Gold Stock Indicator: November 20, 2015

Gold and gold stocks continue to languish as there appears to be no catalyst to propel prices higher. 

The perception of no reason for gold to increase adds to the despondency of traders and investors which compels selling.  However, we’d like to point out that in spite of the conventional wisdom, the prospect of an interest rate rise is the biggest unambiguous reason for gold to increase in value.  While a Fed rate increase is what everyone is waiting for, history suggests that Fed policy  (government regulated) follows short-term Treasuries (market driven).

In a barely perceptible way, the chart above demonstrates that all Federal Reserve rate increases were preceded by a rise in the 3-month Treasury.  The blue arrows indicate the reversal in the declining trend before 3-month Treasuries increased.  From this point, we can easily see that the Federal Reserve’s discount rate follows to the upside not long after.  We’ve only included the point in the interest rate cycle that corresponds to the phase that we are entering, coming from an all-time low to an eventual all-time high.

The price of gold cannot sustain a rise in the face of deflationary forces, which typically brings interest rates down.  As the cycle eventually turns, we will see a sustained increase in the price of gold (with the obligatory volatility).  Analysts will argue that it is not possible for the price of gold to increase in the face of rising interest rates, however, the period from 1948 to 1981 is exactly when gold had its last massive bull market (based on foreign free market price of gold from 1948-1971; U.S. price of gold from 1971-1981).

Gold Stock Indicator

The Gold Stock Indicator applied to the Philadelphia Gold and Silver Stock Index (XAU) is at an all-time low (1983-2015).  Although this is the preferred point to invest capital to gold stocks it takes a lot for investors to see the future benefit when gold stocks manage to defy the bad news by falling even more than anticipated.

Not to be outdone, the Gold Stock Indicator as applied to the Barron’s Gold Mining Index (1973-2015) is also at an all-time low.  At this point, the only conclusion that we can provide to investors is that they should expect any investment in gold stocks to go to zero.  Our prior work points out that gold and gold stocks will decline by a greater percentage than the general equity market if there is a sustained decline of –10% or more.  Considering that many analysts think that the stock market is overvalued and due for a correction of –10% or more, we can only advise caution for anyone interested in pursuing gold and especially gold stocks.  In spite of this warning, we have made some recent acquisitions based on the long-term prospects based on the interest rate cycle analysis above.