Since May 2016, gold and gold stocks, as represented by the Philadelphia Gold and Silver Stock Index (XAU), are managing to give us the most structurally significant pattern that a tea leaf reader could ever want.
Everything becomes easy with the pattern that has evolved. According to Dow Theory, this is what is expected at this time in this excerpt from a 1939 series of articles in Barron’s that later became the book “Making the Dow Theory Work” by Sparta Fritz Jr. and A.M. Shumate:
During the month of September 2016 the price of gold increased +1.12% while the Philadelphia Gold and Silver Stock Index increased +1.90%.
We’ve indicated the area of price movement that would put our mind at ease in terms of the continuation of the upward trend.
During the month of August the price of gold declined –2.28% while the Philadelphia Gold and Silver Stock Index declined –14.16%.
In this posting, we’ll highlight an area that we noted as a weakness in the run-up from the January 2016 low. We’ll also put Barron’s recommendation of GoldCorp (GG) into perspective with an approach for investors to apply when trying figure out which gold stocks to consider. Finally, as usual, we close with the performance of our current gold stock holdings.
In the month of July 2016, gold increased +1.60% and gold stocks increased +12.94%.
The gold market is off and running. There are many reasons for the current rise in the price of gold but it is all after the fact and may only be guessing at best. It is important to note that “Brexit” has occurred six months from the respective lows in gold and gold precious metal stocks with each rising as much as 28% and 165%, respectively. To our minds, giving credit to the turmoil in the UK for the increase of precious metals is somewhat misplaced and could lead to more wrong conclusions than a single “right” one.
All that we’re considering is the price action and that alone is giving us food for thought. Below is the performance for gold and gold stocks from April 1, 2016 to July 1, 2016.
Since our posting on June 5, 2016, the price of gold has increased by +8.02% and the gold stock index has increased by +15.09%.
If you like a rising market then you definitely want the price of gold and gold stocks to increase above the level of $1,294 and 92.85, respectively. Otherwise, there will be a big blowoff in the gold market and sizable downside risk.
Good News, Bad News
You want higher gold prices? You got higher gold prices. However, we have to add, be careful what you ask for. The anxiety associated with what's gonna happen next in gold and gold stocks will have investors and speculators looking over their shoulders. This will mean many sharp declines and dramatic recoveries.
In the month since our last posting, gold has increased only +6.21% while the price of the Philadelphia Gold & Silver Stock Index (XAU) has increased +26.97% in the same period of time.
In our October 3, 2014 posting, regarding the XAU Index, pointed out the following:
“In the chart above we have labeled the three potential downside targets of 75.99, 67.55 and 59.11 from the current level with the additional downside target of 41.85 as the ‘last stop’ in our downside analysis. Anything below the ascending 76.32 level is considered undervalued and underappreciated.”
Little could we have known that the index would actually decline to 38.84, a level below the end of the last bear market that ran from 1996 to 2000. The chart below points to where the current run up could meet significant resistance.
Since our March 2016 posting, the price of gold has decreased by –5.00% while the Philadelphia Gold and Silver Stock Index (XAU) has increased +4.45%.
Since our February 12, 2016 posting, the price of gold has increased by +3.04% while the Philadelphia Gold and Silver Stock Index has increased +10.07%.
There is the mistaken view that in order to verify the trend in the precious metals market based on Dow’s Theory, investors should compare the price of gold with the price of silver. In fact, this is incorrect.
Gold and gold stocks have made a turnaround in the declining trend that has persisted over the last several years. The reactions to a dramatic rise or fall in commodity prices is usually equal in violence and magnitude. Gold has increased +15.59% while gold stock has increased +27.90% since our last posting.
There is a lot of excitement in the gold investing community as there is the belief that this may be the long awaited bull market in gold which has been attributed by some by the advent of negative interest rate policies in major economies like Japan. We remain hesitant to believe that all is well in the gold sector as this is the third year in a row that gold has started strong. The last two years (2014 & 2015) both ended in the loss column for the year, in spite of the early gains.
The above chart shows exactly how gold garnered early gains. For 2014, gold ended the year at a loss of –1.55% while the XAU index declined –21.11%. For 2015, gold fell –9.55% and gold stocks fell –35.89%. The early gains for 2016 are nice but new investors should accept what may come if there is a repeat of the last two years.
Gold and gold stocks continue to struggle in an effort to remain in a trading range rather than collapse. A fall is coming if we see the general equity markets decline, which would compound the abysmal performance of the precious metal stocks over the last five years.
Gold Stock Indicator
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
Posted in 3-month, Federal Reserve Bank, gold, gold bugs, Gold Stock Indicator, interest rates
Since our last posting, gold has slumped an additional –5.44% while gold stocks have declined –17.90%.
It was a tale of two markets with the price of gold increasing less than 1% while gold stocks increased +11.87%.
Since August 13, 2015, the price of gold has increased by +2.15% while the Philadelphia Gold and Silver Stock Index has declined –2.13%.
The price of gold could be considered to be on a tear given the fact that it isn’t falling, at the moment.
