Over the course of gold's bull, the companies that explore for and mine this metal have greatly prospered. The gold-stock sector has thus been one of the top-performing in all the markets over the last 10+ years, and its investors have been richly rewarded. But this last year or so has been a tough one, one that sure has tested investors' mettle.
Gold stocks had been doing great since their panic lows in 2008. Measured by the venerable GDX Gold Miners ETF, gold stocks were up nearly 300% to their late-2010 highs. This well outpaced the gains of both the general markets (+86% as measured by the S&P 500) and gold (+100%) over this time. But once 2011 rolled around, gold stocks' powerful up-leg started stalling out. Even though gold prices stayed strong, the gold stocks succumbed to weakening global equity markets and a weakening commodities patch.
15 months later, now entering Q2 2012, gold has held steady and the S&P 500 has enjoyed an excellent two-quarter run that has brought it to new cyclical-bull highs. These conditions should have boded well for gold stocks. But as you can see in the chart below, they continue to languish in their slump. And the juniors in particular have been getting crushed!
Illustrating this gold-stock malaise are the performances of three of the top gold-stock ETFs that capture the various stages of the gold ecosystem. GDX is comprised of the world's biggest and best gold stocks, the bellwether producers. The GDXJ Junior Gold Miners ETF is comprised of some of the world's finest small-cap producer stocks. And the GLDX Gold Explorers ETF is comprised of several of the world's elite pre-production exploration stocks.
Over time gold stocks' primary driver is gold. Rising gold prices usually lead to rising profits, which ought to translate into rising stock prices. And for producers and non-producers alike, rising gold prices increase the value of their in-ground assets. Consequently in a gold bull gold stocks tend to leverage the metal to the upside, and for the most part they have.
Unfortunately though there are seasons where this hasn't been the case. And in the last year or so we've been entrenched in one of these seasons. As you can see, gold has performed quite nicely over the last 15 months. Since the beginning of 2011 it is up an impressive 17.2% to this week. This run encompasses a strong breakout to its all-time high of $1894 in August, mixed with a few sell-offs. All in all, a nice bullish uptrend.
So with gold performing well, the gold stocks should have followed suit, right? Well if you're a gold-stock investor, you hardly need to see this chart to answer this question. Calling a spade a spade, gold stocks have been dogs! Rather than following gold higher, since 2011 gold stocks have plagued investors with gut-wrenching downward momentum.
Of all the gold stocks the majors have seen the least of the damage. And this is to be expected due to their larger size and institutional support. The stocks that comprise GDX have a weighted-average market cap of $21b based on their percentages of net assets, so naturally it takes a lot more capital inflow/outflow to move these stocks up/down.
Though GDX did have a run that briefly saw it achieve a high in September, on balance it has been trending down. While gold has been up nearly 20% since the beginning of 2011, GDX has been down nearly 20%. Not only is there no upside leverage, the gold stocks haven't even been able to keep pace with gold.
And it gets much worse for the smaller more-risky gold stocks. GDXJ, comprised of a mix of small-producer and elite exploration stocks, has a component weighted-average market cap of $757m based on percentage of net assets. It obviously doesn't take much capital flow in either direction to sharply move the stocks in this ETF. And as you can see, concerted selling has corralled GDXJ within a tight downtrend over the last 15 months, down to the tune of 40%.
Speaking of tight downtrends, GLDX has been subject to the same fate. GLDX is comprised of many of the world's top explorers, companies that haven't yet built their mines. And with its component stocks sporting a weighted-average market cap of $530m based on percentage of net assets, this ETF can move even faster. GLDX has shed a dismal 49% since the beginning of 2011. Ouch!
Unfortunately the performances of GDXJ and GLDX are not the worst of it for the juniors. Since the 90 or so stocks that comprise these ETFs are the crème de la crème of this group, it's safe to assume that the majority of the hundreds of lesser known, less prolific, and smaller juniors have fared even worse over this stretch.
In trying to wrap my mind around this gold-stock carnage, like most investors I've taken part in my fair share of commiserating in recent months. And in talking with numerous acquaintances that have been active in this realm for an extended period of time, I've been taken aback by the amount of negativity towards gold stocks, especially the juniors.
Now of course the vast majority of investors are going to hate any sector if recent performance is rotten. This is the psychology of the markets. But gold stocks have endured previous slumps like this, and there's always been a steady group of contrarians that have used these situations to back up the trucks and load up for the next up-leg. But man, even many of the tried-and-true so-called contrarians seem to have capitulated, all but abandoning this sector.
Seeing such little interest in gold stocks, I decided to try to quantify it by taking a look at the capital volumes of these ETFs. Capital volume is a way of measuring volume in dollar terms, a loose way of gauging interest in a stock. If capital volume accelerates faster than can be justified by stock-price appreciation, then investor interest is likely increasing. And if capital volume is falling at a faster clip than can be explained by declining prices, investor interest is likely decreasing.
I especially wanted to take a look at capital volume during the last six months. Since its correction low in early October, the S&P 500 has been on a tear. And in soaring an impressive 29% to achieve this week's cyclical-bull high, investors have seemingly gained a lot more interest in the stock markets.
Even though gold has only been marginally higher over this same period (+2.3%), this is the type of environment where gold stocks should be soaring to reestablish positive leverage. But the gold stocks have ignored this big stock-market run over the last six months. In fact, over this time the GDX, GDXJ, and GLDX ETFs are down 6.7%, 2.0%, and 5.6% respectively. And as you can see below, GDXJ's capital-volume trend really puts this lack-of-investor-interest-in-gold-stocks phenomenon in context.
Capital volume is calculated by multiplying share price by volume, and is a measure of the dollar value of the shares that trade hands on a daily basis. In order to smooth out the data, essentially normalizing the anomalous high-volume and low-volume days, I used the 20-day moving average. And this six-month chart really helps explain some of the pain gold-stock investors have been feeling lately.
Incredibly GDXJ's capital volume is down 38% since the beginning of October. In dollar terms, this ETF has seen $50m of daily trading activity vanish. And this plunge is more than just the loss in value of GDXJ shares. It is a combination of lower share value (down 2.0% over this stretch), and to a greater extent lower volume. In the last six months GDXJ's 20dma of raw share volume is down by 24%.
And this capital-volume decline is prevalent in GDX and GLDX as well. Over this same period GDX has seen an 18% drop in volume, which mixed with a 6.7% lower share price leads to a capital-volume decline of 29%. And GLDX's 14% drop in volume and 5.6% share-price decline has led to its capital volume being down by 31%.
The fact that gold stocks are down over the last six months is hard enough to swallow. But this lack of investor interest implied by lower capital volume can sure be discouraging. And this begs the questions that have recently been echoing in the beaten-down gold-stock arena. Is all hope lost for the gold stocks? Are investors ever going to return?
As bad as things seem right now, these are questions we've seen many times over the course of gold's bull. And I believe the answers are the same as they've been in the past, emphatically no and yes. The only way these answers can be different is if the gold bull is over. And it is not even close to being over. Gold's structural fundamentals are way too strong. And this metal needs the miners to thrive in order to sustain the integrity of its supply chain.
I know it's hard to believe that investors will return to gold stocks after looking at these charts. But rather than fear them, we can embrace these charts for the opportunities they present. Throughout gold's bull, investor interest in gold stocks has flowed and ebbed. And this interest tends to overshoot in both directions, either blasting them unsustainably higher or unrighteously shunning them like the Black Death.
As mentioned there are seasons where gold stocks disconnect from their underlying metal. And by all accounts we are likely at the tail end of a long one where they have indeed underperformed. But their fortunes are bound to change, and we are overdue for a major outperformance cycle. My business partner Adam Hamilton clearly illustrated this concept in his essay last week that took a deep technical look at how cheap gold stocks really are.
Gold stocks are actually as cheap now as they were near 2008's panic nadir! And if the sentiment cycle that has been so consistent across this entire bull swings back in favor of these stocks, thus drawing investors back in, then I submit to you that this sector, especially the juniors, is poised to explode. And I'm not talking a violent explosion that will lay waste to gold stocks like so many believe, I'm talking an explosion akin to a rocket ship blasting off into space.
Now is the time where the mettle of true contrarians is tested. And the rewards for the brave can be legendary, especially in the beaten-down junior gold stocks. As seen in the first chart, the juniors (GDXJ and GLDX) have big downside leverage to the larger less-risky major producer stocks (GDX). But when gold stocks are in favor, and the majors start to rally, the juniors usually provide big positive leverage.
In today's environment blood is indeed flowing in the streets in the little junior sub-sector. These stocks are being priced with very little value in their assets, as though gold's bull is over and there will be no need for the next generation of gold mines. But this bull is not over, and juniors' place in the supply chain has grown increasingly important with the majors' reserves dwindling.
With juniors solely relying on selling their shares to fund operations, this carnage simply can't last for too long or they'll go extinct. And if the juniors go extinct, then the gold market is in big trouble. Accordingly I expect the underperformance-to-outperformance swing that juniors have been party to in the past to spawn a massive explosion.
And there are plenty of quality junior gold stocks that will explode, via a big inflow of investor capital that will push them sharply higher.
The bottom line is gold stocks have had a rough last year or so. Not only have they underperformed the markets, they've underperformed gold. And the juniors in particular have been sold off with reckless abandon. Consequently this underwhelming sector has flown off investors' radars.
Thankfully gold stocks will always have life in them so long as gold's bull is alive and well. And as contrarian as it is, I believe these stocks will soon be bursting with life. Gold stocks are overdue for a shift in sentiment, and when the bids start coming in they ought to explode to the upside. When this happens, those brave enough to buy the juniors will need to tighten their seatbelts for an exhilarating ride.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.