Gold Ratios
By Steve Saville
Overview
We've reached a point where all the major markets are finely balanced and ready to move sharply in one direction or the other. Gold stocks are very close to important support and if that support gives way it is likely that both gold and gold-stocks will plunge. The US$ has rallied over the past 3 weeks, but has just reached a level where the rally is likely to fail (if it is going to fail). Bonds are testing important support and will probably fall much further if this support gives way. The CRB Index is positioned just below major resistance, needing to gain only 3% or so to break out to a 4-year high. And the major stock indices are all situated just below important resistance (defined by the August highs for the S&P500 and the Dow Industrials and the 200-day moving averages for the NASDAQ100 and NASDAQ Composite). It would make the most sense, based on the current fundamental backdrop, if gold stocks held support and began to rally, thus signaling the end of the Dollar's counter-trend rebound and projecting an upside breakout by the CRB Index and a downside breakout by bonds. But whatever happens we expect gold stocks to provide the early warning signal because gold is likely to move in advance of breakouts in the CRB Index and the Dollar, and gold stocks are likely to move in advance of gold.
The S&P500 in terms of Gold
Below is a chart showing the S&P500/gold ratio (the number of ounces of gold it takes to buy the S&P500 Index). Over the past 2.5 years the ratio has moved in a well-defined downward-sloping channel. Every significant rally in the ratio since April of 2000 has ended right at the channel top, except for the rally that commenced in July of this year (which failed well below the channel top). It is therefore reasonable to assume that the current rally will fail at, or below, the channel top. If the current rally makes it to the top of the channel at some point over the coming 2 months then the ratio would peak at around 3.2:1. With the gold price at $300 this would require the S&P500 to move up to 960 (about 3% above its current level). With the gold price at $320 the S&P500 would need to reach 1024 (about 9% above its current level) to bring the ratio up to 3.2.
The S&P500/gold ratio tends to peak when the S&P500 is near a high and when the gold price is near a low, so if we are going to get a peak in the ratio during the next 2 months then the gold price should soon start moving lower and the S&P500 should continue to work its way higher. The other possibility worth considering is that the ratio will immediately turn lower as gold starts to rally and the S&P500 starts to decline (note that the ratio peaked at around this time last year).
As discussed in the "Overview" at the top of today's commentary, all the markets are finely balanced right now and gold stocks are expected, by us, to point the way as far as the next 2 months of financial-market action are concerned. If gold stocks start to rally over the next few days then the odds would shift in favour of the S&P500/gold ratio falling back to the bottom of its channel over the next 2 months rather than moving up to the top of its channel. In 2 months time the channel bottom will be hit if, for example, the S&P500 is at 700 and the gold price is at $350.
Gold versus gold stocks
A characteristic of the gold bull market that began in the final quarter of 2000, and, in fact, a characteristic of most gold bull markets, is strength in the prices of gold stocks relative to the bullion price. The below chart of the ratio of the TSI Gold Stock Index (TGSI) and the gold price illustrates this relative strength on the part of gold stocks over the past 2 years. Note that, as has been the case with the gold price and most of the major gold stocks, the TGSI/gold ratio has consolidated since peaking in May/June. If the gold price and the HUI break out to the upside from their triangular consolidation patterns then we would expect the TGSI/gold ratio to do the same, that is, we would expect gold stocks to resume their out-performance of the gold price.
Below is a chart showing the stock price of the world's largest gold miner - Newmont Mining - relative to the gold price. As long as the NEM/gold ratio remains above the low reached in July and the TGSI/gold ratio doesn't break below the uptrend-line shown on the above chart we can be confident that the medium-term trend for gold remains bullish.
Steve Saville
Hong Kong
December 2, 2002
Regular financial market forecasts and
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