Thursday, December 24, 2009

What's Really Holding Gold Stocks Back?

The answer, in my opinion, is the stock market. The stock market is doing too well. I think Gold stocks will really start to accelerate higher once the stock market starts to roll over. Before you tell me that I'm off my rocker, allow me to demonstrate the validity of this concept with actual historical data.

People think if the stock market goes down, then Gold stocks will also. It was true in 2008, so it must always be true, right? Actually, no. The opposite has been true during the current secular Gold stock bull market and is shown to be true over longer cycles during the past century. Here is a 10 year log scale chart of the $HUI Gold Bugs Mining Index divided by the S&P 500 Index (i.e. an $HUI:$SPX ratio chart):

Now, this Gold stocks to S&P 500 chart should be a wake-up call for Gold bulls who aren't aware of it. Because if Gold stocks can't outperform the S&P 500, then we should all just go join the paperbug party. I submit to you that three brief legs in the Gold stock bull are all that separates senior Gold stock indices from having the same performance as the S&P 500 over the past 10 years. Of course, those bullish impulse legs were legendary when set against the associated bear market declines of the S&P during those periods and have resulted in an 18 fold out performance of the $HUI to the S&P 500 over these past 10 years. I don't mean to downplay their significance by any means.

So, no, it's not as simple as "stock market goes down, Gold stocks go down." Far from it. And I am not bullish on the future prospects for the general stock markets for those didn't already know. I certainly had my a** handed to me trying to short the general markets earlier in the year and learned an expensive lesson in risk management, but that doesn't change the weak fundamentals underlying the economy that are continuing to play out and will eventually again be reflected in stock prices before this secular stock bear market is over.

Additionally, there is a fundamental underpinning to this relationship between "general stocks down, Gold stocks up." This link is in the "real" price of Gold or the nominal Gold price divided by the nominal price of a basket of commodities, a crude measure of Gold miner profitability. Here is a 10 year weekly log scale ratio chart of the Gold price ($GOLD) divided by a commodity basket/index ($CCI) set against the $HUI (at the bottom of the chart in linear scale) showing this relationship:

It doesn't seem a stretch to see a smallish further rise in the current $Gold:$CCI level after the recent quick plunge in this ratio. When the economy does poorly, most commodities (and stocks) do poorly. Gold tends to outperform other commodities during stock bear market legs, even if its nominal price drops. Notice it didn't take much of a Gold:CCI ratio move higher for leg "#2" labeled in the charts above to move Gold stocks higher because the initial surge from leg "#1" had already made for very bullish fundamentals - we are in the same situation now as the Gold:CCI ratio is at MULTI-DECADE HIGHS. Fundamentals support a further move higher in Gold stocks, the technical position of Gold and Gold stocks is a perfect low-risk buy set-up, and seasonal factors are positive thru to the March to May time frame. This is why I am now insanely bullish on Gold stocks. Well, that and the fact that I now have to talk my book because I am all in on the long side in my trading account...

On a final bullish note, did everyone see the red-headed step child of precious metals today (i.e. Palladium) and is this a vision of things to come in Gold?

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