John Hussman Turns Bullish On Gold

Includes: DGL, GLD, IAU, XME
by: Douglas Dillon

I've been reading (and admiring) John Hussman's weekly Weekly Market Comment for a couple years now. He seems to be among the most sophisticated, well-balanced, conservative and truly insightful money managers out there who publishes his thinking on a weekly basis. I've learned a lot from him.

Because he is so well-balanced, I was really surprised to see him in this week's commentary somewhat on the same wavelength as your author regarding precious metals:

In precious metals, the Market Climate remains favorable, and the Strategic Total Return Fund currently has just under 20% of assets invested in precious metals shares. The U.S. dollar, having cleared its oversold condition, may be vulnerable particularly if employment figures are not particularly strong."

20% is a very large allocation for Hussman as he is such a believer in employing diversification to achieve safety and steady returns (unlike your author who is employing concentration to maximize gains despite increased volatility).

Digging through his archives reveals this article from 1999. It gives his thinking on precious metal stock investing . This is the best treatment, from a moderate, non-conspiracy viewpoint, that I've ever seen on precious metal stock investing. Its pretty interesting to consider how timely it is and probably explains why Hussman is so bullish at this time.

Here's Hussman's money quote from that article:

Not surprisingly, the combination of all of these is rare but extremely powerful. In the rare instances when 1) The rate of inflation has been higher than 6 months earlier, 2) Treasury bond yields have been lower than 6 months earlier, 3) the NAPM Purchasing Managers Index has been below 50, and 4) the Gold/XAU ratio has been above 4.0, the XAU has soared at an astounding rate of 123.63% annualized. In contrast, when none of these have been true, the XAU has plunged at -53.21% annualized. That's a gaping difference.

So, let's see where we stand against Hussman's four criteria right now, at the start of 2008:

(1) Rate of inflation is higher than 6 months earlier -- The year over year inflation has risen from 2.7% in May 2007 to 4.3% in November 2007 even though the month-over-month inflation is unchanged at .6% (see here). While this is not perfectly clear, I would presume that in spirit this matches Hussman's criteria of "rising inflation".

Here's the November BLS CPI summary:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6 percent in November before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The November level of 210.177 (1982-84=100) was 4.3 percent higher than in November 2006.

Here's May's summary:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6 percent in May, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The May level of 207.949 (1982-84=100) was 2.7 percent higher than in May 2006.

(2) Treasury bond yields have been lower than 6 months earlier -- In the last 6 months the 30 year treasury yield has fallen from 5.12% to 4.45%, see here and here.

(3) NAPM PMI under 50 -- We haven't gotten here yet, but are getting close. The last four readings are: 53.8, 52.9, 52.0, 50.9 or steadily trending lower at roughly falling 1.0 per month (see here). These readings come out on the first business day of the month, and we'll get the next reading January 2 at 10AM which could meet Hussman's criteria.

(4) Gold/XAU ratio has been above 4.0 -- Here's the chart, currently at 4.83 which is well above Hussman's criteria. You can see from the chart that for almost the entire bullish period from 2001 onward this criteria was met and that when it was not met (Q2 02, Q4 03 and Q1 06) that the XAU index languished. This is really impressive given that Hussman's criteria was established in 1999 (before this entire period).

To summarize, the current situation:

  • clearly, fully satisfies Hussman's interest rate (2) and XAU/Gold ratio (4) criteria,
  • satisfies Hussman's inflation criteria (3), at least in spirit and probably according to the letter,
  • is trending towards meeting Hussman's PMI criteria and may meet this criteria when it comes out January 2 at 10AM.

In the past when this pattern held, gold stock rose over the next six months at the rate of 123% annualized. My own investments are highly concentrated in Jr precious metal mining stocks that have diverged from the advancing price of gold even more than XAU's large caps. The "reversion to the mean" principle suggests that these juniors that could advance even faster than Hussman's pattern for large caps suggests.