A Theory Of Gold (GLD)
There’s nothing like a few words about gold to bring old Aunt Harriet storming out of the batcave with a rolling pin in her hand.
So it was after last week’s letter, in which we heard from numerous batty types that gold was certain to rally into year end. This is Indian buying season isn’t it? Chinese New Year? And don’t forget Minoan child sacrifice month!
Har, har. You old bootlick.
To reiterate, we reported last week that…
GLD sits a mere 3.5% above the support area at 161. Should it drop below that level, 161 would then become resistance. Note, too, that when moving averages are gathered as they are for GLD, it becomes easier for a single day’s move to slice through support and change a stock’s complexion entirely… [A]ll goldphiles [should] keep an eye on GLD 161. Any move below that level would likely be a game-changer.
The action since last week has brought us closer to that all-important 161 level. Then, GLD sat just below 167. As of yesterday’s close, we’re three dollars lower at 164. Support sits just 2% below our current price.
And the bulls still cry “Quantitative Easing!”
Where’s the Truth?
In the never-ending battle to understand which way gold is headed, we offer the following for your consideration.
It’s a daily chart of GDX, the popular Market Vectors Gold Miners ETF, since it began trading back in the summer of 2006.
Most important for us are the notes in red.
At the bottom of the chart, you can see that at no time in GDX’s history did RSI register so highly overbought as it did at the September highs eight weeks ago. Since then, price action has been straight down, with GDX forfeiting roughly 18% of its value.
RSI and MACD are both trending below their waterlines (in black), indicating we’re in the grip of a full bear move.
And though we have to admit that the miners did a yeoman’s job of rallying off their July lows, putting on nearly 38% in a bid to retake their last retracement high at 58, alas, the effort was in vain, as the six month chart below shows.
GDX ran into strong overhead resistance at the long term, descending moving average at 55 (yellow line, blue annotation), and that’s where things were capped.
GDX investors now face a dark future. With all moving averages trending lower and shortly to be fully unwound, and with the stock itself falling and currently below all its moving averages, and with both RSI and MACD indicators below their respective waterlines, how could anyone possibly believe the future for GDX is golden?
And maybe more importantly, who’s telling the truth? The GDX miners? Or GLD, the metal?
Because according to the GLD chart, we’re still holding above three of four important moving averages, albeit just by a whisker.
The Rough Edge of the Truth
There are two possibilities.
Either A) the miners are just waiting to play catch-up, or B) they’re leading, and it’s the metal that’s about to take a spill.
Let’s examine them both.
Mining stocks are leveraged to the price of gold. If it costs $800 to pull an ounce of gold out of the ground, and gold is selling for $900, the miner’s profit is $100.
But if the price of gold rises to $1000, the miner’s profit doubles to $200 (from $100), and his share price should rise accordingly.
Did you catch that?
The price of gold rose by 11% (from $900 to $1000), and the miner’s profit (and share price) grew by 100%.
Miners’ share prices move on earnings, and earnings are affected by the price of gold itself. Which leads us to wonder why, with gold just 10% off its all-time historical highs, we don’t have gold mining equities shooting through the roof.
And if you explain that current mine supply is dwindling and not being replaced fast enough to maintain the type of profit projections we’ve grown accustomed to (hence the lower share prices), then we have another question for you.
Shouldn’t that push the price of gold higher? Shorter supplies mean higher prices, right?
Unless the truth lies elsewhere entirely.
Is it fathomable that the price of gold simply got extended and is now returning to a level more in line with the profit reality evinced by the miners? And, if so, is it possible that the “appropriate” level for gold is actually closer to $1000 today than $2000?
We think so. But either way, the gap that opened between the two back in mid-2008 will have to close over the long term.
Have a look here:
The two decoupled in the middle of 2008, and since then GDX has gained 15%, while bullion is up almost 150%.
Others will have their explanations. We don’t buy them.
Best play it with a long-short initiative, buying the miners and selling the metal. And if you’re using options, go out as far as you can. This may take some time.
Many happy returns,