Gold Stock Indicator: The Big Picture

Article Summary

  • Start accumulating gold stocks now
  • select gold stocks from those in the XAU Index
  • at minimum, investors must allow for 25% downside risk before reinvesting more funds

Our Take

On November 2, 2011, we posted an article which highlighted the fact that gold stocks routinely underperform the price of gold (found here). Also in that article, we introduced our Gold Stock Indicator to show that the timing of when to buy gold stocks was more important than the fact that prices and valuations appear to be low.

To demonstrate the significance of our indicator, we’d like to contrast it to the widely used Gold/XAU ratio. According to noted market commentator and fund manager John Hussman:

“…since 1974, the Gold/XAU ratio has been greater than 5.0 about 15% of the time. When the ratio has been this high, the XAU has followed with annualized gains of 89.6%, on average.” (Hussman, John. “Gold/XAU Ratio Signals Buy for Gold Stocks”. Seeking Alpha. March 13, 2007.)

Below is a chart of the Gold/XAU ratio since December 12, 1983:


Unfortunately, as gold has transitioned to a secular bull market cycle, the Gold/XAU ratio since 1999 has not provided a consistent signal of when to buy and sell gold stocks. In fact, on July 15, 2008, the Gold/XAU ratio indicated that gold stocks should be bought even as the XAU Index was about to fall an additional –66%.

Also popular among gold investors is the inverse chart of the same ratio known as the XAU/Gold ratio or gold stock/gold ratio. Many variations of these ratios are carelessly used by market commentators with the hope to prove that gold stocks should be acquired. So far, the Gold/XAU ratio has incorrectly indicated that gold stocks are a “buy” for the past 998 trading days in a row. Few who make reference to these ratios are willing to show the full history of these gold and gold stock ratios. In all cases, the ratio is the same and since July 15, 2008 has failed to steer gold stock investors away from significant loses in gold stocks.

In stark contrast, our Gold Stock Indicator had been able to consistently identify long-term opportunities of when to buy and sell gold stocks. Below is the most updated version of our Gold Stock Indicator:


At the current level, our indicator suggests that gold stocks should be accumulated. The last time that gold stocks were at the exact same level, gold and gold stocks posted the following returns:

Year(s) Gold XAU
1986-1987 22.35% 84.11%
1987-1989 -4.81% 52.87%
1992-1993 11.03% 66.44%
1997-2006 83.00% 113.54%
2008-2010 64.14% 99.95%
Average gain/loss 35.14% 83.38%

While we recommend accumulating gold stocks at this time, it is important to understand and accept the possible downside risks. Below is the percentage loss that was experienced after each indication to buy gold stocks and before any gains were realized:

1986 -16.57%
1992 -5.92%
1997 -34.54%
2008 -40.81%
Average Decline -24.46%

The 1987-1989 period was excluded from our downside risk data simply because it did not have any loss before moving to the sell indication. If we included the decline after the 1987 buy signal the average loss would have been –19.57% for all five buy signals since 1983. However, we’d like to opt for the more conservative figure of –24.46% to keep our expectation more realistic.

Those who wish to participate in the eventual run up in gold stocks should consider those that are a part of the XAU index. The members of the XAU index are ranked below based on the percentage from the 52-week low:

Symbol Name price P/E EPS Yield Price/Book % from Low % of Index
NEM Newmont Mining Corp. $45.06 97.31 0.46 3.1 1.72 5.12% 10.90%
BVN Buenaventura SA $36.89 11.17 3.31 2.1 2.88 5.45% 4.60%
ABX Barrick Gold Corporation $33.17 8.11 4.1 2.5 1.34 7.26% 16.00%
GFI Gold Fields Ltd. $13.09 9.72 1.34 4.6 1.66 11.70% 4.70%
AU AngloGold Ashanti Ltd. $34.55 894.90 0.04 1.2 240.61 12.61% 6.60%
PAAS Pan American Silver Corp. $15.18 5.19 2.93 1 0.82 12.68% 0.70%
GG Goldcorp Inc. $36.70 22.94 1.6 1.5 1.36 16.30% 14.50%
HMY Harmony Gold Mining Co. Ltd. $10.07 14.30 0.71 1 1.08 17.00% 2.20%
FCX Freeport-McMoRan $34.01 10.19 3.33 3.7 1.95 17.63% 15.70%
KGC Kinross Gold Corporation $8.59 0.00 -1.96 1.9 0.78 20.60% 3.40%
AUY Yamana Gold, Inc. $15.17 19.86 0.76 1.4 1.49 23.00% 5.60%
SLW Silver Wheaton Corp. $28.27 17.48 1.62 1.3 3.59 23.45% 4.80%
GOLD Randgold Resources Ltd. $91.18 19.84 4.6 0.4 3.68 25.11% 4.10%
SSRI Silver Standard Resources Inc. $13.07 15.24 0.86 0 1.06 30.02% 0.50%
RGLD Royal Gold, Inc. $76.63 46.43 1.65 0.8 2.57 34.40% 2.20%
AEM Agnico-Eagle Mines Ltd. $44.16 0.00 -3.3 1.9 2.31 40.80% 3.60%

In theory, the stocks that have the largest weighting in the index contribute the most movement either up or down. However, this may not result in the largest percentage gains that are possible as compared to other stocks in the XAU index. We prefer those stocks that are nearest the low, so we’d opt for NEM, ABX and GG ahead of FCX, BVN and GFI.

Gold stocks that are a part of the XAU index have the benefit of institutional support and the risk of individual implosions. Also, as we’ve explained in our article titled “Why Gold Stocks Will Decline More Than the Markets,” gold stocks are tied strongly to the performance of the general stock market. This was graphically demonstrated in 2008 when gold stocks declined –68% in the period from March 14th to October 27th. Many claim that 2008 was an aberration, our analysis of gold stocks from the 1924 to the present clearly indicates that 2008 was not a fluke. Keep in mind that a –68% decline in the stock index means that individual stocks within the index likely fell much lower, on a percentage basis.

Investors should take their time in acquiring gold stocks as there is some downside risk. However, if 10%-15% of the portfolio is set aside for such investing, there are good opportunities if the purchases are done in stages.

2 responses to “Gold Stock Indicator: The Big Picture

  1. Scott Oppenheim

    Why is there a difference between your recommendation to start accumulating gold miners now and waiting on NUGT to fall to 7.60? Is it based on the amplified downside of NUGT due to its leverage of 3X and you want to reduce the chance of a large drawdown?

  2. Greetings Scott,

    Thanks for the contribution to our work.

    Regarding your question, “Why is there a difference between your recommendation to start accumulating gold miners now and waiting on NUGT to fall to 7.60?”

    Individual gold miners should be bought when falling below the long-term buy indication (bottom green line) and sold when rising above the long-term sell indication (top red line).

    The purchase of NUGT should only be CONSIDERED when the Gold Stock Indicator is at or below the short-term buy indication. DUST should only be CONSIDERED when the Gold Stock Indicator is above the short-term sell indication.

    As you have described, the volatility that is inherent in NUGT/DUST requires that you allow for the “buy” signal to be registered before taking any kind of a position. Throughout the decline in the Gold Stock Indicator (since Dec 2010), NUGT and DUST have generated positive short-term gains of 7%-15%, at minimum. Additionally, NUGT/DUST is strictly a speculation while accumulating shares of gold stocks are for investment purposes.

    Although gold stocks are considered investments, the holding period should be understood to last only until the long-term sell signal is registered or until the desired percentage gain has been achieved.

    Our work on this topic has suggested that after all signals (long-term and short-term) there is a still some decline to be experienced afterward. That is why it is recommended to break all purchased in halves, thirds or fourths.

    The biggest challenge for us is waiting for the next short-term signal to sell.

    Again, thanks for the question.