Cheap Gold Stocks

Not even mighty gold escaped late September’s commodities massacre, so gold stocks never stood a chance. They were sucked into the violent maelstrom of commodities-stock selling, plunging sharply. And as usual when gold is weak, the gold stocks amplified its downside. The result is very cheap gold stocks today, great bargains. Relative to gold, they’ve been hammered back down near panic levels.

Throughout the entire stock markets, the long-term price of any individual stock is ultimately driven by its underlying company’s profitability. The more any company earns, the higher its stock price will eventually be bid to reflect those profits. And for gold miners, the price of gold is directly responsible for the lion’s share of their profitability. During a secular gold bull, gold prices generally rise much faster than mining costs. This leads to expanding gold-mining profit margins.

So over time higher gold prices directly translate into greater gold-mining profits, which ultimately entice investors and speculators to bid up gold-miner stock prices. Thus general gold-stock price levels are best understood in relation to the gold price that drives them. This critical fundamental relationship is a powerful trading tool too. When gold stocks get too cheap relative to gold, it is a great time to buy low.

And this is certainly the case today, as is readily apparent in the HUI/Gold Ratio. This HGR has been my favorite tool for quantifying the relationship between gold and gold stocks for many years now. It simply takes the flagship gold-stock index, known by its symbol HUI, and divides its close by the price of gold. Charted over time, this ratio provides outstanding insights into when gold stocks are cheap or expensive relative to the precious metal they bring to market.

In order to understand just how cheap gold stocks are today, we need some secular context. This first chart looks at the HGR over the better part of the last decade. It is slaved to the right axis in blue. For comparison, the raw HUI gold-stock index is rendered in red off the left axis. Thanks to the recent commodities and commodities-stock scare, gold stocks are now at some of their cheapest levels of their entire secular bull!

This week, the HUI slumped to 513 despite gold trading around $1642. The first time the HUI hit this level in March 2008, gold had just crossed over $1000! Today’s weak gold stocks despite such strong gold prices were enough to drive the HUI/Gold Ratio down to 0.313x. As you can see in this chart, the only time the HGR has been lower was during 2008’s epic once-in-a-century stock panic. Talk about cheap! (more)