Australian readers please note: The figures used in this post are primarily US centric. That said our Gold stocks tend to closely follow the lead of their US counterparts (US Gold stocks) rather than form their own trend based on the local price of Gold. This fact is made obvious if you just compare the trend between the Australian Gold stock index (the XGD) and the US Gold stock index (the HUI). Below is a chart comparing their performance over the last 5 years:
You can see the trends are almost identical. In early 2009 the price of Gold locally soared to over $1500 as the AUD collapsed against the USD in the heart of the GFC, but it’s clear our Gold stocks stuck to the trend of their US counterparts and didn’t start rallying until the US price of Gold (and their stocks) took off in late 2009. I’m just pointing this out to show that the below information is probably just as relevant to you.
GOLD STOCKS ARE THE CHEAPEST THEY HAVE BEEN SINCE EARLY 2009.
You might be saying “What? The HUI Index was 300 in early 2009, it is 550 now. How can you say they are cheaper? Their prices are almost double!”. To which my response would be “Take a look at the price of Gold stocks relative to the price of Gold”.
Early 2009 was in some ways very similar to the setup that we have now. The stock market had just crashed. Gold had just rallied several hundred dollars (although in the case of early 2009 the large rally was following a late 2008 collapse in the price of metals).
Looking back at early 2009 and Gold stocks were a good buy. It’s during this period that I first started trading precious metal stocks (after buying the metals themselves heavily into the late 2008 price dip) and to this day I still wish that I had just bought as many as I could at the outlandishly low prices and held them until today.
You might be wondering what I mean by saying take a look at stocks relative to the price of Gold. If you take the price of Gold and divide it into the price of an index we get a ratio that you can use as a measure of fair value to calculate whether it's worth buying the metals or related stocks (using the ratio along with other factors of course). It's much the same as the way some investors divide the price of Silver into Gold (resulting in the Gold/Silver ratio or GSR) to work out whether Gold or Silver is the better value at the time.
Here are charts of both the HUI Gold Bugs Index (HUI) & the Philadelphia Gold/Silver Sector Index (XAU), having divided the price of Gold into them:
As you can see we have seen a large fall in the ratios as Gold has rallied strongly and the precious metal stocks have fallen from their highs made earlier in the year.
So here we sit with Gold stocks as cheap as they were in early 2009.
Now it's important to remember that there is more than one way these charts can reverse to a fair ratio. We can see the ratio move higher if the stocks rise or if the price of Gold falls (or a combination of both).
Gold has moved in a very parabolic fashion with a rise of around $300 in only 6 weeks.
A week ago I posted a chart showing that Gold was bumping up against the top of a channel in which it's traded for 3 years (LINK). Well, we've seen Gold smash through the top of this channel and keep going:
Now don't get me wrong. I still think Gold may be forming a (short term) top around these levels. The run we've seen has been extraordinary. However, let me point out another long term resistance that was recently breached to the upside. This chart is from a post I made in February this year (LINK):
Shortly after breaking past the resistance line (which had been in place for 7 years) we saw Silver spike from $30 to almost $50 in the matter of 2 months. Could it be Gold's turn to make a spectacular breakout from a longer term trend and catch the market off guard?
I'm not suggesting that Gold will see a move as spectacular as that, but I think there is potential for Gold to keep moving higher after the breakout.
Investors/traders have just seen Gold maintain course and continue higher during one of the most volatile market crashes we have ever seen. Surely this will give Gold credit in the markets eyes following the ASTOCKALYPSE that we saw.
If Gold does head higher, a shorter term correction is still likely at some point. A move back down to test the channel breakout would give us a low of around US$1680 and it would be a very healthy move.
Even if the price of Gold doesn't rise, the stocks still need to see a 30% appreciation in price (obviously this would change if Gold were to fall or rise further) for them to return to a fair ratio (e.g. a similar ratio to that seen over 2010 and earlier this year).
There are still many potential risks (the bandaid fixes that are being applied to Europe, US and elsewhere are not going to permanently stop the bleeding), but in my opinion there is a case to go long Gold stocks at this point. This should not be considered any more than a trade at this stage and obviously you would be best not taking a position unless you were confident to read the market yourself as given recent volatility it could be a trade you need to exit quickly and decisively if things took a turn for the worst (market turns down again or Gold returns to earth).
As I mentioned in a post this morning, I have increased my own exposure to Gold stocks over the course of the last few days in preparation for this trade, bumping them up to 50% of my portfolio (certainly not a position for the faint of heart).
For a free gram of Gold signup and trade metals on BullionVault.com (CLICK ME).