Tuesday, December 8, 2009

Gold Stocks and Bear Markets

When Gold is in a bull market, so are Gold stocks. There are always exceptions in markets and anyone who looks hard enough can find weeks or even months when Gold is going up and Gold stocks aren't. Speculating isn't easy, to be sure. But one tends to play the odds to maximize one's chances of success when trading or investing.

If you think Gold is going up, then you're safe 8 times out of 10 investing in Gold stocks. It's not 100% and the exceptions generally relate to times when Gold is not in a secular bull market and during market crashes or mini-crashes. Gold is in a secular bull market, so we don't have to worry about this first item. But focusing on the second item, this is what happened to Gold stocks in the Great Fall Panic of 2008 (which the federal reserve and Treasury were absolutely, entirely and irrefutably unable to stop). Ironically, at times like this past fall's panic, the fundamentals for Gold stocks tends to improve rapidly while they are tanking (due to an increasing Gold to commodities ratio during the crash).

But what about Gold stocks during a bear market? If the Dow Jones and/or S&P 500 enters a new leg in this general stock bear market (which is far from over), can Gold stocks still go up? Doesn't a falling market drag all stocks down with it? In the case of Gold stocks, the answer is an emphatic NO!

There are so many examples in history that I will resort to the same old pictures and charts I show every time I am asked this question. The easiest to relate to are those from recent history, no? Before the current bear market that began in the fall of 2007, the last bear market we had was from 2000-2003. Ignoring the NASDAQ, which was a tulip mania sort of collapse, and focusing instead on the S&P 500 index yields information that I believe is highly relevant to the current situation.

Here's a chart of the last bear market from 2000-2003, plotting the S&P 500 (candlestick plot) versus the unhedged Gold Bug Mining Index ($HUI - the black linear plot):

The old adage that Gold stocks rise and fall with the stock market is dismissed as false by even a casual perusal of the actual data. Now, it is true that when the stock market really tanks fast, everything is thrown out in a panic sell off. If you think a market crash is dead ahead, don't buy Gold stocks. I don't think we're due for another crash any time soon. The first leg down, if you believe in Elliott Wave theory, is not the vicious leg down, the 3rd wave down is. In other words, we have a 1st leg down in the bear market, then a bounce into the spring, then we may have a crash-like scenario or at least a vicious drop. The fireworks aren't likely to get started immediately.

And, of course, everyone likes to talk about the worst bear market in the last 100 years, the 1929-1932 bear that claimed 89% of the Dow Jones as its victim. Even if a replay of this scenario is coming, the favorite blue chip senior Gold miner of the time, Homestake Mining, simply yawned once it made it through the 1929 crash and made its way slowly higher in spite of the carnage in the stock market (chart stolen from the Long Wave Group - check out their site if you are into Gold and/or the Kondratieff Cycle):

If a popular blue chip Gold miner can gain 50% during a 90% drop in the stock market, I'd say Gold stocks have the possibility of bucking the stock market bear that I believe is far from over. And how about the 1970s? The best chart I can show you is from the 1973-1975 bear market. During this time, the S&P 500 lost about 50% and here's what happened to a major Gold mining stock index (Barron's Gold Mining Index [BGMI], chart stolen from sharelynx.com):

Some things I have learned by experience and by looking at past historical periods when Gold stocks are in a secular bull market (like now):

1. Gold stocks often fall with stocks during the initial portion of a cyclical stock bear market (i.e. 1929, 2000, 2008) but then start marching to their own drummer.
2. Gold stocks do not survive true market crashes or panics but can rise SIGNIFICANTLY even in the midst of SEVERE bear markets.
3. The steepest and fastest part of a stock bear market tends to coincide with corrections in the Gold stock sector.

So, in my humble estimation, the stock bear market is going to take a few months to get a head of steam up for its next leg down. During that time, once this brief Gold and Gold stock correction is over (I suspect before December is over), I believe both Gold and Gold stocks will EXPLODE HIGHER EVEN IF THE STOCK MARKET GOES LOWER.

This is my thesis. It is backed by actual facts and data from relevant history. If I am wrong and you lose all your money speculating based on the homework I did, I will refund your subscription fees (but not the money you lost...). If it is any consolation to those bullish on Gold and Gold stocks, I will be 100% invested in Gold and Gold stocks (with a small exposure to silver and silver stocks) from the long side before December is over.

My "dream" scenario is to ride the Gold bull higher into the March to May 2010 time frame, then sell Gold stocks and switch to shorting the stock market to catch the juiciest part down of the bear market leg in general stocks that I still think is coming. My physical Gold is not for sale until the Dow to Gold ratio gets to 2 or less.

As far as the shorter term, the current correction is likely almost over in price but needs a little more time if history is a guide. I may well start buying before the end of the week.

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