Gold-Stock Sentiment Shifting | Adam Hamilton

Oct 19, 2018

The gold miners’ stocks have been largely ignored and neglected for years. Speculators and investors wanted little to do with them for various reasons. But that apathetic sentiment is finally starting to shift thanks to last week’s stock-market plunge. Capital is starting to return to this battered sector as traders begin to realize how radically undervalued it is. Sentiment mean reversions can catapult gold stocks far higher.

Sentiment is defined as “a thought, view, or attitude, especially one based mainly on emotion instead of reason”. We humans are inherently-emotional creatures riddled with sentiment on almost everything. That’s especially true in our perceptions of the financial markets, which heavily influence if not dominate our trading decisions. We buy and sell stocks when it feels good, when markets appear to validate our outlooks.

The core mission of speculation and investment is simple in concept, buying low then later selling high to multiply one’s wealth. I’ve given talks to elementary-school kids about trading and they easily grasp this. But unfortunately actually executing on this in real-world markets is very challenging because our sentiment misleads us. Our innate greed and fear relentlessly goad us to buy and sell at exactly the wrong times.

We wax greedy and excited after stocks have already rallied massively, which leads to buying high after most of the gains have already been won. Then after stocks have suffered major selloffs, our fear and despair flare brightly convincing us to sell low after losses have already occurred. Traders who heed their own emotions inevitably end up buying high then later selling low, which ultimately decimates their scarce capital.

Our individual and collective sentiment is overwhelmingly driven by one thing, prevailing price action. We naturally tend to extrapolate present conditions out into the indefinite future. So we assume stocks that are rallying will keep on powering higher forever, while stocks that are falling are doomed to continue spiraling lower. Making such linear assumptions in perpetually-cyclical markets often leads to serious losses.

So while sentiment might serve us well in other areas of our lives, it is our worst enemy in the markets. Instead of being embraced, our inherent greed and fear needs to be ruthlessly suppressed. We can’t buy low then later sell high if it feels good, because that means everyone else is doing it at the same time. Instead we have to fight our hearts and fight the herd, literally buying and selling when it feels the worst.

Everyone loves the mega tech stocks because they’ve rallied on balance for many years. But thanks to that very-long bull, they are dangerously overvalued. So buying them today may feel good, but their stock prices are already very high. The time to buy mega tech stocks was back in March 2009 at the end of the last secular bear when everyone was scared. Over the next 9.5 years the tech-heavy NASDAQ soared 539.2%.

Leading into March 2009 when mega tech stocks were hated, the elite NASDAQ 100 stocks sported an average trailing-twelve-month price-to-earnings ratio of 18.9x. They were relatively cheap with bearish sentiment peaking. But at the end of last month after that powerful secular bull, these stocks had an average P/E twice as high at 37.8x. This is the time to sell high, when traders are exuberant and euphoric.

The gold miners’ stocks have the opposite problem. Their prices have ground lower on balance for so long now that traders have mostly forgotten about them. They are incredibly undervalued and deeply out of favor, choking on suffocating bearishness. So now is the time to buy low when few others are willing, which is the secret to multiplying your wealth in the markets. That’s when stocks are dirt-cheap before big bulls.

The only speculators and investors able to consistently buy low then later sell high are contrarians who’ve hardened themselves against sentiment. They choose to totally disregard their own greed and fear, and then make the opposite trades of the thundering herd. They buy low when stocks are unwanted, and then later sell high when everyone wants them. Contrarian trading is ultimately the most-profitable way there is!

The miserable gold-stock sentiment of recent years is starting to shift because contrarian capital is flowing back into the gold miners’ stocks. This first chart looks at the leading GDX VanEck Vectors Gold Miners ETF over the past several years or so. It is the most-popular way to trade the gold-stock sector today, and its primary benchmark. Historically gold-stock upside has been enormous when sentiment mean reverts.

Gold stocks have suffered a rough year which is why their sentiment has been so darned poor. GDX left 2017 at $23.24 per share, right in the middle of its consolidation basing trading range running between $21 lower support to $25 upper resistance. Gold stocks largely ground sideways this year, leaving them way out of favor. Speculators and investors love to chase winners to ride momentum, and gold stocks had little.

Things took a dark turn for the worse in early August, when GDX started breaking down below that major $21 support line. That heavy selling soon snowballed into a rare forced capitulation, which I explained in depth in a mid-September essay. At this sector’s echo-capitulation low early that month, GDX was down a brutal 24.4% year-to-date. So it’s no wonder traders were very bearish, extrapolating that trend into the future!

Sentiment in gold-stock land was absolutely miserable at that point, as collective greed and fear are the product of technical price action. The worse stocks have performed, the more and longer they’ve fallen, the more bearish traders get on them. The despair in gold stocks was so thick 6 weeks ago you could cut it with a knife. Virtually everyone, including professional analysts who should know better, expected more selling.

Sentiment of course is ethereal, impossible to directly measure. The only ways to get decent reads on it are to watch what other people are saying and actually doing with real-world trades. If you go back and check market commentaries in early September, you’ll find virtually all of them were very negative on the gold-stock outlook. I was an exception, writing how wildly bullish gold stocks looked the very week they bottomed.

For decades I’ve been in the financial-newsletter business, researching, trading, and writing about markets. That blesses me with some unique ways to analyze prevailing sentiment. First I’m always getting tons of e-mail questions, thoughts, and feedback from our subscribers and readers all over the world. The overall tone of these always gets really bearish and depressed when gold stocks are carving major bottoms.

The more dejected people are about gold stocks, the more bullish their near-term outlook. Conversely when people get excited about the gold miners, they are usually topping before major selloffs. When you get dozens to hundreds of personal e-mails every day about the markets, how traders collectively feel is readily apparent. I try to share that aggregate sentiment zeitgeist in our newsletters to help others see it.

Second, our newsletters have always been explicitly contrarian in focus. We strive to fight the crowd to buy low when few others will, so we can later sell high when few others can. Interestingly our hard sales also closely mirror prevailing contrarian sentiment. When speculators and investors are down on the idea of buying low, like when gold stocks are really weak, fewer people bother purchasing our research newsletters.

Over the past couple decades or so, weakening revenues have been a telltale sign the gold stocks are bottoming. Unfortunately most traders are so caught up in their own emotions that they either don’t seek out or can’t handle contrary opinions. That leads to a sad ostrich effectin the markets. Most people simply check out and bury their heads in the sand if prevailing price action frustrates them, so they miss bottoms.

I’ve never understood this ill-fated approach. I bought my first stocks with money earned mowing lawns when I was 12 years old. In high school I eagerly devoured financial newsletters, which helped me learn a great deal about markets and trading. If I had only read about and studied markets when it felt good, I’d have cheated myself out of all kinds of priceless lessons and essential education. That makes no sense!

To gradually grow successful in the exceedingly-challenging realm of speculation and investment, one can never stop studying and learning. It’s actually way more important to stay plugged in when you don’t feel like it, because that’s when markets are bottoming before massive new bulls. It takes discipline to always stay abreast of markets, but the ultimate payout in profitable future trades vastly outweighs the costs.

The gold stocks indeed started bouncing and reversing following their deep early-September losses after that forced capitulation ran its course. Once all the cascading trailing-stop-loss sell orders had already been triggered, the selling was largely exhausted. So GDX surged 7.7% higher over the next week and a half or so. But it soon stalled out near $19, because popular gold-stock sentiment remained heavily bearish.

That all started to change last week, when a major inflection point in the markets was likely witnessed. Out of the blue on October 10th, the flagship US S&P 500 stock index plunged 3.3% on no news! That was its worst loss by far since a sharp-yet-shallow-and-short correction in early February, driven by fears of surging 10-year Treasury yields and hawkish Fedspeak. Such a sharp drop really spooked complacent traders.

The S&P 500 had been powering higher on balance for 9.5 years in a huge bull ballooning to a truly-monstrous 333.2% gain. That was the longest and second-largest in US stock-market history! That left traders euphoric, they extrapolated big gains into the indefinite future. But once their stock-heavy portfolios started getting whacked, they remembered gold. It is the ultimate portfolio diversifier, rallying as stocks slide.

Gold reversed from earlier losses to a minor 0.3% gain that day, no big deal. But under the surface a big change was happening. After shunning gold for months as stock markets levitated to new records, that day American stock investors started buying gold in a major way. That was evident in the physical-gold-bullion holdings of the dominant GLD SPDR Gold Shares gold ETF. They surged a massive 1.2% higher that day!

GLD acts as a conduit for the vast pools of stock-market capital to slosh into and out of gold. What GLD’s holdings are doing often account for the great majority of the changes in global gold investment demand which drive gold’s price action. I recently wrote an essay explaining all this in depth in late September if you need to get up to speed. When GLD’s holdings are rising, stock-market capital is flowing into gold.

This leading gold ETF’s mission is to track the gold price. But the supply and demand of GLD shares is independent from gold’s own. So when investors buy GLD shares faster than gold itself is being bought, its share price threatens to decouple from gold to the upside. GLD’s managers need to avert this in order to maintain tracking. So they issue new GLD shares to offset excess demand, raising capital from those sales.

Then the proceeds from these GLD-share sales are immediately plowed into physical gold bullion held in trust for GLD shareholders. So GLD effectively shunts stock-market capital directly into gold. This next chart shows GLD’s holdings and the gold price over the past few years or so. Note the sharp reversal in GLD’s holdings back higher which ignited that very day the S&P 500 plunged. Gold investment started to return!

That 1.2% GLD build on October 10th arrested a major multi-month decline in GLD’s holdings when American stock investors were pulling capital out of gold on balance. It was a big deal, the first differential GLD-share buying at all since late July. And it was the biggest GLD build by far since mid-March. Finally seeing a material stock-market selloff motivated investors to start redeploying in gold, a super-bullish omen.

That wasn’t a flash in the pan either, that investment gold buying continued with additional GLD builds of 0.8% on Friday the 12th and 0.6% on Monday the 15th. We hadn’t seen sizable capital inflows into GLD in a multiple-day cluster since early September 2017. So investor sentiment on gold was starting to shift, potentially in a major way, on that sharp stock-market plunge. Once that starts, it tends to run for some time.

After long periods without stock-market corrections, investors grow way too complacent and forget the risks of stock-heavy portfolios. They sell down their meager gold allocations to anomalously-low levels. So when stock markets inevitably drop again and rekindle anxiety, they have to do lots of buying to reestablish more-normal gold positioning to hedge their stocks. So their gold buying runs for months on end.

Back in late 2015 a pair of back-to-back S&P 500 corrections ignited a new gold bull out of major secular lows. While the second selloff ended in mid-February 2016, the powerful GLD-share buying that selloff spawned continued virtually unabated until early July almost 5 months later! Sharp stock selloffs are the trigger for gold investment demand returning, but that buying soon reaches critical mass to take on a life of its own.

Gold powered 29.9% higher in just 6.7 months almost exclusively on that differential GLD-share buying by American stock investors! That alone accounted for nearly the entire annual jumps in quarterly world gold demand in those two quarters. So if this latest bout of stock selling persists long enough to get investors redeploying into gold, we’re likely on the verge of a major new bull-market upleg. That’s great for gold stocks.

That sharp 3.3% S&P 500 plunge on October 10th wasn’t the end of that serious selling, as this leading benchmark dropped another 2.1% the next day! That’s when gold really caught a bid, blasting up 2.5% on both investors and gold-futures speculators buying aggressively. That was a huge rally, gold’s best up day since late June 2016’s surprise pro-Brexit vote in the UK. The gold stocks took off like a rocket on that.

GDX soared a massive 6.7% higher that day, its major gold miners leveraging gold’s advance by 2.7x! That shattered this leading ETF’s recent $19 resistance, paving the way for a return to its consolidation trend channel of recent years between $21 to $25. And if gold investment has indeed turned the corner to a new accumulation phase, the coming gold-stock gains should be huge. Consider early 2016’s example.

Much like last month, the gold miners’ stocks were deeply out of favor in January 2016. This small sector was largely forgotten and despised, leaving the gold stocks trading at fundamentally-absurd all-time lows. That very week I fought prevailing sentiment to take the contrarian side and argue that a major new bull was imminent. And indeed GDX skyrocketed 151.2% higher in 6.4 months, leveraging gold’s upleg by 5.1x!

That massive gold-stock mean reversion higher out of extreme anomalous lows started when sentiment was overwhelmingly bearish, when gold stocks were left for dead. As traders’ sentiment started to shift back to neutral and eventually bullish, that psychological change fed on itself. The more gold stocks rallied, the more traders wanted to buy them. The more traders bought them, the more gold stocks rallied.

Given the magnitude of these new gold-stock and gold surges on last week’s stock-market plunge, and the crucial confirmation of strong gold investment buying via GLD by American stock investors, there’s a good chance sentiment is again shifting. Seeing the mighty S&P 500 plummet 5.3% in just two trading days after widely being considered riskless is a major, jarring discontinuity. It has to really taint sentiment.

And if investors start worrying these lofty stock markets are getting riskier, they will naturally start upping their tiny portfolio allocations to gold. As gold powers higher on that, the gold stocks will return to favor. They are actually the last cheap sector in these entire stock markets, likely the only sector refuge if the S&P 500 rolls over into a long-overdue new bear. The Fed’s record QT tightening virtually assures that outcome.

The greatest gains in the next gold-stock upleg won’t be won in the popular ETFs like GDX and GDXJ, as they are far-overdiversified and burdened with way too many under-performing gold miners. So it’s much more prudent to deploy capital in the best individual gold miners with superior fundamentals. Their gains will handily trounce the ETFs, further amplifying the already-huge upside potential of this sector as a whole.

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 weeklyand 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 doublethe long-term stock-market average. Subscribe today and get invested before gold stocks soar way higher!

The bottom line is gold-stock sentiment looks to be shifting. It was naturally very bearish following the recent forced capitulation, which left this small contrarian sector despised. But gold stocks soon started recovering from those extremely-oversold and absurdly-undervalued lows. Then last week they surged with gold as the general stock markets plunged. That may prove a major sentimental inflection point.

American stock investors suddenly remembered gold, aggressively buying it to diversify their bleeding stock-heavy portfolios. Once gold started moving, the gold stocks nicely leveraged its gains like usual. All this suggests speculators and investors are just starting to warm to gold and gold stocks again. That portends a sentiment mean reversion and overshoot, fueling massive new uplegs in gold and its miners’ stocks.

-Adam Hamilton, CPA