Gold-Stock Triple Breakout | Adam Hamilton

Adam Hamilton     December 14, 2018

The beleaguered gold stocks are recovering from their late-summer capitulation, enjoying a solid young upleg as investors gradually return.  Their buying has pushed the leading gold-stock ETF near a major triple breakout technically.  That event should really boost capital inflows into this sector, accelerating the rally.  A major gold and gold-stock buying catalyst is likely imminent too, a more-dovish Fed next week.

The gold miners’ stocks have always been a small contrarian sector, a little-watched corner of the stock markets.  But they’ve been even more unpopular than usual in recent months.  That pessimistic sentiment is driven by price action, which has mostly proven poor in 2018.  That’s really evident in the performance of the flagship gold-stock investment vehicle, the GDX VanEck Vectors Gold Miners ETF which is struggling.

As of the middle of this week, GDX was down 12.0% year-to-date.  That leveraged gold’s YTD decline of 4.4% by 2.7x, which is perfectly normal.  Because gold-stock earnings are heavily dependent on prevailing gold levels, gold-stock prices tend to amplify gold’s moves by 2x to 3x.  That’s a double-edged sword, really profitable when gold rallies but cutting deeply when it retreats.  The drawdowns are challenging to weather.

But gold stocks’ inherent leverage to gold is starting to work again on the upside, portending big gains ahead.  This first chart looks at the major gold stocks’ technicals through the lens of GDX over the past several years.  This sector soared in a new bull market, plunged with gold after Trump’s surprise election win goosed the stock markets, consolidated sideways to base, and then suffered an extreme capitulation selloff.

Investors and speculators often forget how explosive gold-stock upside is when gold is powering higher in an upleg.  In largely the first half of 2016, GDX skyrocketed 151.2% higher in just 6.4 months!  Capital just flooded back into the gold miners driven by a new gold bull’s parallel 29.9% upleg.  That catapulted GDX to very-overbought levels and a 3.3-year high in mid-2016.  So a normal correction got underway soon after.

GDX found support at its critical 200-day moving average, which is often the strongest support zone seen in ongoing bull markets.  But that failed in November 2016 after an anomalous surprise.  Trump defied the polling and odds to win the presidency while Republicans controlled both chambers of Congress.  So the stock markets soared in that election’s wake on euphoric hopes for big tax cuts soon.  Gold wilted on that rally.

So the gold stocks naturally followed it lower, again mirroring and amplifying its price action.  After it had enjoyed stellar 5.1x upside leverage to gold in its powerful H1’16 upleg, GDX dropped 39.4% over the next 4.4 months.  That leveraged gold’s own correction by 2.3x, relatively low in that usual 2x-to-3x range.  GDX soon bounced sharply with gold and established a new consolidation trading range between $21 to $25.

The major gold stocks mostly meandered within that GDX range for 21.5 months.  While it was vexing at times to see upside-breakout attempts fail, basing consolidations are very bullish.  They provide time for bullish newer investors to acquire shares from bearish exiting ones, establishing new price norms well above previous bear-market lows.  And the $23 midpoint of that GDX trading range proved relatively high.

This gold-stock bull was born out of fundamentally-absurd lows of GDX $12.47 in mid-January 2016.  It peaked at $31.32 in early August that year.  Oscillating around $23 on balance, GDX was basing 4/7ths up into its young bull’s entire range.  The major gold stocks GDX holds were biding their time waiting for another major gold upleg to catapult them higher.  They nearly broke out above $25 in early-September 2017.

But that attempt’s failure damaged psychology so traders gradually sold, this small contrarian sector left for dead.  The subsequent lower highs over the next 10.4 months into mid-July 2018 formed a downward-sloping resistance line.  Gold-stock prices were being compressed into a bearish descending triangle, as lower highs slumped ever closer to that major $21 support.  This sector really needed a major gold rally.

Unfortunately the opposite happened this past summer, gold got hammered crushing the weakened gold stocks.  The US stock markets were powering higher trying to regain record highs in July and August 2018, heavily retarding gold investment demand.  On top of that the US Dollar Index was surging too, both on expectations for more Fed rate hikes and an emerging-markets currency crisis led by the Turkish lira.

So gold-futures speculators started short selling gold at extreme record levels, blasting their aggregate downside bets far up into anomalous territory never before witnessed.  Gold fell sharply on that record gold-futures shorting spree, dragging the struggling gold stocks down with it.  So in early August GDX plunged and knifed through its longstanding $21 support.  That major breakdown spawned self-feeding selling.

Gold stocks are an exceptionally-volatile sector not for the faint of heart.  So it is essential to run loose trailing stop losses on gold-stock positions.  While these protect investors from excessive losses, they greatly exacerbate selloffs.  The lower gold stocks fell this past summer, the more stop losses were hit.  These mechanical automatic sell orders then add to the downside pressure, pushing gold stocks lower still.

That vicious circle of selling begetting selling snowballed into an extreme capitulation in gold stocks, as GDX plummeted in August and early September.  In just 5 weeks GDX collapsed 17.0%, far worse than gold stocks should’ve performed with gold merely slipping 1.4% lower in that span.  That devastated already-shaky sentiment, leaving most investors and speculators to throw up their hands in disgust and flee.

But with GDX being pummeled to a deep 2.6-year low, the major gold stocks were wildly oversold.  I explained all this in depth in an essay on gold stocks’ forced capitulation in mid-September.  They were due to mean revert dramatically higher after that extreme selling anomaly.  And that process has indeed been underway ever since.  The gold stocks have been recovering, clawing their way out of those deep lows.

As usual gold stocks’ dominant primary driver has been gold, which has been grinding higher in its own young upleg as speculators cover their record gold-futures shorts.  Investors started returning too when the lofty US stock markets began rolling over hard in mid-October.  As of the middle of this week, GDX just hit a new upleg high of $20.45 on close.  That extended gains since the capitulation low to 16.4% in 3.0 months.

Although considerable, the gold stocks’ rally still hasn’t grown large enough to return to the radars of contrarian investors.  That could be about to change though as a rare triple breakout looks imminent!  GDX, the leading gold-stock investment vehicle, is on the verge of simultaneous upside breakouts from its 3 major upper-resistance zones.  That will likely unleash big gold-stock buying from technically-oriented traders.

These major resistance levels have all converged near $21.  The first and most important is GDX’s key 200-day moving average, which was $20.78 this week.  200dmas are seen as the dividing line between bull and bear markets.  When prices surge back above 200dmas after long periods underneath them, the upside momentum often explodes.  Traders love chasing gains and 200dma breakouts portend big ones.

The past few years have several examples of gold stocks surging dramatically after 200dma breakouts.  The main one was in early February 2016, when GDX rocketing back over its 200dma after deep lows confirmed a new bull market was underway.  The great majority of its initial massive 151.2% upleg came after that 200dma upside breakout.   Another upleg surged after a 200dma breakout in mid-August 2017.

The latest one came in late December 2017, although that was truncated early by gold stalling out.  Realize that no technical line is more important to traders than 200dmas.  When they see major gold stocks power decisively back over their 200dma as measured by GDX, they are likely to rush to buy in to ride the momentum.  Like selling, buying begets buying.  The more gold stocks rally, the more traders want them.

That imminent 200dma breakout will be all the more potent as a new-upleg signal because 2 other major resistance lines have converged there.  That downward-sloping resistance line of the descending triangle has also extended right on $21.  So once GDX powers decisively above it, this past year’s vexing trend of lower highs will end.  Traders will see that as evidence the major gold-stock trend is reversing to higher.

The final resistance line of that triple breakout is the major $21 support of GDX’s consolidating basing range that held rock solid for over a year-and-a-half.  When prices fall, old support zones often become new overhead resistance.  Traders tend to want to sell again when those old support levels near.  So when GDX decisively breaks back out above $21, technical fears of that former support level will vanish.

Once back over $21, GDX will return to its multi-year consolidation basing trend between $21 to $25.  So the triple breakout above that old support line, downward-sloping resistance line, and 200dma would set the stage for a sharp surge back towards the top of that old trading range.  While GDX $25 isn’t very high in absolute terms, it’s still another 22.2% above this week’s levels.  Such a rally would spark some excitement.

Because historical gold-stock uplegs have been so enormous, generating life-changing wealth, there is always latent gold-stock interest lurking.  Contrarian investors and speculators alike sour on gold stocks when they are weak, but quickly return when they show technical signs of life.  A GDX triple breakout sure qualifies as that!  And much-higher gold-stock prices are certainly justified fundamentally, long overdue.

Gold miners’ earnings and thus ultimately stock prices are largely a function of gold levels.  Mining costs are essentially fixed during mine-planning stages.  So higher gold prices flow directly through to bottom lines in amplified fashion.  This is easy to understand with an example.  A month ago I waded through the Q3’18 results of GDX’s major gold miners.  Their average all-in sustaining costs weighed in at $877 per ounce.

That is what it costs them to produce and replenish gold, and $877 was right in line with their previous 4 quarters’ average of $867.  Those collective costs will remain stable even as gold’s upleg accelerates.  At gold’s own extreme-futures-short-selling-driven bottom of $1174 in mid-August, the major gold miners of GDX were still earning about $297 per ounce.  Such solid levels prove that capitulation wasn’t righteous.

Last Friday gold hit a new upleg high of $1248, up 6.3% from its anomalous late-summer lows.  Imagine this young upleg grows to 30% like the H1’16 one, which is quite small by historical standards.  That would leave gold near $1525.  At those $877 average GDX AISCs, the major gold miners’ profits would rocket to $648 per ounce.  That’s 118% higher on a 30% gold upleg!  Big gold-stock upside is fundamentally justified.

The ratio between the closing prices of GDX and the dominant GLD SPDR Gold Shares gold ETF is an easy approximation of the critical fundamental relationship between gold-stock prices and gold levels.  This last chart is updated from a mid-October essay where I explained why gold stocks are the last cheap sector in all the stock markets.  The GDX/GLD Ratio shows gold stocks have vast room to mean revert higher.

This GGR construct has averaged 0.186x during the 3.0 years of this current gold bull so far.  This week the GGR clawed back to 0.174x, hitting its own 200dma.   But at the gold stocks’ deep capitulation low in mid-September, the GGR plunged all the way down to 0.155x.  That’s 0.031x below normal for this bull.  After GGR extremes in either direction, this key ratio tends to mean revert the other way and overshoot proportionally.

That argues GDX is easily likely to surge far enough leveraging gold’s gains to regain a 0.217x GGR.  That’s certainly not a high level even in the modest context of this gold bull.  At this week’s $1245 gold levels which translated near $118 in GLD terms, GDX would have to surge to $25.56 to accomplish that normal mean-reversion overshoot.  That’s another 25.0% higher, which would make for a solid upleg well worth riding.

And that GGR target is still incredibly low in longer secular context.  In the 2 years before 2008’s first stock panic in a century, the GGR averaged 0.591x.  Though gold stocks plummeted in the extreme fear that panic spawned, the GGR rebounded to average 0.422x in the 2 years after that epic anomaly.  Over a longer 4-year post-panic span, it averaged 0.381x.  So seeing it regain 0.217x is nothing, it should go far higher.

The bigger gold’s own upleg, the more the gold stocks will outperform by the usual 2x to 3x and force the GGR higher.  At $1525 gold after a relatively-small 30% upleg, that 2009-to-2012 post-panic-average GGR of 0.381x would yield a GDX upside target around $55 per share.  That’s 169% higher from this week’s levels, even without an overshoot!  Gold-stock profits growth from higher gold prices justifies huge gains.

And rather conveniently on the verge of that GDX triple breakout, a major gold-buying catalyst is likely next week.  On Wednesday December 19th, the Fed’s FOMC meets to decide on whether or not to hike rates for the 9th time in this cycle.  That rate hike has been universally expected for months now, it is fully baked in.  But the thing gold-futures and dollar-futures traders are really watching is the rate-hike forecast.

While the FOMC meets 8 times per year, at every other meeting it releases something called the dot plot.  That summarizes where top Fed officials making the decisions think the federal-funds rate should be in coming years.  The last dot plot was published on September 26th when the S&P 500 remained just 0.8% under its all-time record high from a week earlier.  Fed officials are boldly hawkish when stocks are high.

But the stock markets soon fell apart in Q4’18, the first in history seeing full-speed quantitative-tighteningmonetary destruction by the Fed!  Various Fed officials including the chairman have waxed more dovish since stocks started sliding.  Fearing a negative wealth effect adversely impacting the US economy, their resolve to hike rates withers.  So there’s a good chance next week’s dot plot will be more dovish than the last one.

Late September’s had effectively forecast 5 more Fed rate hikes including at next week’s meeting.  So if this new dot plot shows less than 4 total rate hikes forecast in 2019 and 2020, dollar-futures speculators will likely sell motivating gold-futures speculators to buy aggressively.  Fewer expected rate hikes are very bullish for gold, as proven in past dot plots.  A great example was the 5th hike of this cycle in December 2017.

A year ago this week the FOMC hiked, but its dot-plot rate-hike forecast was dovish.  Instead of upping it to 4 rate hikes in 2018 as traders expected, Fed officials left it at 3.  So over the next 6 weeks, gold shot up 9.2% to $1358 on heavy gold-futures buying by speculators.  A similar rally after next week’s meeting if the dot plot forecasts fewer rate hikes than the last one would drive gold right back up near $1360 again.

That’s on the verge of a major bull-market breakout which would likely unleash massive new investment buying.  And any material gold rally will light a big fire under the gold stocks, rapidly driving them higher.  That would put GDX’s triple breakout in the bag with haste.  Nothing drives big capital inflows into the gold stocks faster than seeing them decisively rally.  They are perfectly set up for major gains in coming months!

A big mean-reversion rebound higher is inevitable and likely imminent.  While traders can play it in GDX, that’s mostly a bet on the largest gold miners with slowing production.  The best gains by far will be won in smaller mid-tier and junior gold miners with superior fundamentals.  A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation than ETFs dominated by underperformers.

The key to riding any gold-stock bull to multiplying your fortune is staying informed, both about broader markets and individual stocks.  That’s long been our specialty at Zeal.  My decades of experience both intensely studying the markets and actively trading them as a contrarian is priceless and impossible to replicate.  I share my vast experience, knowledge, wisdom, and ongoing research through our popular newsletters.

Published weekly and monthly, they explain what’s going on in the markets, why, and how to trade them with specific stocks.  They are a great way to stay abreast, easy to read and affordable.  Walking the contrarian walk is very profitable.  As of Q3, we’ve recommended and realized 1045 newsletter stock trades since 2001.  Their average annualized realized gains including all losers is +17.7%!  That’s double the long-term stock-market average.  Subscribe today and take advantage of our 20%-off holidays sale!

The bottom line is the gold stocks are nearing a rare triple breakout.  Three major GDX resistance zones have converged just above current levels.  Once the gold stocks surge decisively over, the technically-oriented traders will take notice.  They will likely start chasing the momentum accelerating the gains, with buying begetting buying.  And gold stocks are so undervalued big gains are totally justified fundamentally.

This bullish outlook should be really bolstered by next week’s FOMC meeting.  Worried about the recent stock-market selloff and surging volatility, top Fed officials are likely to dial back their rate-hike forecasts for next year.  That will almost certainly hit the US dollar and goose gold.  If gold surges again on a dovish dot plot like it has after other rate hikes in this cycle, the gold stocks will blast higher achieving that triple breakout.

Adam Hamilton, CPA     December 14, 2018

Comments are closed.

Free newsletter for stock pics, interview transcripts & investing ideas