Gold Stocks Coiled Spring 2

The gold miners’ stocks largely ground sideways in 2017, lagging gold’s solid rally. Being trapped in this vexing consolidation has decimated sentiment, leaving a bearish wasteland bereft of hope. But contrary to perceptions, this deeply-out-of-favor sector is actually a coiled spring today. Gold stocks are ready to surge dramatically higher as psychology inevitably shifts, pointing to much higher prices coming in 2018.

The main appeal of gold-mining stocks is their underlying profits’ leverage to gold. The gold miners are much riskier than gold itself, facing many operational, geological, and geopolitical challenges that the metal doesn’t share. Thus investors and speculators alike must be compensated for these large added risks with superior returns to gold. That didn’t happen in 2017, which is why gold stocks are so widely despised.

All year long, the extreme stock-market rally driven by hopes for big tax cuts soon stole the limelight from gold. The flagship S&P 500 stock index has blasted 19.7% higher year-to-date, stoking incredible levels of euphoria. That sucked all the oxygen out of the investment world, overshadowing everything else. So investors have largely shunned gold this year, since it is normally the anti-stock trade moving counter to stocks.

Usually soaring stock markets crush gold, like back in 2013. That year the Fed’s new third quantitative-easing campaign conjured $1020b out of thin air to monetize bonds. The resulting artificially-low interest rates fueled a stock-buyback boom, catapulting the S&P 500 29.6% higher. So investors felt no need to prudently diversify their stock-heavy portfolios with gold, thus this metal plummeted 27.9% lower that year!

Considering gold is often hostage to stock-market fortunes, it performed remarkably well in 2017 despite the endless record highs in major stock indexes. Gold was up 10.0% YTD as of the middle of this week, very impressive considering the circumstances. Gold miners’ inherent profits leverage usually enables their stock prices to amplify underlying gold rallies by 2x to 3x, so they should be up 20% to 30% this year.

The dominant gold-stock index is the HUI NYSE Arca Gold BUGS Index, which is closely mirrored by the leading GDX VanEck Vectors Gold Miners ETF. Unfortunately its performance this year has been utterly dismal compared to gold, with the HUI up just 1.8% YTD! That makes for horrendous leverage of 0.2x, wildly unacceptable considering gold miners’ big additional risks compared to the metal they bring to market.

Gold stocks are underperforming so massively this year due to sentiment. Because this small contrarian sector is languishing, traders want nothing to do with it. And because they are widely avoided, the gold stocks are trapped in consolidation hell. The only thing able to start shifting sentiment back to bullish is a meaningful gold rally igniting material gold-stock buying. The resulting gains would win back capital inflows.

Sentiment and technicals are inexorably intertwined. No matter what else is going on, when stocks are high traders get excited and bullish. That’s obviously happened in the stock markets this year, despite the Fed and the ECB on the verge of radical tightenings that will strangle this stock bull. The parabolic bitcoin mania is another wild case in point. But when stocks are down, traders naturally wax sullen and bearish.

As at all sentiment extremes, traders assume gold stocks are doomed to suffer this frustrating weakness indefinitely. But that’s a bad bet, as sentiment perpetually meanders back and forth between excessive greed and fear. The longer psychology remains on one side of that arc, and the more extreme it gets, the greater the odds for an imminent mean-reversion swing back the other way. Those tend to overshoot proportionally.

The last time gold stocks were this out of favor drifting near lows was the second half of 2015. The gold miners were left for dead, with nearly everyone predicting they would spiral lower forever. Yet sentiment shifted out of that bearish echo chamber, and the gold stocks skyrocketed like North Korean ICBMs. In merely 6.5 months, the HUI soared 182.2% higher! That amplified gold’s concurrent 25.2% rally by a big 7.2x.

2017’s painful consolidation is the perfect breeding ground for another monster gold-stock upleg in 2018. After spending a year basing at deeply-undervalued prices relative to today’s gold levels, it shouldn’t take much of a sentiment shift to catapult gold stocks way higher. From a contrarian standpoint this unloved sector’s technicals are actually quite bullish today, with the gold miners’ stocks wound up like a coiled spring.