Gold is Shining: Painting the Metal Miner Picture

Includes: DBP, DGL, GDX, GLD, IAU, XME
by: Greg Silberman

Finally! Nearly eight months have passed since gold made its exhilarating move to $725. It has taken months for gold to work out its over-bought condition, to dampen investors' enthusiasm. But wait, gold is heating up again!

Gold recently moved above important resistance at $650. It’s now working its way through congestion in the $650 - $675 zone (blue lines).

Based on the low readings of MACD and RSI (green lines) it looks as if it has every chance of taking out $675 and soon.

And then? Then it’s back up to test the old May ’06 highs of $725.

Gold challenging resistance

As gold moves ever higher the rhetoric and media attention (both positive and negative) will grow. When gold breaks to new highs the speculative juices will flow and many a NEW investor will be drawn in to the gold story.

What they will find is a massive amount of confusing and conflicting information.

Some analysts will be telling them to buy gold the metal. Their argument is that gold stocks will fall with all other stocks. Others will recommend buying gold stocks for leverage. And yet others will convince them to steer clear of such a risky investment in gold.

Whom to believe? When in doubt step back and take a look at the bigger picture:

gold big picture
HUI Gold ratio consolidating since 2004

The HUI:Gold ratio charts the performance of gold stocks vs. gold the metal.

From the above monthly chart we see that from 2001 – 2004, gold stocks led the metal higher.

From 2004 to today, however, the metal led the stocks, then the metal again.

However, every time the metal has outperformed the stocks (chart moves down) the declines have halted at the 50-month moving average (blue line).

Also of interest is how gold stocks outperformed the metal from 2001 – 2003 (green rectangle) when the S&P (below) was being hammered lower.

Current interpretation

We should see a bounce off the 50-month moving average, and the HUI:Gold ratio should move up to re-challenge its old high of 0.63. Nobody knows yet whether we will better the old highs, but there is evidence that we will:

gold oil ratio
Gold Oil ratio - BREAKOUT from reverse H&S

The monthly oil vs. gold chart paints an interesting picture. Since 2004, the oil-gold ratio has been mapping out a large reverse head and shoulders formation. It broke above the neckline at the beginning of 2007 and portends to a higher gold vs. oil price (target is 14.5).

A lower oil price is great news for gold miners as it reduces the cost of one of their MAJOR operating expenses - energy!

For such a condition to exist, we would have to see the price of oil languish at recent correction lows whilst gold strengthens. The only scenario I can imagine would be a continuation of the current economic slowdown. Weaker growth leads to weaker energy prices and higher margins for gold miners. This in turn causes gold stocks to outperform the metal.

If we are right to anticipate a period of out performance by gold stocks relative to the metal, then we would also be right about expecting a stock market tumble resembling the 2000 – 2002 meltdown.

For a new gold investor, the answer is to have a core position in the metal and an investment in large, medium and small miners, depending on one’s risk profile.