After a very impressive rise in the first half of the year gold stocks have been going through a prolonged correction since topping in early June 2002. We are now moving well into fall and we find ourselves in a period where gold stocks could once again begin to shine. Since gold futures started trading on the NYMEX in 1974 we have noted particularly in the past decade a number of lows for the year in the August/November period. The strong rally into 2002 made its last important bottom November 2001. The sharp rally in 1993 had its beginnings in October 1992. Ten years later we could once again be making a significant low in the October/November period.
The actual range of lows for gold predominates in the October-April period so it is possible that our final low in gold occurs somewhere in that period as opposed to just at the beginning of the period. Some cycle analysts we follow are also pointing to potential cyclical lows in gold in the period October 2002-February 2003. We have some important lows now and some further ones due in mid to late December. It doesn't mean that the lows in December have to be lower than any lows we might be seeing now but it would give rise to another opportunity to enter into gold and gold stocks for what well may be a good run in 2003.
So why are gold stocks coming once again onto the radar screen? Well in a nutshell the US Dollar is once again about to come under pressure due to a weakening in the US economy. After a sharp drop in the US Dollar through early July 2002 there has been over the past several weeks a recovery attempt. This rise in the dollar has been accompanied by an upswing in monetary growth (most recent 13 weeks growth for M3 is 7.9%) and a recovery in the stock market following lows on July 24, 2002 and again on October 10, 2002. Recent GDP growth in the 3rd quarter came in at 3.1% and while below expectations it has given further buoyancy to the market and the dollar.
But that period may be coming to end. Recent economic numbers have been weak with deteriorating consumer confidence, naggingly high and growing unemployment, and a deteriorating manufacturing picture. Other things like the threat of war in Iraq remain in the background. As at the time of writing we were still awaiting the latest Federal Reserve moves. Rumours have abounded that the Fed might cut by 50 basis points. But then mixed economic numbers keep the pressure off the Fed. Odd that everyone is so centered on another rate cut when over the past year the Fed has cut rates 11 times from 6.5% to 1.75% and the economy is stagnant at best, and moving into a recession at worst.
All this is beginning to once again put pressure on the US dollar. As well US Treasury bonds that had enjoyed a stellar year up until early October fell sharply (yields up) (prices move inverse to yields) in the latter part of October reflecting concerns that bond yields were no longer attractive, and amid growing credit concerns and deteriorating bank balance sheets. Bank and financial institution woes just continue to deepen. In addition to the deteriorating balance sheets large securities firms have been facing a raft of civil law suits related to the go-go days of the late nineties. Fortunately for these institutions the suits have remained civil rather than criminal. Accounting firm Arthur Anderson faced criminal charges and now no longer exists. Can anyone imagine the ramifications for example of a Citigroup facing criminal charges? Well don't hold your breath, as we are aware of a possible criminal action being filed against Goldman Sachs by the State of Utah. Goldman may be soon be churling on the stock picks of Abbey Joseph Cohen.
While gold stocks often show a strong correlation with the general stock market there is an even stronger inverse relationship between gold and the US Dollar and bonds. Sinking US bonds and US Dollar may allow gold stocks to rise even as general market falls into another funk.
Certainly holding gold or even precious metals such as silver and platinum has been a clear winner this year as opposed to being in the stock market. A study by Bullion Management Services the holding company for the Millennium Bullion Fund, a mutual fund trust, has shown that on balance to the end of October gold was up on average 29% against an on average fall of 13% for a select group of global stock markets. In Canada gold was up just over 11% in Canadian dollars to the end of October 2002 while the key S&P/TSX had fallen 20%. The BMS summary chart is provided below.GLOBAL GOLD - EQUITY PERFORMANCE COMPARISON
January 1, 2002 - October 31, 2002
One interesting observation from the above table is the sharp rise in gold prices in Argentina, Brazil and Venezuela. In each case the local currency has been under extreme pressure over the past year. This is a prime lesson that in a period of devaluing currencies that holding gold was a superior strategy. At the end of the day paper currencies are worth only whatever the monetary authorities and the markets tells us it is worth. Gold meanwhile can always hold its value, as it is an asset with no liability. Paper money can of course be ultimately well just paper as history has too often proven.
An interesting article we read drives this home. The article is by James Jaeger entitled "Beyond Diabolical: A perspective on Gold, Silver and Paper Money". There were two premises. The first premise is that there isn't enough gold and silver in the world to finance the economy of the United States (let alone any country). Money is merely a measure. If you measure a rug its size does not change no matter how you measure it whether in meters, feet, yards or even miles. If you had to make purchases in gold, silver or precious metals we would have different weights or sizes of coins to make the purchases but it doesn't change the amount of the metals available unless more supply is found.
But paper money destroys this as it can effectively expand infinitely. Over the past two years alone US money supply (M3) has grown by $1.3 trillion while the economy as measured by GDP has grown only by about $350 billion. Debt growth has been even more phenomenal growing roughly $2.1 trillion in the same period. What that means is that it has taken roughly $6 of new debt to purchase $1 of GDP or $3 of money supply to buy $1 of GDP. We do seem to need an awful lot of money just to keep things going.
The second premise is a myth statement that gold and silver are no better than paper as currency. The analogy the author used was that in 1913 when the US established the Federal Reserve the average annual wage was $633. Gold was priced at $20.67 so if a person were paid in gold they would have earned roughly 30.6 ounces. Updating Jaeger's numbers to 2001 the average per capita income in 2001 was $22,851. The average price of gold in 2001 was roughly $271. That meant that the person was paid 84.3 ounces in gold. While income in dollars has increased roughly 3500% in gold terms it is only up 175%.
What this translates into is that the purchasing power of a dollar had fallen roughly 40% per year while in gold terms it had fallen only about 2% per year. Now which would you rather be paid in?
We have attached a daily chart of the Philadelphia Gold & Silver Index (XAU) and gold. The large symmetrical triangles forming on both the XAU and gold while holding bullish trend lines coming up from the fall of 2000 lows (and in gold's case from the lows in December 2001) suggest that the breakout should be to the upside. While we cannot rule out a break down we put less probability on that scenario. We could, however, continue to trade in a narrower range before we have the actual breakout. We have cycle lows in mid to late December that could be preceded by break out high.
We continue to favour the producers over exploration plays. Our favoured plays are NMC, MNG, G, AGE, K, HRG and ELD on the TSX, NEM, AU and GFI on the NYSE and HGMCY and DROOY on the NASDAQ. Favoured silver plays are SSO on the TSX venture, PAA on the TSX, CDE and SIL on the NYSE.
Note: Charts created using Omega TradeStation or SuperCharts. Chart data suppliedby Dial Data.