Gold Miners ETF (GDX)

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Gold Stocks to Overshoot
By: Adam Hamilton | July 19, 2024

The gold miners’ stocks have blasted higher to a powerful upside breakout this month. Amplifying gold’s underlying surge, they’ve achieved major new bull-market highs. Yet despite that big rallying, gold stocks remain undervalued relative to the metal they mine that drives their earnings. They still need to mean revert much higher to reflect prevailing gold prices, with momentum buying fueling a proportional overshoot.

Markets are forever cyclical, flowing and ebbing in endless marches of uplegs and corrections within bulls and bears. Price action is pendulum-like, oscillating between opposing extremes. Those include high and low technicals, overvalued and undervalued fundamentals, and greedy and fearful sentiment. Long-term averages reflect the bottom midpoints of pendulum arcs, mean-reversion targets for stretched prices.

But pendulums pulled way to either side don’t stop in the middle once they start swinging back. Their kinetic momentum carries them well through their midpoints in proportional overshoots to the other side. Markets dragged to either extreme function similarly, not just normalizing to averages but swinging right through to opposing extremes. Gold-stock cycles are no exception, and they recently saw an extreme anomaly.

Gold-mining profits are overwhelmingly driven by prevailing gold prices, as mining costs only change gradually. This is readily evident in the major gold miners included in the benchmark GDX gold-stock ETF. Their last-reported quarterly results were Q1’24’s, where the top 25 GDX gold miners averaged $1,277 all-in sustaining costs. Subtracting those from gold’s average price yields a great sector earnings proxy.

In Q1 gold averaged $2,072, so GDX-top-25 profits ran $795 per ounce. A year earlier in the comparable Q1’23, gold was $1,892 while it cost these elite majors $1,302 to produce. That made for unit earnings of $589 per ounce. So during a year where average gold prices rallied a nice 9.5%, the GDX-top-25 majors’ profits surged 34.9%. This latest real-world example clocked in at excellent 3.7x upside leverage to gold!

Stock prices ultimately reflect some reasonable multiple of underlying earnings, and gold price trends fuel the great majority of gold miners’ profits. Thus gold stocks have always acted like leveraged plays on the metal they mine. After painstakingly analyzing the GDX top 25’s latest results for 32 consecutive quarters now, I can sure tell you that takes a ton of work! But an easy proxy decently reflects this key fundamental link.

It’s simply the ratio between gold-stock and gold price levels. Charted over time, this shows whether gold stocks are overvalued or undervalued relative to the metal driving their earnings. For many years I’ve been using the GDX/GLD ratio or GGR variant of this metric. It divides that leading gold-stock ETF’s daily closes by those of the mighty American GLD gold ETF, the largest physical-bullion-backed one in the world.

The GGR’s positioning relative to recent-year averages is analogous to gold stocks’ valuation pendulum. That was recently pulled to an exceedingly-anomalous extreme, with the mean reversion now well underway. Odds highly favor that momentum buying fueling a proportional overshoot, arguing much more gold-stock gains are coming. In this chart the GDX/GLD ratio in blue is superimposed over the raw GDX in red.



Flagging market extremes is important for trading since they mark major cyclical reversals, the tops of pendulums’ arcs. The more-extreme any extreme, the greater the likelihood it will spawn a proportional mean reversion and overshoot. An astounding one happened in late February, when GDX plunged to just $25.79. That was actually marginally under early October’s $25.91 when gold’s latest upleg was born.

Over a 4.8-month span where gold had powered 11.7% higher in a strong upleg, the leading gold-stock ETF somehow slipped 0.5% lower! That was insane, as I pointed out to our newsletter subscribers at the time. Normally major gold stocks amplify material gold moves by 2x to 3x, thus GDX should’ve been up 23% to 35%! So our newsletters added a bunch of cheap gold-stock trades in February as this anomaly worsened.

On February 28th at that inexplicable GDX nadir, the GDX/GLD ratio collapsed to just 0.137x! Though an extreme 4.0-year secular low, that understates how anomalous this was. The GGR had only been slightly lower at 0.133x on one single day in the dark heart of March 2020’s pandemic-lockdown stock panic! The market fear then was off the charts, as the flagship S&P 500 index plummeted 33.9% in just over one month!

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