Investing In Gold – Why It’s Time To Start Watching VERY Closely

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For thousands of years people have mined, hoarded, even fought wars over gold. Entire empires have been forged and continents colonized in the pursuit of the rare, shiny stuff.

Nowadays, gold is seen mainly as a contrarian “insurance” type of investment, protecting a portfolio against the threat of inflation or another global financial crisis (GFC) type market meltdown.

It performs this function because for most of time, civilization has seen gold as the best true store of value.

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Love it or hate it, gold is probably the single oldest investment known to man and in today’s highly volatile, financialised world, it’s relevance looks set to remain, despite the bemusement of some.

Now, just to be clear – as a geologist, I’ve always been interested in gold, but I’m no gold bug. I’ve never owned any physical gold, nor have I ever invested significantly in gold miners – I’ve had the odd dabble, but gold sentiment has been so bad for the majority of the time I’ve been in the markets that I’ve never really bothered with it.

ButI’m always on the look out for opportunities, and I’m definitely seeing a lot of value in the beat up gold space at the moment – the best bargains (value) are almost always found in the most deepressed sectors in the market.

That’s the one main reason why I’ve been paying very close attention to commodity markets for a while now – It’s starting to look that depressed.

In saying that, timing is crucial when attempting to pick entries into any market, none more so than the commodities space (particularly at the speculative end of the market).

The highly volatile nature of commodity markets (and precious metals in particular) means that if you’re too early – you’re going to loose your shirt (in a big way). On the flip side, if you’re too late, you’re going to miss the majority of the easy gains.

Before we dive into why I think now may be a very good time to consider investing in gold, lets take a quick look at an historic gold price graph to get a feel for the last 15 years or so in the gold market:

Gold Price Trends – A Quick Recap

I recently wrote a post about the current state of play in commodity markets, in which I outlined that, as with all other commodities, gold has had a particularly rough time over the past few years:

0. Gold chart

Chart showing the gold price trends since 2002, in U.S. dollars.

Two things should be abundantly clear from the above gold price chart – firstly, gold went through one hell of a bull market starting in the early 2000’s, rising from a low of US$250 in 2001 to a peak of US$1,921 (a rise of over 660%) in just 10 years.

Secondly, the four and a bit years since has seen quite the bear market for gold, with spot prices currently sitting around US$1,100, down almost half from its September 2011 peak.

Technically speaking, gold is still very much in a bear market and has been stuck in a strong, orderly, down-trending channel for the better part of the last three years.

Because of this, gold related securities (i.e. gold miner stock prices) have suffered heavily, far more so than the precious metal itself, as the following chart shows:

Gold price graph comparing the U.S. dollar spot price against the performance of the GDX (U.S. based Market Vectors Gold Miners ETF) and the XGD (Australian based All Ordinaries Gold Index)

Graph comparing the U.S. dollar gold spot price against the performance of the GDX (U.S. based Market Vectors Gold Miners ETF) and the XGD (Australian based All Ordinaries Gold Index). Both indexes track the performance of a range of gold miners.

To sum things up, after experiencing one of the biggest bull runs in its history, gold is currently experiencing one hell of a hangover.

But, I’ve recently come across some data that indicates that the tide may be about to turn, and when it does happen, it could offer up the trade of the decade…

Why I Think The Gold Price Might Be About To Turn

There is one main piece of data I’ve noticed in the last couple of months that makes me think gold may be about to see a strong change to a bullish sentiment in the near term, but before we get to that, there’s a couple of acronyms and concepts you need to be familiar with:

Firstly, I’m going to be referring to the price of gold in two different currencies:

  • Australian dollars (AUD) and,
  • U.S. Dollars (USD)

You can compare the price of gold in any two currencies you like, but I’m most familiar with gold in AUD and USD, so that’s what this post is going to focus on.

The price difference between the two varies based on movements in the currency markets. Gold is primarily traded in USD, therefore it’s price benchmark is set on the USD value of gold. Right now the AUD is significantly lower than it’s USD counterpart, therefore gold priced in Australian dollars is nominally higher than it is priced in U.S. dollars.

In other words, someone selling gold will receive more Australian dollars for one ounce of gold than they will U.S. dollars (after the proceeds are received in USD’s and converted to AUD’s) – something that’s important to understand if your an Australian gold miner.

Clear as mud? Check out this article if you need to know more about how the currency market works.

Secondly, I’m going to be referring to three major gold indexes – two from the U.S and one from Australia:

  • The U.S. based Market Vectors Gold Miners ETF, also known as the GDX,
  • It’s smaller cousin, the Market Vectors Junior Gold Miners ETF, also known as the GDXJ, and
  • The Australian based All Ordinaries Gold Index, known as the XGD

All three indexes track a range of gold exposed companies (i.e. miners) in their various U.S. and Australian markets and provide a decent snapshot into the overall performance of gold miners in their respective countries.

Now that we’ve got the “admin” out of the way, lets dive in and take a look at why I think there’s a decent chance we may be about to see a turn around in the gold price.

Gold Miners are Starting to Out-Perform the Spot Price.

It might sound overly simple, but in my opinion, the fact that the share prices of gold mining companies are starting to out perform gold itself, is a serious smoke signal that there’s a definite “brewing of interest” in the sector as a whole.

As always, a picture (or in this case, a chart) paints 1,000 words, so I’m going to show you what I mean in a series of charts below:

1. USD gold indicies vs spot

Chart comparing the USD price of gold to the two main US gold miners Indexes, the GDX and GDXJ (J for junior or smaller companies).

What should be subtle but clear in the above chart is a distinct divergent trend between the two main U.S. gold indexes, the GDX and GDXJ, and the spot price of gold since about November last year (2015).

Typically, gold spot prices and the indexes tend to move in the same direction (albeit at a different rate). Whats unique about the last three months is that spot is moving in the complete opposite direction to the indexes.

To make things a little more clearer in the next chart, I’ve shortened the time frame and normalized the data so that all three start at the same level and show % change over the last 3 or so months:

Normalised chart comparing the USD spot gold price vs with the GDX and GDXJ.

Normalized chart comparing the USD spot gold price vs with the GDX and GDXJ.

As you can see, over the last three months or so the two major U.S. gold indexes have outperformed the USD spot price by over 10% and are actually rising, all the while spot gold prices are heading in the opposite direction (down).

This divergence is even more obvious when we examine how the Australian XGD index has fared vs both the USD and AUD spot gold price:

Normalized chart comparing the XGD to both the USD and AUD spot gold price.

Normalized chart comparing the XGD to both the USD and AUD spot gold price.

Even though the AUD gold price has actually decreased more than it’s USD counterpart during this time, we are still seeing a strong positive divergence in the value of the index (I’ll elaborate more on my thoughts on this in a future post).

So there’s a recently developing divergence between the spot price of gold and the indexes containing gold miners, but why does identifying this pattern really matter – why exactly do I think that identifying this phenomenon indicates there’s a decent chance we’re not far off a precious metals wide turnaround?

Why this Divergence Matters – the Past is Key to the Present.

The main reason I’m interested in the divergence in gold price trends, is that the past gives us clear examples of how such developments in the market have played out in the past.

For example, lets take a quick look at how the last change in sentiment in the precious metals market played out – a text book example that I think is likely to be highly prescient of the next turning point:

Annotated chart showing how the GDX behaved relative to the spot gold price before the gold price topped in September of 2011.

Annotated chart showing how the GDX behaved relative to the spot gold price before the gold price topped in September of 2011.

Here are a few key points to note from the chart above:

  1. The GDX started forming a clear top towards the end of 2010, almost a full year before the gold price peaked in late 2011. Note how the gold price continued steadily higher during this time.
  2. Hindsight shows the gold price experienced a clear buyers climax, or final explosive upwards movement before peaking in September, 2011. We also see a less prominent buying climax in the GDX. This signifies the end of the bull market.
  3. The gold price begins a slow decline, but essentially meanders sideways for almost a year and a half, all the while the GDX begins to significantly under-perform the gold price.
  4. Gold makes a series of “lower highs” before eventually breaking downwards out of its sideways meander in early 2013 and the “downtrend proper” begins.

To hammer the point home, lets take a look at another similar but slightly different chart comparing the gold price to the Australian XGD, a market I’m currently very interested in (again, I’ll mention more on this in a future post):


Annotated chart showing how the Australian XGD index has behaved relative to the gold price since 2010.

Like the GDX, the XGD trading activity around the top of the gold market in 2011 clearly lead the gold price itself by about a year, with a clear top and decline occurring well before the turn in the price of gold.

The chart also clearly shows the recent positive divergence between the XGD and the USD gold price, which has began in earnest just over a year ago towards the end of 2014 – a sign I think means we are starting to see the begging of a trend reversal in the precious metals market.

What Divergence Between Miners and the Gold Price Really Means.

What this essentially means is, at least some investors have decided that there is value in the gold miners market and have started to buy. If prices are rising, there’s no other way around it- someone is buying.

That in itself isn’t unusual. What is unusual is when this buying is happening in spite of falling gold prices (both in USD and AUD terms) AND during a very significant and sustained bear market.

When you stop and think about things, who’s usually the first group of investors to take positions before a reversal – it’s certainly not “dumb money” retail investors. Its the “smart money”, i.e. the powerful investment firms and those with astute industry know how.

“Smart money” does this because it’s well known that miners trade at a much higher beta (i.e. rise and fall faster) relative to the gold price itself, therefore it makes total sense that those most “in the know” would:

  1. Exit positions when things look expensive before spot gold market selling sets in (i.e. late 2010 through 2011)  and
  2. Begin to take positions in miners when they look exceptionally depressed and/or cheap, if they thought a turn around in the gold spot market was about to occur (late 2015…?).

In other words, when gold does finally turn, it’s the beaten up gold mining stocks that are likely to lead the way with initial “smart money” buying before going on to make the really explosive gains when the price of gold actually turns.

It’s a phenomenon that’s history tells us often occurs around market sentiment changes, as is clearly shown in the charts above.

It’s a phenomenon I’ve been on the look out for a while now.

It’s a phenomenon that looks (to me at least) like it is starting to manifest.

To Conclude

There’s no doubt about it, the precious metals market is totally beat up. We’ve been in sustained bear market for over 4 years in which the gold price has lost over 40% of it’s value. Most gold miners have lost much, much more than that, as is shown in performance all the major indexes that track gold miners.

However, we are starting to see signs that money has begun flowing back into the market as is evidenced by the recent out-performance of the mining indexes relative to the gold price.

Historically, this kind of activity has preceded major sentiment changes in the market and is a sign that perhaps the”smart money” is anticipating a reversal in the fortunes for gold in the near to mid term.

In saying that, there is no guarantee that “past is prologue” and even if it is and the bottom plays out much like the 2011 top in reverse, it’s likely that we may see a “selling climax” and a final swift sell off (likely below US$1,000).

It could even be traders simply taking positions betting on a bounce off the lower trend channel, although we haven’t seen divergence this strong at previous support levels before:

Gold is in a clear down trending channel and is at a "moment of truth" as to whether it is going to bounce off the lower trend line.

Gold is in a clear down trending channel and is at a “moment of truth” as to whether it is going to bounce off the lower trend line.

Regardless, in my opinion, there’s enough signs around that now is the time you should start paying very close attention to the gold market and I’ve personally opened a number of small positions in anticipation that we’re very close to a bottom.

I’ll be looking for miners to continue to outperform gold for the next few months to strengthen the smoke signal. The next few months are going to be very telling.

Timing is everything in this game and when things do turn, miners are likely to offer up the trade of the decade.

What do you think? Comment below and let me know if you think gold is about to turn, or whether you think the bear market is just heating up.

If you’re interested in reading more about commodity markets, including what I think are the best sub-sectors of the commodity market to invest in right now, check out this post and be sure to subscribe to my newsletter for more exclusive insights.

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