WHEN WILL GOLD STOCKS JOIN THE PARTY?

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1 Contents Introduction Gold Wave Analysis XAU Analysis API Analysis Australian Theoretical Gold Price Update Closing Comments Disclaimer Associated Sponsors WHEN WILL GOLD STOCKS JOIN THE PARTY? In this issue I want to specifically tackle the question currently concerning many precious metals investors: What s going on with the gold stocks? While the gold price has recently exceeded most people s expectations a lot sooner than anticipated, the gold stocks in general have been incredibly lack luster. At this point I must confess that few things frustrate me more than an insipid gold stock environment amidst record breaking gold prices! Unfortunately it is one of the occupational hazards precious metals investors often endure. This, in my opinion, is one of the major factors turning off potential new investors to this sector. What you would logically expect to drive the share prices of gold mining companies higher has next to no positive immediate impact. Then, to add insult to injury, the gold price inevitably corrects from its highs and these stocks that virtually stood still throughout the entire rally proceed to fall! What is important to realize here is that investing in gold the metal and gold shares are two entirely different animals. Whilst they are obviously interrelated, every now and again the markets go into major sell off mode which adversely affects all stocks regardless of fundamentals. Gold stocks, importantly, need a certain degree of market confidence to realize their potential. The fact is, regardless of strong fundamentals, all stocks tend to get sold off in a market panic. Looking back over the last 10 years there have been 3 major adverse market events. By my estimates, we are presently at about the half way point of this third one. Shortly, I will show you a chart which will clearly outline the chain of events which typically occurs during these sell off periods. I am hoping this will give you an understanding of what to potentially expect in the coming weeks and months. Once you know what to expect, these events become much less frustrating and you can patiently prepare for them and take advantage of emerging opportunities. The weekly chart below has a number of components. Starting from the bottom and working our way up, the first section is the Dow Jones Index. The second section looks at the Dow Jones relative strength versus the US dollar gold price. Note the downward sloping trend line. Each time this trend line has been hit (blue vertical lines) it has been followed shortly there after by a major market sell off. The present sell off commenced in late July The next section up is a standard 14 week Relative Strength index. Note the typical bottoming pattern for each of the two previous major sell offs. It has been signaled with an initial breach of the 25 level followed by a brief reprieve and then a follow up breach of the 30 level which has typically seen a bottoming of the markets (green circled areas). This is important and is specifically what we will be looking for with the present market correction. The top section contains the XAU gold index. I have thrown this in to show you how gold stocks typically behave in these sell off cycles. Initially they hold up well as the gold price rallies to new highs. This lures many investors into a false sense of security as they interpret this to be the gold shares breaking away from the mainstream markets. All that is really occurring, however, is the gold shares holding their own due to higher metal prices. The longer this occurs the more an obvious problem starts to develop. What happens when The Global Speculator 1

2 the gold price inevitably corrects? The result is usually a delayed sell off in the gold shares. Dow Jones versus Gold and the XAU So this begs the obvious question. When is the ideal time to get into gold shares in the midst of so much market uncertainty? The answer: When the mainstream markets become deeply oversold on an RSI basis. That is when the 14 week RSI initially breaks 25 for our Dow Jones chart. The gold price typically starts consolidating during these periods and the gold shares become a screaming buy. Personally, I always like to keep my core holdings of quality gold and silver stocks throughout these periods. Technical analysis is not a perfect science and these relationships have been known to change. The best case scenario for gold stock investors, as I see it in the coming weeks and months, is if the gold price continues to perform strongly as the market commences phase 2 of this sell off. This will indeed cushion the blow and create a softer landing so to speak. The worst case scenario will be if the gold price corrects heavily in the midst of any further market carnage. This is what happened during the latter stages of the GFC and caused a heavy sell off in gold stocks. At this stage, I am leaning towards the softer landing scenario with the XAU perhaps holding 170. The reason for this can be explained with a look at the recent Commitment of Traders information. The Global Speculator 2

3 The fundamentals for gold appear to have strengthened considerably since 2008/09. Where the gold price used to be heavily dependent on speculative interest for its spikes, the recent strong rally in gold has not seen nearly as much speculative interest. COT Report Last issue we discussed the bullish implications of a rising gold price during a phase where the commercial shorts have largely been covering. Historically, this short covering has occurred under a falling gold price environment (blue circled areas above). For anyone unfamiliar with this chart, I encourage you to visit the archive section of our website and pull up the last issue for an explanation. Since our January/February 2011 issue, this trend has very much continued with the gold price recently taking out $1,800 /oz. If you cast your eye to the bottom section of this chart you can see the Commercial Open interest. Historically, most of the key levels for gold have been achieved with record Commercial Open interest. That is when the speculative longs were doing their thing and the Commercials were selling short into the strength (red circled areas). For the last 8 9 months, note the falling Commercial Open Interest (blue circled area) coinciding with key new levels in the gold price. The Global Speculator 3

4 Summary So in summary what can we potentially expect over the coming weeks and months? Plenty of gut wrenching volatility that is for sure! I think gold stock investors will need to remain patient over the coming months. Major rallies in gold stocks have typically commenced once mainstream markets become heavily oversold. I think the increasing strength in the physical market for gold, however, will somewhat limit the downside of speculative liquidation (unlike in 2008). My advice to investors would be to hold onto core positions tightly and use what could very well be the last major buying opportunity over the coming weeks and months to add to your positions. Gold Wave Analysis Update COMMENTARY Since the last issue, we completed our a b c d e" consolidation which did in fact mark the beginning of the next major wave higher. This briefly saw the US$1,900 level taken out before the start of what resembles a new consolidation. As we will see shortly in our XAU analysis, this rally has done little to boost gold stocks. If our recent highs are in fact a temporary peak, my feeling is we could now see another more conventional consolidation phase for the metal with perhaps a trading range of US$1,500 US$1,800/oz. I see this occurring within the current corrective phase of the markets which could see a market bottom put in by October/November. The Global Speculator 4

5 XAU The chart below highlights key points in time when the XAU is overbought (RSI 35) and oversold (RSI 70), relative to gold (opposite to our usual understanding of RSI). Once the respective indicators trigger (blue vertical lines), it then becomes a task of following trends in the ratio looking for definitive breaks to signify entry (green vertical lines) and exit (red vertical lines) points for gold stocks. The gold price wave analysis above helps us get our bearings. Our last definitive buy signals were in November and December 2008 (during the GFC) and we unfortunately never saw a definitive overbought indication (RSI less than 35) although one came very close to occurring in March 2011 (our Australian analysis below got a definitive breakdown). This period has seen gold stocks rally 119% along with the gold price which is up 92% through to the 11 th of March Since then we have had the usual outperformance of the gold price which has beaten gold stocks by 30%. We are now awaiting an entry signal to point out the ideal time to become overweight gold stocks once again. GOLD/XAU LONG TERM PICTURE The Global Speculator 5

6 GOLD XAU RATIO Extreme Key Dates Gold/XAU XAU XAU Performance Gold Price 3/11/ Gold Performance Net Position 01/06/ % 271 2% 31% 07/12/ % 275 1% 8% 14/06/ % % 28% 30/08/ % 313 3% 7% 23/12/ % % 20% 20/08/ % 411 0% 9% 03/03/ % % 7% 28/11/ % % 70% 11/03/ % 1,412 73% 46% Current (26/08/11) % 1,788 27% 30% GOLD/XAU INTERMEDIATE TERM The Global Speculator 6

7 COMMENTARY It has been a while since out last commentary on the XAU and in that time the gold stocks have distinctively broken down against the metal (occurred on the 11 th March 2011). Since then, the XAU has treaded water as the gold price has gone on to make record highs. As the Gold/XAU ratio hits overbought levels (RSI 70), we see our ratio in the bottom section taking on a very similar look to August/September 2008 during the GFC. The ratio is trending higher on a steeper angle which suggests the worst is perhaps yet to come. As I expect world markets to experience ongoing pain, I would not be surprised to see the Gold/XAU ratio surpass 10 again in the coming weeks and months. This, in my opinion, would get us closer to realizing the ideal gold stock buying signal. AUSTRALIAN PRODUCERS INDEX (API) The Australian Gold Producers Index has a consistent format to that of the XAU. The relative strength comparison is with a USD gold price instead of an Australian dollar gold price. This is because Australian gold shares tend to be influenced more by the USD gold price. GOLD (USD)/API LONG TERM PICTURE The Global Speculator 7

8 GOLD (USD) API RELATIVE AMOUNT Extreme Key Dates Gold/API API API Performance Gold Price 25/07/ Gold Performance Net Position 17/10/ % 370 2% 22% 08/07/ % % 9% 17/02/ % % 90% 19/12/ % % 35% 28/01/ % 1,319 58% 92% Current (26/08/11) % 1,788 36% 28% GOLD (USD)/API INTERMEDIATE TERM The Global Speculator 8

9 COMMENTARY Last Issue (03 March 2011): On the 28 January 2011, this trend line broke down (red vertical line). This is intermediate term bearish in its implications for Aussie gold stocks. Since then the index has rallied 8% but so has the gold price. Healthy and sustainable rallies see the gold shares typically outperform the gold price. When this fails to occur, it is a warning sign that the rally is probably not sustainable. My expectations are for the API index to correct back down towards support at around 800 over the coming months. Gold should continue to outperform the gold stocks over this period. Once we see the RSI (top section of the chart) cross 70, we will get our first indication that the gold shares are oversold against the metal. Then it will be a case of tracking the trend of the Gold/API ratio and looking for a safer entry point to buy. There is no denying the outperformance of the gold price over the gold shares which presently stands at 28% since our ratio sell signal was issued on the 28 January I still think the index is due a correction before we get our gold stock buy signal. If the drop is shallow I would expect 850 to hold. If the gold price doesn t fair so well, I would expect the next level of support to be 750. We will continue to monitor the API/Gold ratio for clues of a potential major rally in gold stocks where the shares outperform the metal. We have already hit the gold overbought/gold shares oversold RSI level (RSI 70) twice signaling we are getting closer. The Global Speculator 9

10 AUSTRALIAN THEORETICAL PRICE OF GOLD UPDATE Date 10 Year AGB Interest Rates Headline CPI M3 Aggregate Money Supply Rate of Australian M3 Change Gold Production Av Annual Increase (1.73%) Australian Theoretical Gold Price Actual Gold Price (AUD) Actual as a % of Theoretical Jun , % 0.14% 3, , % Jul , % 0.14% 3, , % Aug , % 0.14% 3, , % Sep , % 0.14% 3, , % Oct , % 0.14% 3, , % Nov , % 0.14% 3, , % Dec , % 0.14% 3, , % Jan , % 0.14% 3, , % Feb , % 0.14% 3, , % Mar , % 0.14% 4, , % Apr , % 0.14% 4, , % May , % 0.14% 4, , % Jun , % 0.14% 4, , % 7 Year Performance Snapshot 2010/ / / / / / /05 Actual Gold 4% 26% 19% 26% 16% 18% 8% Theoretical Gold 8% 3% 13% 17% 14% 16% 6% M3 Growth 9% 4% 14% 19% 16% 17% 8% CPI (Latest) 3.6% 3.1% 2.5% 4.5% 2% 4% 2.5% M3 Growth (%), 10 Year Government Bond (%) and Gold The Global Speculator 10

11 COMMENTARY Last Issue (03 March 2011): We are now getting into Aussie dollar gold friendly conditions once more as the Reserve Bank of Australia leaves interest rates steady amid a fall in house prices and uncertain business conditions. These fundamentals support our earlier bullish technical assessment of the Aussie dollar gold price which looks poised for much bigger things. A look at the updated chart below tells the story as the gold price in Aussie dollars has busted out after an 18 month consolidation. We came close to our profit taking level of 1.3 for the spot % of the 40 Week Moving average (top section of the chart). If or when we get the next phase of the correction in world markets (probably by Sep/Oct), I fully expect the 1.3 profit taking level to be taken out. Our interim target gold price in Aussie dollar terms remains A$2,000/oz. The present rally has taken spot gold to more than 42% of our longer term theoretical value of just over A$4,000/oz (A$1,700 /oz). Once our profit taking levels are hit, the next logical place to transfer the money will be gold stocks which are already starting to look undervalued versus the higher metal prices. AUSTRALIAN GOLD PRICE (EFT: ASX:GOLD) The Global Speculator 11

12 CLOSING COMMENTS Our indicators continue to be a useful guide during these turbulent times. Whilst the surging gold price makes it tempting to dive into gold shares, which have virtually stood still throughout the entire move, our indicators tell us caution and patience may be required. I repeat, gold shares are a very different animal to the metal itself. They need market confidence to realize their potential. As the last 10 years have demonstrated (3 major corrections), the best time to add to positions is when the overall market becomes heavily oversold. We will await these conditions for the Dow Jones and All Ordinaries Index as signaled by the RSI index (RSI 25 or less) and follow our Gold/XAU and Gold/API ratios closely for clues. If you are new to the sector and scratching your head as to the underperformance of the shares versus the metal, hang in there. The gold sector moves in mysterious ways so as to disappoint and confuse the majority. This often acts as a deterrent for new comers. The key is to learn as much as you can about the relationships. This will save yourself the confusion enabling you to ride this bull market (one of very few at present) as far as it will take you. That has and will continue to be the sole purpose of this free newsletter. Troy Schwensen Editor of GN North America Editor ww.goldnerds.com.au DISCLAIMER This publication has been prepared from a wide variety of sources which the editor, to the best of his knowledge and belief, considers accurate. The editor does not warrant the accuracy of the information and forecasts contained in this publication. This information is provided for educational purposes and nothing written should be construed as a solicitation to buy and sell securities. The Global Speculator 12