Take for example, Candy, our three-year-old golden retriever. Normally her coat is a beautiful shiny golden hue. However, during heavy rains, she often goes outside as a golden retriever and returns to the back door more closely resembling a black Labrador (what is it about dogs and digging anyway?).

Also there is a radio station that I listen to and one of their standard ads touts “gold as a store of value." Har. That’s a good one. “Yes, gold is the only investment to hold its value in times of market turmoil." Double har. Actually this would be incredibly great news for investors - if only it happened to be true. Okay, I suppose if the nuke goes off nearby and all hell breaks loose, gold might seem like a valuable thing to have on hand for trading purposes. Not as useful as, say, food or water perhaps (“Dad, what will we eat?” “Here, eat this gold bar.”), but useful nevertheless “as a store of value." Still, the idea of bartering with the checkout lady at the grocery store over how many gold bars I need to hand over to buy the bread and milk is an image that, quite frankly, kind of tees me off. Plus, just lugging the darn things around seems a bit daunting. But I digress.  

Let’s forget the doomsday scenario for now and speak of your more generic period of “market turmoil." The theory regularly touted by gold promoters is that if all of your other investments – stocks, bonds, gold, and dollar denominated assets – are tanking – gold (bumpadada!) will stand strong and keep you solvent. OK, sounds great, how about an actual track record. “Um, er, well, you see, everyone knows this is true.”  Right. Let’s roll the tape, shall we.

Table 1 displays a variety of stock market “danger zones” over the past several decades. The table also displays the performance of gold bullion (bumpadada!) during the same time frame.

Table 1: Gold performance during various stock market declines

As you can see in Table 1, there were times when gold “held up” while the stock market fizzled. Still, on the whole the results suggest that the idea that gold is a bastion of strength while everything else goes to heck in a hand basket is something of a myth.

So does this mean that gold has no value? Not all all. The thing to remember, however, is that gold is just like any other tradable commodity. Sometimes it will go up in price, sometimes not. So, bottom line: if you want to buy gold by all means buy gold. But don’t buy it simply because you think it will “hold up” better than your other investments. Because chances are, it won’t.

For All Things a Season

In the mid-1980s (or as I personally refer to it, the “Farewell to Hair” era) I was a budding stock market analyst. And one of the things I liked to do a lot was to divide one number by another. And virtually any two numbers would do. Then I would look at the resultant ratio and see what happened to the ratio over time (Okay, I didn’t have a girlfriend at the time, alright). Now before you start saying “Wow, what a pathetic waste of a life,” consider the following discovery.

One day I divided the Barron’s Gold Mining Index (printed each week in Barron’s Financial Weekly) – heretofore referred to as BGMI - by the price of gold bullion. The more I studied this particular ratio the more interesting the results became. In a nutshell what I found was that gold stocks are much more volatile than gold bullion. It’s sort of as though investors once becoming enamored with gold simply go crazy buying gold stocks to the point of – what else – excess. Likewise, once the worm turned and gold fell out of favor, gold stocks would hit the ground like a safe. Which sounds like a bad thing at first. But as good traders we know to look at these things in a slightly different way.

You smell that? I love the smell of opportunity in the morning.

In a nutshell, what I found was that by tracking the ratio between gold stocks and gold bullion (heretofore the BGMIGB ratio), it was possible to identify some superb times to buy or sell gold stocks. To wit:

• When the BGMIGB ratio falls below 1.20, an excellent buying opportunity is typically at hand.
• Conversely, when the BGMIGB ratio rises to 2.00 or higher, tough times are typically ahead for gold stocks.

Table 2 displays the performance of the BGMI following readings of 1.20 or less in the BMGIGB ratio since 1975.

Table 2: Performance of Gold Stocks following bullish Gold Stock/Gold Bullion readings

Table 3 displays the performance of the BMGI following readings of 2.00 or higher in the BMGIGB since 1975.

Table 3: Performance of Gold Stocks following bearish Gold Stock/Gold Bullion readings

As you can see in Tables 2 and 3, there is a definite difference between subsequent gold stock performance following low BGMIGB ratio readings versus high readings. As you can see in Chart 1, the XAU Index – another index of gold stocks – has plummeted dramatically in the past two months.

Chart 1 – Gold stocks sell off

This is of course, bad news for those “store of value” Stepford investors holding gold bullion or gold stocks. However, for alert investors this may be the early stages of a buying opportunity. Chart 2 displays the Barron’s Gold Mining Index versus the price of gold since 1975.

Chart 2: Barron’s Gold Mining Index versus Gold Bullion

Chart 3 displays the actual BGMIGB (i.e., gold stock index divided by gold bullion) ratio since 1975.

Chart 3: Barron’s Gold Mining Index divided by Gold Bullion

As you can see, if you look closely at Chart 3, the recent plunge in gold stock prices has pushed the BGMIGB ratio blow the 1.20 level to 1.17.

Summary

So does this recent plunge in the BGMIGB ratio means that gold stocks are a screaming buy? Well, maybe. Unfortunately, when it comes to investing there are no guarantees that what worked last time around will work well this time around. Gold stocks could lower still, or could bounce around in a wide, volatile range, certain to send the average investors into nights of sleeplessness. Still, we have to go on something. Whenever I find something that as been 87% accurate over 30+ years of data, I tend to give it the benefit of the doubt.

Glitter on.

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Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site