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Gold Miner Performance Relative to Gold

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January 10, 2010 – Comments (9)

My last post looked at Gold Miner Performance: A Look Miner Cost Inputs vs. Gold Price. In this post I want to look at the performance of Gold Miners (GSMs = Gold/Silver Miners) relative to Gold.

ENLARGE

Let's first start with the HUI/Gold Ratio. I like using the HUI since it is a basket of unhedged (no gold hedges) GSMs. You will notice there are times then the HUI advances more relative to gold and vice-versa. I have drawn (somewhat arbitrarily) some lines defining when Gold or GSMs are overvalued with respect to it's opposite. The point is to notice how this ratio is trending and when it gets to an extreme reading it is likely to reverse and oscillate the other direction.

In 2000, in the aftermath of the Tech crash (as the markets were still crashing) the HUI sold off faster than gold. In 2001, GSMs were so oversold relative to their profit making ability (the price of gold) that they represented a good "value" with respect to gold. Now, keep in mind, this is a ratio. When a ratio is increasing, it means that the numerator is increasing faster than the denominator OR the numerator is not dropping as fast as the denominator. Outperformance means either moving up faster or not dropping as quickly.

But I have also included the chart of both the HUI (above) and Gold (below) with the HUI/Gold ratio. And you can see during this time, the HUI is growing faster than gold (both are trending up).

This is an important fact that was helping to signal the next bull market (2003-2007).

Why?

Because you need to understand what gold is and what it has historically meant: Gold is sound money. Now you may be a gold bear, and think it is a useless shiny piece of ... metal. But the odds of someone of that mindset actually making it far down this post is probably unlikely. However, my point is, there are *many* people who feel this way, even if you don't happen to agree with them. And so it is important to understand what many other investors think. My $0.02, and take away from that what you want.

Gold is sound money, which means it represents safety. It is a safe haven move in times of crisis to go to physical gold or to funds that have claims on physical gold (there is a *very important* distinction to be made here about gold / gold funds / types of gold funds. But I have made them many times before and this is beyond the scope of this post).

GSMs, on the other hand, are leveraged plays on gold. They have reserves in the ground that have to be extracted. You can think of it as a vault (and that is a very good way to think of it) but the economic conditions (GSM cost inputs) may be different when the GSM goes to extract its gold. As such, they are leveraged *future* gold plays. There is more than simply the Gold Price and available liquidity that drives the price of miners. See this post for the HUI correlation with the Gold/Oil Ratio: Gold Miner Performance: A Look Miner Cost Inputs vs. Gold Price

Which brings us to the first key observation: During times of increased liquidity and leverage, GSMs tend to outperform Gold.

This is why I say that the HUI/Gold ratio, in 2001, was pointing to a stock market recovery. Because speculative money (liquidity and leverage) began to increase again in 2001 after the tech crash. GSMs (which are equities that produce a leverage play on gold) began to rise in a rising gold environment. This is why it was primarily a liquidity event and not a sustainable economically driven stock market rally. If this were the case, then gold should have been falling (gold prices and stock prices should *NOT* be positively correlated).

GSMs continued to outperform gold for several years, staying at a very high ratio up until 2007. When the stock market peaked, the HUI/Gold ratio started to trend down. Then in 2008, it crashed. Almost all US Dollar denominated assets crashed. But the HUI/Gold ratio is telling us a key fact about the current market behavior: It is a liquidity / leverage crisis. And your response should be, "No sh**, Sherlock. Everybody knows that's what happened". But what I am getting at is that is still happening (that the bounce was a reliquification act by the Fed, not because of some magic recovery) and the ratio is forecasting another move down. More on that in a minute.

Another key observation is that the HUI and Silver correlate very well.

This makes sense. Silver is as much as commodity as it is a monetary metal (whereas gold is almost exclusively a monetary metal and a commodity only a very distant second). Which makes Silver much more correlated to positive economic activity (where we have sustainable growth in commodities as fuel for productive economic endeavors). This optimism typically occurs during times of leverage and liquidity. Silver is a tricky animal though, because besides it straddling the line between money and commodity, it is also warehoused at a tiny fraction in comparison to other commodities or to gold. My next post in this series will talk about Silver and the Gold/Silver Ratio. I will leave it at that for the moment.

So what does all this mean?

I will, of course, give you binv's take on the issue (after all, how could I give anybody else's taken besides my own ... unless I am actually somebody else ... ?).

First I am bullish on Gold, Silver, and GSMs. I think Gold is is a massive bull market. I have discussed these in many other places (Gold Miner Performance: A Look Miner Cost Inputs vs. Gold Price, Crazy Bullish Gold Count, The Gold Blog. Gold/Silver/GSMs (and a little Oil for good measure), Thoughts on the US Dollar, Analysis of the USDX Long Term, Follow up on the Gold Blog, Steve Saville: Dubai, Inflation, and Gold, Thoughts on the Dow/Gold Ratio) and I think the worst possible call would be to short one of the few asset classes in a legitimate bull market. This, of course, is my $0.02.

But let me get to the unanswered question about the HUI/Gold ratio. I think the ratio is projecting another large leg down. Since March, the ratio has been tracing out a bear flag. A bear flag is a pattern, with a lot of overlapping price action that generally trends up in almost a channel. The tighter the channel with the more touches on the upper and lower trend lines makes the pattern more valid. And this looks like a big bearish flag to me.

So what does this mean for the equity markets?

Remember what I was saying above bout the HUI/Gold Ratio back in 2001. It started from an oversold condition and started to rally up. In fact, the move up looks very much like an impulse move (O Mandelbrot, O Mandelbrot). Compare this to 2007-now. The move started at a high condition (GSMs high relative to Gold) and is trending down, which indicates a flight to safety. On top of that, the rally in the HUI/Gold ratio is *very* corrective looking (my bear flag observation above), which means there is another downleg in the ratio to come. And the first leg was brought on my deleveraging and liquidity locking up. I think the next leg down will be brought on my similar conditions as well as a major loss in confidence of current government central planning activities. But since the Fed, through its massive POMO and liquification efforts, has ameliorated the liquidity situation, the next drop will be primarily based on a loss of confidence. I think this ratio is signaling another large leg down for equities.

What does this mean for Gold, Silver and GSMs?

Like I have said above and before, I believe gold is in a bull market. And all the things I just said that are bearish for equities, are bullish for gold. Gold and equities should *NOT* be positively correlated. And I think the next phase of the crisis will break that correlation. I think the HUI/Gold Ratio is going to take another sharp leg down, which means that Gold will outperform GSMs. I don't think GSMs will crash, and I think it will be one of the few equity sectors that posts gains during the next crisis. But I expect another liquidity crisis and I think that will hold GSMs back, which is why Gold will outperform. Which is also what I think the HUI/Gold ratio is telling us. I could make a somewhat similar case for Silver, but I will make it in my next post.

Wrap-Up

The point of this post, just like the point of any of my posts, is *not* to try to convince you of anything. I am an analyst who is sharing observations. That's all. It is immaterial to me whether you agree or disagree with my observations or conclusions. But I do hope that my observations are useful in helping you to formulate your own opinion, even if your conclusion is completely opposite of mine.

9 Comments – Post Your Own

#1) On January 10, 2010 at 6:51 PM, EV38 (99.06) wrote:

Added to favourites. Gonna read this after the Packers game lol

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#2) On January 10, 2010 at 8:33 PM, Tastylunch (29.41) wrote:

Exactly what I was looking for Binve thanks!  This may be your best post of the last three months. And it confirms my outlook as well, maybe that's why I liked it. 

Wave three baby!

It as they say in the english language

PARTY TIME

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#3) On January 10, 2010 at 9:04 PM, XMFSinchiruna (27.09) wrote:

binve,

An excellent post as always! Your thoughtful analysis is such a great resource here!!

Please forgive the intrusion, though, as I offer a friendly challenge to one statement on your first chart above. On that chart, you make the suggest that "Silver outperforms gold when the economic outlook is positive. Gold outperforms during times of crisis".

It is just not that simple, my friend. In a crisis scenario, you can have silver skyrocketing once gold is priced out of reach of many retail investors. Also, gold and silver are seperate physical markets, and the silver supply as you know is exceptionally tight. Regardless of economic outlook, silver could easily skyrocket relative to gold if a shortage happened to appear first in silver. And finally, being such a miniscule market, silver is unlike gold in that it is plausible for a small number of wealthy investors to corner the physical market in a way that is not plausible with gold at the same level. Think Hunt Bros. The point is, for these and other reasons, it is just not correct to state such a rule as a black & white absolute. Given where the ratio stands today, silver could very easily outperform gold from here on out regardless of economic outlook.

Sorry to be a stickler for details, but I thought it an important point to make.

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#4) On January 10, 2010 at 10:30 PM, binve (< 20) wrote:

EV38, Thanks man!

Tastylunch, Hey man, thanks!!

This may be your best post of the last three months. And it confirms my outlook as well, maybe that's why I liked it.

That is an awesome compliment man thanks! Glad you liked it :) You know, I did write this post because of our conversation before.

Wave three baby! It as they say in the english language PARTY TIME

LOL! Indeed :) Thanks man!

TMFSinchiruna,

An excellent post as always! Your thoughtful analysis is such a great resource here!!

Thank you my friend!! Thank you for the compliment, they always mean a lot coming from you!!

I offer a friendly challenge to one statement on your first chart above. On that chart, you make the suggest that "Silver outperforms gold when the economic outlook is positive. Gold outperforms during times of crisis". It is just not that simple, my friend.

LOL! No worries :) I am limited by the amount of notes that I can put on a chart and I was running up against my annotation limits on that one. That is why I wrote all the text in the blog post too :)

Of course I realize it is not that simple and I said exactly that above

Silver is as much as commodity as it is a monetary metal (whereas gold is almost exclusively a monetary metal and a commodity only a very distant second). Which makes Silver much more correlated to positive economic activity (where we have sustainable growth in commodities as fuel for productive economic endeavors). This optimism typically occurs during times of leverage and liquidity. Silver is a tricky animal though, because besides it straddling the line between money and commodity, it is also warehoused at a tiny fraction in comparison to other commodities or to gold. My next post in this series will talk about Silver and the Gold/Silver Ratio. I will leave it at that for the moment.

The supply situation makes it a very tricky animal indeed. And also like I say above, I am bullish on not only gold, but silver and GSMs as well. I own quite a lot of all three.

But, all things being equal, I expect gold to outperform silver during a time of crisis. But like both you and I have stated here (me in the post and you in the comment) as well as before in other post, things are not equal when it comes to silver. The supply and manipulation situation means that it is not fairly valued (IMO) and at some point could experience a crisis event. That is why CEF will always be my largest holding as it gives me exposure to both monetary metals.

Thanks man!!..

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#5) On January 11, 2010 at 1:05 AM, EV38 (99.06) wrote:

This is a very good chart, and it confirms what I have felt for years based on the performance of my portfolio. That gold/silver/commodity stocks always perform their best through March, but perform poorly, no matter what gold does through the summer.

And you'll notice in every single instance of the chart GSM/Gold takes a dip in April/May since 2004. When to buy back gold stocks and sell physical metal is not as clear. Sometimes its as early as August, sometimes its as late as October.

But I don't think this year will be an exception. I think we are headed for 2-3 very good months on equities, particularly commodity-based equities, where many small-medium caps could double in price from their Jan 1 start. After that its time to take profits and get into physical assets.

I'm not going to call a top, but come March if the market does continue its rise, I will be getting market neutral with a mix of longs/shorts on equities, uncorrelated speculative biotech plays and hard assets like silver or real estate. Given the time it takes to close on real estate deals, I'll probably be sitting on a substantial amount of cash which is usually something I do not do.

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#6) On January 11, 2010 at 11:50 PM, anchak (99.86) wrote:

BInve....Outstanding post as always.....

My 2 cents on this - I think I have been wrong on this current Gold move up - and I think you are possibly wrong assuming it to be corrective.

2 charts

ENLARGE

You'll see how the White lines have acted as resistance but never been able to stop it. Also the pattern almost calls for a 5th up!

Of course the Wave down in 2008 - seems to have been a 5 wave - so it would be interesting to see how it unfolds from here.

The long term chart - really leaves very little doubt about the long term bull for Gold. I really expected the White fans to act as resistance given the 5 down for a 5-3-5 - but an index to come back all the way to the first fan - almost surely points to a Wave 3 territory.

I think there maybe a corrective here - but possibly not that much. The tough thing though - Long terms are on a bullish path.

Somethings are just too complicated these days.

ENLARGE

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#7) On January 11, 2010 at 11:51 PM, anchak (99.86) wrote:

I meant Long term Rates

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#8) On January 12, 2010 at 12:35 AM, binve (< 20) wrote:

Hey AC, thanks man!

My 2 cents on this - I think I have been wrong on this current Gold move up - and I think you are possibly wrong assuming it to be corrective.

AC that is *NOT* what I said. I said that the HUI/Gold **RATIO** was corrective up. That is what the chart and indeed this entire post was about. The GSM/Gold ratio. I do counts of the HUI, and I think it is in an impulse up, just like gold is. The whole point of this post was to compare the relative performance of the GSMs relative to Gold, not GSMs or Gold by themselves (I have already done several posts on both Gold and the HUI and am bullish on both based on their wave counts.

The long term chart - really leaves very little doubt about the long term bull for Gold. I really expected the White fans to act as resistance given the 5 down for a 5-3-5 - but an index to come back all the way to the first fan - almost surely points to a Wave 3 territory.

I think there maybe a corrective here - but possibly not that much. The tough thing though - Long terms are on a bullish path.

I very much agree :) Thanks man! ..

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#9) On January 12, 2010 at 3:32 PM, Tastylunch (29.41) wrote:

anchak

I don't trust Ewave much for Gold, since the gold market is heavily manipulated by central banks I figure only the longer term charts are of any reliability...

So yeah Onwards and Upwards!

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