We all know what is causing the huge falls across virtually every asset class. It’s the global margin call, deleveraging on an unprecedented scale, forced selling of everything – call it what you will. Assets – the more liquid the better – are being sold off wholesale, regardless of their fundamentals, to raise cash to repay debt.
But at some point this deleveraging has to end. What we all want to know is – when? And what will be the best performing asset class when it does?
Recent price action may be giving us some clues. Let's take a look at some charts and see what they tell us. Things, finally, are looking up for gold stocks…
Gold stocks will be the first to rise from this disaster
At the World Money Show two weeks ago, I was asked what I thought would be the best performing asset class coming out of all this. Straight away, I said, gold stocks. Just as they were coming out of the dot com crash, I think gold stocks will be the first to rise from the ashes of this financial disaster.
This first chart shows the ratio of the major gold producers (XAU) against gold (the ratio is the blue line in the bottom half of the chart). As you can see, it is at an extreme level not seen in the last twenty years. Just a reversion to the mean will see a significant outperformance by the stocks over the metal itself.
The HUI is an index of the gold producers who have not sold their production forward (in other words, they are exposed to changes in the gold spot price). The gold to HUI ratio (again, the blue line) is almost at the levels seen in 2001 at the beginning of that bull market in gold stocks.
Even without a significant rise in the price of gold, miners will be making more money. Their costs are coming down. Energy costs are falling. Many base metals mines are closing down. This will lead to an oversupply of labour and equipment and a subsequent fall in the price of both.
The gold stocks followed the stock markets down. We had a major capitulation in October, followed by a bounce and then a retest of the lows. What is interesting is that the October low in gold stocks held on the retest. In fact they made a higher low (see chart below).
This is a bullish set-up. The chart action suggests there are fewer sellers and more buyers at the lows. And looking at a slightly longer-term chart of the HUI, we can see an almost perfect double or W bottom (below).
However, if we look at other commodities, we see that the October low did not hold and in November we made a lower low (below). This suggests there are still more sellers and fewer buyers. It does not indicate a strong market.
Oil, too, made a much lower low. Oil has a tendency to exaggerate to the upside and the downside during a boom and a bust, but the considerably lower November low does not show the same strength displayed by the gold stocks.
The same goes for the stock markets, as shown below by the S&P. The October lows did not hold.
However, if we look at a longer term chart (below), we see this is an obvious place from which to stage a rally. The post-dotcom crash 2002 lows have held. For now.
I think a bounce into the spring in virtually every class is on the cards, with a corresponding decline in the dollar. But I'm hoping gold stocks will be the outstanding performer until spring and beyond. The easiest way to play this is with the US-listed exchange-traded fund, Market Vectors Gold Miners (GDX), which more or less tracks the HUI.
A number of you have asked me for more specific junior gold mining tips, so I'll try to provide some in the coming weeks. But, please, do not trade on margin (using borrowed money) and only drip money into the markets. Swings are so violent even on a daily basis, you can be wiped out even before you've had a chance to re-assess your position.
What happened to gold stocks after 1929?
We have just had a stock market crash of 1929 proportions. There are so many parallels between then and now, that it’s not unreasonable to use that period as a model. Homestake was the biggest gold miner back then. As you can see below, despite falling at first with the overall markets, like the HUI now, it was the first sector to show strength, and went on to perform extremely well during the 1930s, up some 700% and paying a hefty dividend along the way.
Roosevelt made it illegal for Americans to own gold in 1933. He confiscated citizens' gold in exchange for dollars, then devalued the dollar. It must have been one of history's greatest thefts. But it was still possible for citizens to own Homestake – and look how the price gapped up in 1933 as the American government stole from its people.
I doubt with the HUI we will see quite the same scale of success, but measured in badly flawed sterling it may well do. It’s nice to have something positive to look forward to after all this time.
Good news for those who bought gold with sterling
Talking of sterling, another positive note can be sung by those of you who bought gold with it. Last week gold in sterling broke out to new highs (see below). It's up about 25% on the year. You have messrs Brown and Darling to thank for that.
This financial mess was brought on by loose monetary policy, loose lending and easy credit. That the Government is proposing to solve the mess by borrowing more at just a time when we should be saving is, I think, despicable. It is placing an unreasonable and heavy burden on the future and we will all pay dearly for it – as though we haven't enough already - with more inflation and possibly the collapse of our currency. Buying gold – particularly for sterling investors – just looks better and better every day.
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