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.
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.
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.
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.
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.
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.
Posted in Fundamentals, gold, Gold Stock Indicator, junk
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.
Where to Now?
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.
The dates for the primary trend indication are as follows:
The percentage change for the primary trend indications above are as follows:
Dow Theory Primary Trend Analysis at VI
Posted in 50% principle, Dow Theory, gold
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.
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%.
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:
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
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