Having been a professional independent analyst specializing in the gold market since 1969 I have developed several methods that usually give excellent indications of the bull and bear phases in the gold market.
The first utilizes the dictum that shares always outperform the bullion price in a true bull market. This is due to the leverage on profits that occurs as rises in the gold price lead to exponential profits as mining revenues that extrapolate above the costs of mining. This is especially applicable to the marginal mines and that is my second indicator. I use the relative strength of Durban Deep as a major pointer to gold bull and bear markets.
Durban Deep is the most marginal mine amongst the large producing mines in South Africa. It reputedly requires a gold price above $360, depending on the Rand /Dollar rate, to break even. When the gold price dips well under this threshold investors hit the panic button and the share is sold off, sometimes dramatically. This occurred in late 2000 when the gold price hit $252 and Durban Deep collapsed to a ridiculous low of R4,65 on the JSE. Above $330 and euphoria takes control of this share causing the move to the upside to be astronomic, such as occurred last year when it eventually peaked in May at R55 for an 1100% rise. I have yet to hear from the Elliott bears on how the JSE gold index can appreciate 600% and a share like Durban Deep can appreciate 1100% in a bear market rally!!!
The FT Gold index is an amalgam of North American, South African and Australian gold stocks. It represents an across the globe gold index. The vertical price axis on the above chart is on a semi log scale and thus the two charts are directly and quantitatively comparable. Every upward thrust in the gold price results in a rocketing index whilst the downside bear phases cause a collapse in the index. The slope of the trend lines on the chart speak for themselves.
If we transpose this data by dividing the FT Gold index by the gold price we obtain the simple relative strength chart below. An up sloping line indicates that the gold share index is out performing the rate of increase of the gold price whilst a falling line denotes that gold share prices are collapsing at a faster rate than the gold price.
Gold shares are substantially undervalued below the 250 level whilst above the 700 mark they are euphorically over valued. Currently the gold shares are relatively under valued!!
But take another look at this chart without the lines, as detailed below, and you will note the huge reverse head and shoulders pattern brewing that gives an upside target of 700, back to the overvalued level from its current relatively undervalued zone.
My conclusion on using the relative strength of the FT Gold index compared to bullion is that any bull phase MUST be accompanied by a faster rise in the price of the shares and in particular the marginal mines such as Durban Deep. We are in a massive bull market in which the first corrective phase since last May has ended and the powerful third wave already under way. This upward thrust MUST take all gold shares back to well above their highs of last May. Get into gold and silver stocks as well as mutual funds …. NOW!
Readers wishing to have an expanded analysis of this phenomenon in this week's Gold Action newsletter can email chartist@mweb.co.za
Dr. Clive Roffey
chartist@mweb.co.za
www.shareaction.co.za
May 19th 2003