Wednesday, August 10, 2011

Gold Stocks – Cheapest since early 2009

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.


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 (CLICK ME).


  1. Always good quality posts Hobo, You must put a lot of effort into this. Keep it up.

  2. Thanks euphoria. Does take some time to writeup, but I enjoy getting my 2 cents out there and it's handy as something to reflect back on at times.

  3. Hmm SMT says "a move back down to $1200-$1300 over the next 3 to 4 months." for gold.
    So Im unsure about gold stocks right now, short term they might be good though.

  4. Lets say I want to put something away for my sons. I could buy them a gold or silver coin each, some stocks, or put some money in banks for them. Or I could borrow from a bank to own a piece of land that will certainly increase in value. All of these are sensible things to do right?

    The punter like me generally hasn't got a clue. Gold looks set for a fall in my view, but was just as convinced when it was USD$1400/oz. The question of currency seems more important to the punter. Who can afford gold coins after all? Not many of us.

    What if DOW:Gold continues to decrease, or rapidly increases? That's just confusing for gold stocks in whatever currency you trade them in. So I guess if gold is volatile, I want to diversify my stocks away from it and not put all their eggs in that basket.

    However, you make a brilliant point BB, so I'm really curious which stocks you own to offset your risk with dividends. Whose got the highest franking credits and how reliable are they?

    Also, why not just buy a 10z contract with a local CFD provider? Wouldn't that be the cheapest way to invest in gold.

  5. Anon, I am a SMT subscriber. Gary has been calling that D-wave on and off for the last several months. Gold is in a parabolic spike, we could get a correction to $1300, we could also see a huge blowoff top unlike anything we've seen in this bull market to date (like Silver saw earlier in the year).

    antipody, the affordability of Gold coins is relevant to the size you are buying. For example I bought some 1/10oz coins a few weeks back for $180 each. Last weekend I bought some 10g Gold Olympic coins for spot ($510 each at the time). In 1980 punters were buying Gold at $850, in this bull run they will be buying at over $2000. It depends on how and why you are buying Gold as to whether it’s expensive. There are those that stack Gold as they think it will be remonetised or we will see SHTF so they will literally need coins to trade for food, so it's not expensive to them because the price is not really relevant.

    I certainly wouldn't advocate putting all eggs into one basket, but it does depend on your situation as to what suits. I'm young, no kids, no debt & watch the market like a hawk; I take more risk than I would expect a parent to.

    I hold two stocks that pay a dividend. One is stock in the company I work for and I would sell the shares if I could. The other is RCO (Royalco Resources) who are paying around a 10% FF dividend (but there is no guarantee that rate of return will be stable long term). I don't offset my risk with dividend paying stocks.

    Buying a CFD is 'paper Gold', it really goes against the whole philosophy of buying a physical metal to protect wealth. I buy physical Gold as a hedge against a complete financial collapse and to hold for exposure to the bull run (will look to sell some when I think the peak is coming). I speculate shorter term with Gold shares as I enjoy analysing individual companies and find it works well for me.

  6. Nice analysis, BB.

    Do you have any view on the often heard comment (at least in the US) that the rise in the popularity of the big gold and silver ETFs (GLD and SLV) has contributed to retail buyers preferring to get their gold and silver exposure through GLD/SLV rather than the miners?

    After all, GLD and SLV didn't exist in the "old days", and if you were bullish on the metals your only real choice was to buy the mining stocks.

  7. Thanks Turdle GG.

    I think there is probably some truth to that, however the internet (and online trading) has opened up investing to many more people than would have been involved in 1970s/80.

    For example how many young blokes working in IT were buying mining stocks in their spare time (like I am) back in 1980? Information wouldn't have been nearly as accessible to the common man. They would have been relying on brokers and information on stocks through newspapers, rather than the instant access to company & price information we have today.

    So I still think there will be plenty of people to buy the mining stocks and drive them higher with the metals. It is worth noting though that Gold stocks actually performed better in the 10 years following the end of the bull market than during it according to some sources I've seen.

    I'm personally of the belief those ETFs have the metals they claim, so they are probably still adding to real demand for physical.

  8. Good post again BB. Do you know of a product (eg like an EFT) that we can trade that tracks the XGD? It seems to be performing well at the moment and diversification across so many miners would be great!

  9. Thanks Dave, not sure on a product that tracks the Australian Gold stock index. There are other global Gold share ETFs. It doesn't look like there is one that tracks our local index, having checked Google, eTrade and IG Markets.

  10. I think you will find Newcrest tracks the XGD pretty well - cross correlation between 67 and 100% over the last 2 years. Nothing else seems to come close. Stands to reason really, although I haven't checked out the current weighting of NCM in the XGD