It is generally accepted that a 21-year bear market in gold turned in 2001, since when we have been in an emerging bull market.

Captain Hook challenged me recently to come up with a wave analysis of the XAU : Gold price ratio. This compares the standard XAU index of gold shares versus the price of the metal. In general, it is thought that as gold rises this ratio too should rise, in favour of the shares.

In order to see how the PM shares have done relative to the metal, I have plotted not only the XAU : Gold ratio but also the HUI (Unhedged) Gold shares : Gold ratio. Furthermore I have time- and ratio-aligned both charts for ease of comparison, as shown below.

The HUI : Gold ratio is the blue chart of course. White vertical dotted lines show obvious feature correlations between the two charts, as might be expected - they tend to go up and down together. The un-hedged share index ratio, as you would expect, is more price sensitive to spot gold. This can clearly be seen between 1997 and 2001, when both ratios declined with spot, the HUI much more so. However, a curious thing has happened since then. The HUI : Gold ratio is almost back at the chart high, while the XAU : Gold ratio languishes. Furthermore the (dotted red and blue) trend lines are at markedly different angles. This suggests to me that spot is set for a move way above prices corresponding to the chart years, and that some hedged miners are as a consequence dragging the XAU down. I wonder why? To begin to understand we will light the blue touch paper and see what happens.

Three fans are shown. Pale green lines are picked up from successive waves in the XAU chart pre 1999. Their focus lies at a value above 0.1 mid 1999. The yellow fan starts from a similar ratio, but from an earlier time, mid 1998, and picks up price action from mid 2000, exactly the same time as the HUI fan flipped over from a descent into ascent. The HUI incoming and outgoing fan apices coincide at a ratio considerably less then 0.1. Obviously un-hedged companies fare extremely badly when Gold falls below a certain price.

Possibly co-incidentally, the upper pale green line is actually a fan of the HUI chart! Corresponding HUI & XAU high/low poles are ringed.

Comments

The HUI : Gold ratio appears to be geared to the price of gold, acting pretty much as expected, dropping almost to zero should gold fall close to $200, and rising to 0.5 or higher as gold approaches $400. The XAU Gold ratio is not behaving in so simple a manner. The incoming and outgoing fans are displaced, and the outgoing recovery is slower than might be expected. This may be due in part to de-hedging, but it may also be due to over-hedging. It is even possible that one or more companies in the index are negatively correlated to the rising gold price now.

The following wave analysis was drawn onto a chart with many fan and support/resistance lines. I have left in only the most profound, in the interest of clarity.

There is much to say about this chart.

1. The black dotted sine curve is the XAU wave (red curve) expanded to fit the HUI. Note that up until late 2001 (Sept 11?) the shape of the wave was similar, even if the gearing was not. However, a massive divergence is shown (blue HUI wave) going forward.
2. The XAU is forming a fairly symmetrical triangle.
3. The HUI is forming a very steeply rising triangle.
4. Taking the top points A B and C for both the HUI (blue) and the XAU (red) and connecting them with a smooth curve generates a parabolic upper envelope limit to the ratios. Once again the divergence between the HUI and the XAU must be frightening to some people…..
5. You probably missed it, but camouflaged in the background (so as not to confuse the foreground) is a best fit of the long waves, approx 1 sine cycle in the case of the XAU, and a parabolic in the case of the HUI. The XAU wavelength (approx 8-10 years) suggests that the HUI rate of increase is probably already falling off.
6. If the XAU ratio breaks above the red resistance line, it may reach about 0.3 before hitting the upper envelope. If the HUI beaks out it is looking at about 0.6-0.65.

Conclusion

I think that the HUI : Gold ratio may be headed for somewhere between 0.55 and 0.75. This would give at gold 400 - HUI 220 - 300. Previous wave analyses I have done (Gold, HUI) targeted 395 and 275 respectively by/before October. I will gladly be proven wrong - so long as it is to the upside!