Gold Market Update
The following are extracts from recent commentary that appeared at The Speculative Investor web site.
Flexibility is vital
One of the difficulties of making forecasts based on how different markets have historically inter-related with each other is that the relationships sometimes change, particularly over a relatively short period of time (6-12 months). It is important to be able to recognise those changes when they occur and not be married to a particular view on how the markets are supposed to move in relation to each other. For example, throughout much of last year several gold market analysts pointed to the surge in the oil price as a reason to be bullish on gold. The link between the oil price and the gold price is actually quite tenuous, but the belief that a rising oil price would put upward pressure on the gold price probably stemmed from the knowledge that both of these commodities rallied together during the 1970s. However, as we pointed out in several commentaries during August and September 2000, the rising oil price was actually helping to boost the US$ relative to the European currencies and was, therefore, indirectly putting downward pressure on the gold price. This led us to forecast, in September 2000, that gold and gold stocks would not begin to rally until after the oil price had reversed lower. As it turned out, the oil price peaked during the September-November period and gold stocks began to trend higher in mid-November. Last year's inverse correlation between gold and oil has not been apparent this year nor do we expect it to re-surface since different forces are now exerting a greater influence on the currency market. Another example of the need to be flexible and remain alert to the possibility of changing relationships is the positive correlation that has been exhibited by gold and the stock market over the past several months. Historically, gold has had an inverse correlation to the overall stock market, but on occasion the monetary and cyclical forces have lined-up in such a way as to move both markets in the same direction. Now appears to be one of those occasions.
An early warning sign of bond and/or Dollar weakness
From our March-12 commentary: "We expect the Dow Jones Utilities Index (DJUI), which is currently trading at around 390, to trade below 300 before this year is out. The 'utes' have been supported by a strong bond price, a strong Dollar and a general flight to safety, but we expect them to be one of the hardest hit sectors of the market when bonds and the Dollar eventually plummet."
As the following 2-year chart shows, the DJUI has been very weak over the past few months. We think it is significant that this weakness has occurred while the Dollar has remained strong and bonds have suffered only minor damage. The DJUI appears to be signaling that a sharp drop in bonds and/or the Dollar is going to occur over the coming months.
The TGSI versus the XAU
The TSI Gold Stock Index (TGSI), our own creation, is much better than any of the official gold indices (XAU, HUI, etc.) because:
a) It contains major gold producers only
b) It has a balance of hedged and unhedged producers
c) It includes gold producers from each of the 3 major gold-producing regions (North America, South Africa and Australia)
d) Its components are given equal weightings
The XAU is a terrible gold index because:
a) It includes a significant copper weighting
b) It includes no Australian gold stocks and only one South African gold stock
c) Barrick Gold in particular, and hedged producers in general, are allocated a disproportionately-large weighting
Strangely enough, despite its huge flaws the XAU still seems to perform in a way that makes it a reasonable proxy for the gold sector. The following chart compares the performance of the XAU and the TGSI since March 2000. While gold stocks were in a bear market (prior to November 2000), the TGSI and the XAU tracked each other very closely. During the bull market that commenced in November of last year the XAU has tended to under-perform during both up-swings and down-swings, although its overall performance could still be regarded as acceptable. Note that the sharp drop in the XAU during the second half of June was not duplicated by the TGSI since it was primarily the result of excessive weakness in Barrick Gold.
The bull market continues
Below is a chart of the Gold/TGSI ratio (with the scale reversed so that a rising line indicates that gold stocks are out-performing the bullion price). As difficult as this may be to believe with the gold price languishing in the 260s, the continuing up-trend shown on this chart indicates that gold and gold stocks are in a bull market. The peak is likely to occur when the gold/TGSI ratio moves to around 3:1.
Steve Saville
Hong Kong
1 August 2001
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