When Will Gold Be A Buy

Includes: GLD, SLV
by: George Kesarios

Just because gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) were going up for the last decade or so, does not mean that this uptrend had anything to do with the "fundamentals" whatsoever.

Gold was up because it was up. Gold was up because many people said it had something to do with central bank printing. Gold was also up because people thought it was "real money". And gold was up because those who had a vested interest in gold being up, successfully persuaded everybody of their arguments.

In reality, gold can go up and down for any number of reasons. It does not matter what the reason is, because in reality, it is not based on any type of fundamentals as we know of. Besides the true cost of mining gold, all other reasons why gold might go up and down are rubbish. Simply put, gold is a function of speculation, wild-wild west style. Yep, sorry to spoil the romantic notion that gold is actually worth anything -- beside the cost to get it out of the ground -- but it isn't.

So if one believes -- as I do -- that gold is simply a function of speculation and nothing else, then if you want to speculate on gold, you have to find data that might point you in the right direction, to do the correct speculating.

One very simple rule of thumb is when the Dow/Gold ratio is on your side. I have showed this chart several times and warned investors in all things gold that the tide was against them. How many listened I am not sure.

(Click to enlarge)

When gold went to around $800 an ounce in 1980, gold was rising much faster than the Dow, so the Dow/Gold ratio did a nose dive (middle of the chart). When gold started correcting and the Dow started rising, then the ratio looked north again. So in the above chart, when the ratio is rising, it means gold is losing compared to the Dow Jones Industrial average.

Since November of 2000 gold was rising and the Dow corrected and thus the ratio was diving again. Today (as evidenced by the above chart) the ratio is rising again, meaning stocks are a better bet than gold once more.

The above chart serves two meanings, On the one it tells you if you should be in gold or not, and it also tells you what asset class -- gold or stocks -- is a better bet. Today the ratio is rising which means stocks are the place to be.

Another clue as to when gold might rally again are gold stocks. Stocks are much smarter than the metal, because they follow the rules of investment that are known to us. Price multiples, cash flow, book value etc.

(Click to enlarge)

The above chart should be interpreted the same way the Dow/Gold ratio described above. Meaning, when it is rising, gold stocks are a better bet than gold itself. It does not mean that gold is falling, just that gold stocks, as opposed to gold, is the preferred speculators asset class.

And why is this important? See, when stocks think they will make money mining gold, they will go up, usually giving us a head start before gold rallies. I think the XAU/Gold ratio does a good job at that. And the reason is, stocks are smarter than the metal. So I look at the above chart as a gold leading indicator.

Another clue (and this has more to do with the real world, than just speculating) is the actual cost to get gold and silver out of the ground plus, a markup for the good mining companies that do the hard work.

This is more tricky, because it is different for every company. But if you can find reliable average industry data, that will give you a clue, because theoretically gold cannot fall below the cost of mining for too long. Sure gold can fall below the average industry cost for months, but that can not last forever. So buying gold -- and more important gold stocks -- below the cost of gold production is probably as good as it gets (assuming of course that your gold company stocks are still solvent after such an ordeal).

Bottom line

Because there is no fix formula for what gold is worth, there is no way to know how low or how high it might go. However, the three things I pointed out above, provide more than ample clues as to when gold -- for whatever reason -- might decide to rally again.

Finally, when the trend will reverse, the gold crowd will once again remind us of all the reasons to buy gold. And even if we know that they are the wrong reasons, we will play along and pretend they are right, because it really doesn't matter why gold will go up, as long as we can make money buying its trend.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.