But Q3’s highest-yet last year torpedoed those misleading hopes, so that stock crashed 14.7% in its worst daily loss in 27 years!  As GDX’s biggest component, that really dragged down this ETF.  Worse, it soured institutional investors on gold stocks despite Newmont’s endless operating problems.

Smaller mid-tier and junior gold miners were way-outperforming their larger peers, often reporting lower and stable AISCs generating massive record unit profits.  Newmont hasn’t represented this sector for many years if not decades.  On top of that sentiment-tainting Newmont AISC miss, just a few trading days later gold rolled over into its own overdue selloff.  That scared gold-stock traders who sold hard into year-end.

But all that has passed now.  The gold miners are on the verge of reporting their best quarter ever with epic record earnings.  Gold is surging to new record highs despite the still-very-strong US dollar.  The AI stock bubble diverting attention from gold is getting closer to bursting, as NVIDIA’s 17.0% crash last Monday warned.  And GDX is only 6.9% under that dozen-year secular breakout starting just over $44.

All this ought to increasingly shift herd sentiment to bullish again, attracting back capital into these deeply-undervalued gold stocks.  The more they rally, the more the financial media will bullishly cover their mounting gains.  That will grow awareness driving expanding capital inflows, accelerating the sector upside.  Speculators and investors alike love chasing winners, and gold miners are winning fundamentally.

Again major gold stocks have long amplified major gold uplegs and corrections by 2x to 3x.  Midweek they were still languishing in this monster gold upleg, with GDX up 58.4% for dismal 1.0x leverage.  To get back to 2x to 3x, GDX’s parallel upleg would have to soar 115% to 172% in total catapulting it way up near $56 to $70!  That would mean another 35% to 72% of rallying from here, big gains that are well worth chasing.

And actually during monster gold uplegs defined as 40%+, gold-stock psychology eventually grows so greedy that upside leverage outperforms.  Gold’s last monster upleg crested in early August 2020 right at 40.0% gains.  GDX’s parallel upleg which was born at that 0.133x GGR not much under late December 2024’s 0.140x ultimately skyrocketed to 134.1% gains for 3.4x leverage!  Gold stocks’ upside potential is huge.

With this sector deeply out of favor exiting last year, not many traders were paying attention.  As January dawned, I wrote an essay explaining why 2025 would be gold stocks’ revaluation year.  Gold revalued way higher last year, reflecting a major paradigm shift in how traders perceived it in this still-inflationary economic environment.  Gold stocks are going to follow their metal this year reflecting their epic fundamentals.

The opportunities for riding this overdue mean reversion and overshoot much higher are enormous.  GDX’s overall 2024 performance was atrocious, climbing just 9.4% last year despite gold’s 27.2% surge besting the S&P 500’s huge 23.3% gains.  Yet the 84 mostly-gold-stock trades we closed out in our subscription newsletters in 2024 still averaged excellent +43.1% annualized realized gains!  How was that possible?

For over a quarter-century now, we’ve specialized in actively trading smaller fundamentally-superior mid-tier and junior gold miners.  They’ve long outperformed with better production growth often at lower costs than most of the majors.  We painstakingly study smaller gold miners to find the best coming growth, and try to buy in relatively-low.  Our newsletter trading books are currently full of still-cheap gold stocks ready to soar.

The bottom line is gold stocks have suffered an extreme valuation anomaly during this past year.  Despite enormous ongoing earnings growth to epic record profits, traders mostly ignored this sector in 2024.  Enthralled by the AI stock bubble, they weren’t interested in alternative investments led by gold and its miners’ stocks.  That left gold stocks starved of capital inflows, leaving them deeply-undervalued relative to gold.

This shocking fundamental aberration guarantees a mean-reversion overshoot is coming.  Like all other stock sectors, gold-stock prices will gravitate near some reasonable multiple of their underlying corporate profits.  With gold forging deeper into record territory, the miners about to report their best quarter ever, and GDX nearing a dozen-year secular breakout, gold-stock psychology will increasingly shift bullish again.

Adam Hamilton, CPA

February 7, 2025
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