Gold Versus Paper

Turning paper into Gold March 16th, 2012 1. LONG TERM PICTURE (months to years) I didn’t think we’d get back to the current 8 level again in the Dow to Gold ratio, but here we are. This is very bullish going forward and sets us up for a multi-month decline in this ratio in my opinion. Below is a weekly log scale chart of the Dow to Gold ratio over the past 15 years thru today’s close:

This ratio should begin falling and it should decline significantly for a minimum of 3 months. This is bullish for Gold mining stocks with the exception of crash-like conditions (i.e. didn’t work in fall of 2008). I suspect a turn downward in this ratio will coincide with a major bottom in the Gold stocks. Another long-term chart that I think is very relevant and important is the ratio of Gold stocks to common stocks, using the XAU senior Gold mining index and S&P 500 as proxies (i.e., $XAU:$SPX ratio chart). Here’s a 12-year log scale weekly chart of this ratio through today’s close:

And lastly, the “big picture” chart that every Gold stock bull is sick of seeing, that of the Gold stocks to Gold ratio, using the HUI mining index as a proxy for Gold stocks ($HUI:$GOLD ratio chart) on a monthly 12 year log scale chart thru today’s close:

These are extremely important “big picture” charts when looking at the risk to reward proposition in Gold stocks. These charts keep me extremely bullish on the intermediate to long term in Gold stocks (i.e. weeks to months). With this backdrop in mind, we should

be leaning bullish in the PM sector, particularly when it comes to PM equities. Finally, let us remember the sentiment backdrop in the PM equities here. I shouldn’t have to remind any of my subscribers on this, as you are probably all as tired and frustrated as I am waiting for some significant metal stock outperformance. Here is a basic sentiment indicator based on the Rydex Precious Metals mutual fund that looks at total amount of investor money in the fund from 2003 thru now. The Y-axis is the net asset value (i.e. amount of investor funds held in USD terms) and the X-axis is the date. When the plot in the chart below is low, it means investors are bearish. When it is high, investors are bullish. You want to fade the herd at extremes. The current prolonged malaise in the PM stock sector is reminiscent of the 2003 bottom, which was also in March: RYDEX PRECIOUS METALS FUND NAV DATA – 1/1/03 THRU 3/16/12

What more can you ask for when you are trying to buy low so that you can sell high later? I don’t think it gets any better than this. I believe the current conditions, when looked at a year from now, will be an obvious “no brainer” time to buy Gold stocks.

2. INTERMEDIATE TERM PICTURE (weeks to months)

Gold and silver In addition to the very bullish “big picture” data above, we have very good short to intermediate term data in terms of how oversold we are. I want to show you a chart of

Newmont Mining (ticker: NEM), a blue chip bellwether senior Gold stock that is an institutional favorite. Here’s a daily chart of NEM over the past 2.5 years thru today’s close using a daily plot:

If Newmont is bottoming here, then the whole senior Gold stock sector can’t be far behind. The same exact style chart of the GDX ETF shows a similar bullish posture of oversold and under loved:

Gold, using the GLD ETF as a proxy, is in a similar bullish, washed out position that has marked prior bottoms using the same style of chart thru today’s close:

Scaling into the shorter term, here’s a 60-minute intraday chart of the GDX ETF over the past 3 months thru today’s close:

I have mentioned my 47 target on GDX and it is possible that we can get there before the turn. However, since I am not sure, I wanted to start scaling in last week. My recommended first entry point at 50.40 on GDX was far from perfect, to be sure. Any move to 47 in GDX is likely to be followed by a violent and rapid reversal to the upside and there is no guarantee we get that low before the turn. For now, more watchful waiting

for the turn while holding a 50%/partial bullish position in Gold stocks. The next move up, once the turn comes, should last at least several weeks. I doubt we make it to the end of next week before bottoming and moving higher, but we’ll have to wait and see. The same comments apply to Gold and silver, although it is quite possible that the bottom is already in for Gold and silver (not sure yet). I remain stubbornly committed to Gold stocks over metal here given how oversold the stocks are and given that I think we are on the verge of starting a new cyclical bull market in Gold stocks. I also continue to like the appearance of the GDXJ to GDX ratio chart. It is good to see the junior Gold stocks outperform the senior stocks, as this indicates a healthy, speculative-type market. Here’s a 2-year daily ratio chart of GDXJ:GDX thru today’s close:

As others become more fearful, I am getting greedier. I think we are on the verge of a juicy move higher in the PM sector. I think stocks will outperform metal and silver will outperform Gold in the next cycle. I remain uncertain as to whether or not silver will outperform Gold stocks, so I am sticking with Gold stocks for now.

Common stocks Strong market that needs a rest, but this has been the case for a while. A flattening stock market may play into the hands of sector rotation into beaten down Gold stocks. Nothing else to add here. Commodities Oil seems to be consolidating here in a bullish pattern. It will be interesting to see what crude does over the next few weeks. Not much else to add here, as I am focused on the PM sector. Bonds and Currencies Everyone seems excited by the action in the US long-term bond market. I am not. We could easily be bottoming here in the long bond price (i.e. top in yields). Again, unlike most Gold bulls, I have no problem with low rates persisting for some time and do not believe that the long bond is the “short of the decade” at current levels, short term action aside. I think the US government debt markets will continue to hold up. Once Japan and Britain’s government debt/bond markets implode, then we can start talking about the biggest whale of them all (i.e. US government debt market) going down. Not a lot of significant action that I can see in the currency markets, although the Yen is now ripe for a bounce and seems like a good bull trade for those interested (I am not).

3. TRADE RECOMMENDATIONS I remain 50% in cash and 50% in the NUGT ETF (i.e. long Gold stocks using a partial position).

Remain in “long Gold stocks” trade with a partial (50%) position. We will look to move to a 100% long position, hopefully this week.

I will be travelling again this weekend, so excuse any delays in responding to email inquiries this weekend. Happy trading. Adam

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