Either Gold Has to Come Down - Or Gold Miners Need to Come Up

In February of '08, I wrote an article titled "When is it Time to Buy Gold Stocks?".

Please read that post for background info as I don't want to repeat myself, but the ratio of gold stocks to bullion is near all time lows at .86. I used to track this every week for a whole host of commodities (oil, silver, etc). More than anything it can help give perspective to how expensive or cheap a basket of stocks is relative to what a commodity is doing - kind of a "forest from the trees" analysis.

So, either gold has to come down, or gold stocks need to come up... a lot. Here is a recent article on the newsletters being bullish on bullion. Hussman uses the gold/XAU ratio which currently is above 7. (Hussman talks about a similar method here and here.)

Historical ratio vs. gold stocks: [click images to enlarge]

Below are charts for the 3,6, and 12 month excess returns (nets out the average return for gold stocks over the time period). There is a nice stair step that you want to see with this type of analysis. The highest ratios (stocks expensive relative to the commodity) result in future underperformance, and vice versa.

The ratio is around .86 - near the lowest reading ever. Absolute returns for this decile have been strongly positive at 14%, 20%, and 43% for the following 3,6,12 months, and up 90% of the time a year later.

A little regression, and the red line is where we are currently. . .

Comments

[HBWOW:]

The answer here is the big money and stock manipulators are holding the market for gold stocks down so they can slowly pick up the mining stocks at bargain prices. Big steps/buys would cause jumps in mining stocks prices, of course. When they are essentially guiding the market prices, they can also pick up daily gains while manipulating the stocks, Track GFI, Gold Field, as this company holds a lot of gold reserves but is priced way, way, below value. The insiders appear to be increasing their holdings as well.

Jan 11 11:29 AM

[Ranjit Thomas:]

Most gold miners hardly generate any cash. Take a look at the cash flow statement for NEM. Free cash flow for the last 12 months is negative. So I would argue that the miners are overvalued.

Jan 11 11:33 AM

[rustymet:]

In brief, could it be because of the current risk aversion to holding stocks? GLD may b perceived as safer, as it is backed up by physical gold.

Jan 11 11:57 AM

[rustymet:]

In brief, could it be because of the current risk aversion to holding stocks? GLD may b perceived as safer, as it is backed up by physical gold.

Jan 11 11:58 AM

[adan:]

the answer to whether mining stocks will rise or gold go down, may be more related to the time frames the answers fall into

i'm no expert, at all, but it seems if debt levels, job losses, and risk aversion rise for equities, which the might into earnings season (just starting), then mining stocks won't be able to rise, and gold will fall (though less so, relatively) than other metals, to other assets

after earnings season, and as hope is crytalized into concrete plans and legislation via the new administrations' stimulus, via construction of actual physical things our country needs (roads, bridges, etc), and the cost of doing so is more plainly laid out (as obama seems more intent to be more open re what we, the american people, must face), then, a perceived advantage of owning mining stocks for a profit, and owning gold, for the perservation of the value of that profit, possibly both mining shares and the gold price would go up

but regarding the timing of all that, only time will tell - tell me at least ;-)

Jan 11 01:37 PM

[Zooka:]

Know how you can tell when the big boys are back in the game?
Volume.
Look at the average volumes from say a year ago vs. today, for a basket of mining stocks. In fact, divide that basket into bullion etfs, majors, juniors, and explorers. Now check out the volume trends.
Simple answer is, when the big boys come to play, the volumes spike. Until then, the volumes are relatively low, and it is composed of the 3rd stringers, Independents, and Clueless tryin to predict the next earthquake. I consider myself to be one of the Clueless, working towards Independent status.
Oh, and volumes are picking up, across the board in the mining and gold etf categories. I would not say it is another bubble/spike time, but things are going a heck of a lot more predictably than say 4 months ago.

Jan 11 04:01 PM

[Jingle-Jangle:]

"Either gold has to come down or gold stocks have to come up a lot."
That is a mouth full!
Which way will it go? Only time will tell. Many sites are predicting gold to go down. Even Jon Nadler at Kico.com is always predicting the down turn in gold price.
However, the downturn in price will only hasten the closing of many new mine projects as well as the many zinc and copper mines that produce gold and silver by-products. This will only help dry up the availability of gold and silver for sale at any price.
That is the up-side for the gold and silver stocks.
Eventually, the stocks will go up because of low inventories of the metals and the demand for them that is being ignored now. (Try to buy some, you will pay dearly on premiums.)
Us neophites/newbees/smal... investors are the ones left twisting.
Thank God for the folks above us doing the math and watching the market AND explaining it to us.
Thanks!

Jan 12 10:45 AM

[Jingle-Jangle:]

The demise of mine projects will hurt those of us invested in them, even though they are great projects, they are being killed off by manipulators.
Shame on them. They are anti free-market, anti-capitalist manipulators.
What does that say for the future of trading? Will only the rich be allowed to get richer because the game is rigged?
And now we have a Socialist in the White House and Socialist Democrats in charge of the Congress.
It is going to be a bumpy ride no mater how you play the market for the next four years.

Jan 12 10:51 AM

[Stone Fox C...:]

Miners were a great short when they peaked at year end. Carter Worth had a great report about how they hit long term resistance at that point. Covered my GG short yesterday. Looks like the market wants an Obama rally.

Jan 16 05:37 PM