Category Archives: gold

Precious Metal Considerations

For anyone that is interested in investing in precious metals, there are two articles that are required reading.  The first article is titled The Definitive Dow Theory of Gold dated March 18, 2017.  The second article is titled The Hidden Story of Gold dated February 15, 2018.

The March 18, 2017 article is instrumental in outlining where exactly we are in the cycle of gold.  The February 15, 2018 tells us that regardless of what most analysts think, the current market is no different than when gold was not freely traded on the open market in the U.S.  These articles are instructive because they put context around the idea that this isn’t the first rodeo and all change in the price of gold is relative.

Applying the context and relative themes should result in some very obvious questions that all precious metal investors need to ask.  However, there are two very basic questions precious metal investors should be asking themselves right now.  First, are we headed for an extended trading range before the price of gold skyrockets?  Second, what is a reasonable upside targets?  This posting will demonstrate the rationale for these questions and present possible answers to both.

Gold Stocks: Hedge Free

We have been quoted here on many occasions saying that when the general equity market takes a dive of –10% or more, so too does gold stocks by a greater margin.  Our point, gold stocks are not a hedge from general market drops.

In our September 24, 2014 article titled “Gold Stocks: Risks and Remedies” we highlighted the numerous instances from 1939 to 2011 of when the Dow declined by more than -10% and showed how either the Barron’s Gold Mining Index or the Philadelphia Gold & Silver Stock Index declined by a greater percentage.

In the recent decline of the DJIA from January 26, 2018 to February 8, 2018, the index declined –10.36%.  So how much did the Philadelphia Gold & Silver Stock Index (XAU) decline?  The XAU declined –11.57%.

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In the chart above, we have excluded the decline of –14.75% from January 24, 2018 to February 9, 2018 in the XAU index.  Add this to the growing list of instances of when the DJIA declines more than –10% and gold stocks also decline by a greater percentage.

The Hidden Story of Gold

Gold is currently languishing in a trading range between $1,366 to $1,049. This trading range is thought by many to be a pause before the eventual increase above the previous high at $1,895.  After all, the price of gold had managed to decline from $1,895 to the low of $1,049.40, a drop of –44.62%.  Part of the thinking of a new high in gold is predicated on the idea that we are entering a phase of rising inflation after years of decreasing inflation from the 1980 peak.

Introduction

If the thinking is that gold is on the cusp of new highs, there is one question that we need to answer.  The question is, “What happens with the price of gold in the early stages of an inflation cycle?”  What is amazing about this question is that in the early stages of the last inflation cycle from 1939 to 1942, gold was fixed at $35 until 1971.

Never in the history of the United States have investors seen the reaction of the price of gold to the early stages of rising interest rates.  In this posting, we’ll attempt to show a reasonable benchmark for gauging what would happen if there weren’t restriction on the  price of gold.

How are we going to explore the price of gold in a period when there was not a free floating price for the metal?  By examining what the price of silver has done in the period when interest rates rise in response to increasing inflation.

Silver is the perfect means to convey the message of what would have happened to the price of gold if it were allowed to navigate the whims of Mr. Market.  While silver is more volatile than gold and prone to extremes it still tells the story of gold when gold did not have a voice.

Interest Rate and Inflation Cycle

We start with the price of silver from the peak in 1925 because, according to Dewey and Dakin's in their 1947 book Cycles: The Science of Prediction, the last peak in wholesale prices, which generally corresponds to interest rates.  If you have a beat on interest rates, you can get a better sense of where we are and where we might be going as it relates to precious metals.

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Remember, you don’t have to be a fan of cycle theory to appreciate the quality of analysis that reflects what has already happened from a book written in 1947.  Calling the peak in 1979 and the trough at 2006, while not exact, is the best way to learn from the past.  Looking at the 3-month Treasury, we can see the fulfillment of an entire cycle in rates from 1940 to 2009.

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Just think, there is no official data that extends from prior to 1934 to the present.  Without this important continuous information, it is difficult to find data that we can compare like-for-like stages in the cycle.  However, we do have data from the price of silver in the previous cycle top to the low that corresponds to the low in interest rates and silver.  This will be our introduction to the secret history of gold.

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Gold Stock Indicator: January 2018

On September 17, 2017, we said the following:

“We’re still in the diabolical no-man’s land where, according to Dow Theory, the previous trend (bear market) is in place until proven otherwise.”

The price of gold continues to confound even the most bullish gold analyst.  However, as we can see below, it is make-or-break time for the precious metal.

Dow Theory on Gold

Dow Theory attempts to define and identify major moves in markets referenced here as the “primary trend.”  In this piece, we will outline the price of gold according to Dow Theory.

We’re going to review and analyze the primary trend that extends from the September 2011 peak to the currently established low in the price of gold in December 2015.  We believe that this information is critical to understanding where we are and where we might be going.  This interpretation is based on the work of Charles H. Dow, co-founder of the Wall Street Journal and namesake to the longest continuous stock market indexes. 

Keep in mind that all of the analysis that follows is done in generalities so that an individual who is curious about Dow Theory can refer to the technical manual on the topic titled The Dow Theory by Robert Rhea.  However, the true heart of Dow’s theory is found in his original writing which covered the topic of earnings, dividends, effect of dilution of shares and economic outlook AND NOT lines on a chart.  Two books that cover Charles H. Dow’s work as a fundamental analyst and an adept economist are titled Dow Theory: Unplugged and Charles H. Dow: Economist, respectively.

Lines on a Chart

Dow Theory has been synthesized down to a level of lines on a chart, which isn’t all bad.  The lines still reflect fundamental economics.  The challenge is the accurate interpretation of what is implied by the meaning of those lines.

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Gold Stock Indicator: May 2017

Gold and gold stocks have been treading water since January 2017.  While a trading range has been established, there are ominous signs on the horizon.

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Are There “Values” in Gold Stocks?

Looking at any analysis of gold stocks, you would think that fundamentals matter.  The companies have quarterly reports that reflect operating expenses, pre-tax profits, estimates reserves, sometimes earnings and in rare instances dividends. 

However, when it comes to gold stocks, the only thing that matters is the direction in the price of gold.  If you believe you know the direction of gold then, by default, you know the direction that gold stocks are headed.  All semblance of fundamental analysis is ultimately not relevant to the price of a gold stock, in spite of proven & probable reserves, acquisitions, share buybacks, AISC or claims by the CEO that things are looking up (they rarely, if ever, say the opposite).

Take a look at a comparison between gold and the price of Barrick Gold Corp. (ABX) in the period from October 2003 to April 2017.

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The only distinction to be made between the price of the stock and the price of gold is the magnitude of the direction up or down.  If fundamental investing mattered, then at some point there should be some level of divergence in the general direction of gold and gold stocks.  This would allow savvy investors to seize on the mispricing of a stock and ride the wave up or down.

For the sake of comparison, look at the difference between corn and Archer Daniels Midland (ADM) over the same period as the ABX and gold review.

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In the case of ADM, we can see the areas (blue boxes) where there are distinct divergences between the price of the stock and the price of corn.  These are key areas where fundamental values, and basic economics, demonstrate key levels of under/overvaluation.  Of course, ADM is not simply a pure play on corn as they’re involved in other agricultural products.  However, knowing the industry, pricing, competition and other attributes of the business could give you a distinct advantage as a buyer and seller of ADM stock.  This is not the case for gold stocks.

Lest we be called out for being selective in choosing a period that was only in a rising trend, we have included the period from 1983 to 2001 and compared the Philadelphia Gold and Silver Stock Index (XAU) to the price of gold, a time when gold was in a declining trend.  In this more expansive period of time, there was only one point in time, January 1986 to July 1986, when there was a material divergence between the price of gold and gold stocks.

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It is precisely when there is a material divergence between gold and gold stocks that a fundamental review will reveal the true “value” and therefore warrant contrarian investments (short/long) in the gold stock complex.  If a period of divergence isn’t as readily identifiable, as in the ADM example, then you know that what should be examined isn’t the stock but the underlying commodity.

Ultimately, when a well known stock analyst ( or unknown) applies fundamental analysis to a gold stock, you know that you are reading material that is of little or no value in relation to reality.

Gold SRL

On June 5, 2016, we said the following of gold:

“Upside resistance is at the ascending $1,055.42 level.  the current downside move looks to retest the previous move to the ascending $843.32 level.”

Breaking this down, we note where gold was at on June 5, 2016 on the accompanying chart.  At the time, gold had come off of a +17% spike in price from the December 17, 2015 low.  A run up to the ascending $1,055.42 level would have brought gold as high as $1,400.  The best that gold could do on the upside was $1,366.25 before falling back down to the ascending $843.32 level.

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Where to Now?

The Definitive Dow Theory on Gold

Dow Theory attempts to define and identify major moves in markets referenced here as the “primary trend.”  In this piece, we will outline the price of gold according to Dow Theory.

We’re going to review and analyze the primary trend that extends from the September 2011 peak to the currently established low in the price of gold in December 2015.  We believe that this information is critical to understanding where we are and where we might be going.  This interpretation is based on the work of Charles H. Dow, co-founder of the Wall Street Journal and namesake to the longest continuous stock market indexes.

Keep in mind that all of the analysis that follows is done in generalities so that an individual who is curious about Dow Theory can refer to the technical manual on the topic titled The Dow Theory by Robert Rhea.  However, the true heart of Dow’s theory is found in his original writing which covered the topic of earnings, dividends, effect of dilution of shares and economic outlook AND NOT lines on a chart.  Two books that cover Charles H. Dow’s work as a fundamental analyst and an adept economist are titled Dow Theory: Unplugged and Charles H. Dow: Economist, respectively.

A Look Back

It is necessary to outline the history of primary trends in the price of gold to ensure clarity of where we are coming from and where we might be now.  Below is a graph of the price history of gold with the primary trends.

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The dates for the primary trend indication are as follows:

  • December 1969 at $35.17
  • December 1974 at $188.25
  • August 1976 at $104.20
  • January 1980 at $760
  • August 1999 at $255.35
  • September 2011 at $1,895
  • December 2015 at $1,049.40

The percentage change for the primary trend indications above are as follows:

  • I: +435%
  • II: -45%
  • III: +629%
  • IV: -66%
  • V: +642%
  • VI: -45%

Dow Theory Primary Trend Analysis at VI

Gold Stock Indicator: February 2017

Since our January 2017 posting on gold and precious metals stocks, the price of gold has increased +3.48% while at the same time precious stocks have declined –5.87%.  There are some contradictions in the movement of each indicator which we will interpret below.

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Gold Stock Indicator: December 2016

After our assessment on gold and gold stocks in October 2016, the price of both have declined but to varying degrees.  Gold declined by –7.82% while gold stocks, as represented by the Philadelphia Gold and Silver Stock Index (XAU), fell by –2.91%.

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Gold Stock Indicator: October 2016

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.

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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:

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Gold Stock Indicator: End of July 2016

In the month of July 2016, gold increased +1.60% and gold stocks increased +12.94%.

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Gold Stock Indicator: July 2016

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.

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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%.

Gold Stock Indicator: June 2016

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.

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