Rise and Shine?
by Brian Pretti CFA, Contrary Investor. July 20, 2007
Is it gold and gold shares' time to rise and shine? Of course we all wish we had a definitive answer, but we'll just have to see how it all plays out. To be honest, I still maintain a favorable long-term outlook for some very simple reasons. First, I'm convinced inflation will be an important thematic issue ahead, with implications for all investment decisions. I'm talking over a period of years here, not weeks or months. Secondly, I'm of the opinion that the melt down in sub prime and Alt-A mortgage paper will be a much bigger issue than market participants believe at the current time, ultimately leading to the macro repricing upward of risk in the credit markets over time. Both of these themes, if they are even close to being correct, suggest there will be upward pressure on longer-term interest rates stateside over time. And lastly, almost a week doesn't pass these days when yet another global sovereign entity declares its intention to "diversify" away from holding too many US dollars as part of their total reserve holdings. Again, trying to keep it very simple, this all speaks favorably for gold as a global asset class. As for short-term wiggles and jiggles in the price of the metal and the stocks that represent them, I plead guilty as to not having much of a clue.
But in the spirit of trying to listen to the ongoing message of the markets, and trying also to have some type of a sense of historical rhythm, below are a few charts hopefully helpful to review. First a look back. Let's start off with the monthly seasonality of gold prices over the prior three and one half decades. This is exactly what we are looking at below.
As per the message of the historical data used to put the chart above together, the two strongest months for the metal in terms of seasonality lie dead ahead of us prior to the setting of the 2007 sun - September and December. As is evident, the entire August through year-end period has been positive historically.
Although maybe it's a bit more for fund than not, the next little look back at life encompasses only the third year of each presidential cycle in terms of displaying the monthly seasonality of the metal price. I've put current year monthly experience alongside simply for perspective. Again, the three strongest months for gold performance within this seasonal view of life lie ahead - September, November and December.
Of course historical experience is all well and good, but what about the here and now? Is there anything we can hang our hats upon that might be saying something about the near term for gold and the shares? To be honest, I've put together a chart of the XAU below that I believe may indeed be saying something very important about the potential for near term performance. As you'll see, there's a lot going on in this technical view of life. The basis of the chart is clearly the XAU itself. As is self evident, the top section is the weekly RSI indicator where I've drawn in historical patterns of declining tops trends in the RSI being broken to the upside. In the third section of the chart below shows us the performance of the XAU relative to the metal itself. Again, I've done the same thing and drawn in the experiences where the relative performance declining tops trend lines have been broken to the upside, as the stocks started to outperform the metal itself. Next comes the relative performance of the XAU set against the S&P. One more time, declining tops trend lines drawn in.
By now, you are getting the picture. What we are looking at here is a confluence of technical indicators that have been coincident or corroborative in the past at the exact times that the XAU was about to embark on solid and very meaningful double digit rally sequences. The blue lines drawn in, as are clear, show this simultaneous confluence of occurrences where declining tops trend lines in the weekly RSI indicator, XAU performance relative to gold, and the XAU performance relative to the S&P, were all being broken to the upside in synchronous fashion. The minimum rally in the XAU for these three breakout occurrences of this nature since 2001 was 55%.
So here we stand today with what appears to be an upside break out in the RSI. Also an upside break of the XAU relative to gold itself. And for now, a possible break out of the XAU set against the S&P 500. This same technical set up that produced these no miss rallies of the past is again in place. Is past prologue? Of course I wish I could say with certainty to jump in with both feet, but no one knows what lies ahead. This chart is telling us that until proven otherwise, statistical probability is indeed on the side of higher XAU prices ahead. Lastly, and this is certainly more of an intuitive comment than not, I believe recent prior period sentiment regarding gold has been extremely poor. Many of the large cap bellwethers such as Newmont haven't been punished; they have been taken out to the woodshed and beaten senseless in terms of price. Disappointment and give up has reigned. At least as per the message of what appears to be the very important chart above, combined with the seasonal historical data, that may be all about to change. Let's face it, is there anyone with any credibility at all out there calling for a potential big run in the XAU? That has to be the last thought on investor minds at the moment, even the supposed twisted minds of the gold bugs.
Again, is it time to jump into gold stocks right here without reservation? Good investors know that it pays to allow the markets to "show" them whether their thoughts regarding what is to happen in the future are correct or otherwise. For now, these technicals suggest a trading setup, not a guarantee of investment prescience or infallibility. As per the message of history, it’s a high probability setup. But in the game of relative asset class performance, it pays to look at assets classes from more than one angle. Below is just long term perspective. It's the relative performance of the S&P 500 and gold going all the way back to 1980. It's clear that holding the S&P was much preferable to holding gold from the 1980 to 2000 period. Since then, gold has vastly outperformed the S&P. But you can see in the chart that we rest at a relatively critical juncture here as the relative performance line is now touching an important downtrend line for the S&P set against gold. If this breaks to the upside, risk management is in order. But if it’s a failed attempt to break to the upside, that would increase my confidence that gold shares may be entering a favorable period ahead relative to what has been the case for a while now.
The only reason I bring this alternative view into the light is really to remind myself, more than anyone, that risk management is the key to successful longer-term investment results. If indeed the technical setup in the XAU of the moment is to be successful, the time to press the bet is when the market shows us this line of thinking is correct. We'll see how it all goes from here in terms of continued technical corroboration, stock and metal price action. Stay tuned.
© 2007 Brian Pretti