July 12 2007

Cause and Effect

No doubt about it, its been a frustrating year for those who trade gold and the shares of companies that seek it. Well, those who tend to be long both the metal and stocks, that is. All those stalwart supporters in the market that gold could count on seem to have lately deserted it. Oil, many people’s favourite fellow traveller, has been red hot for the past few months but little of that warmth has been rubbing off on gold. The first relative performance chart below shows the price of West Texas Intermediate gaining by almost 40% from its bottom near the start pf the year. Gold’s move for the same period was a modest 7%. You can see from the chart that there was definitely some correlation earlier this year but that broke down in April. Oil continued to climb, with some pullbacks along the way, but the gold price faded.

So what happened in April to put the gold market in a funk?  We think the next chart explains some of the problem. The chart below is a relative performance chart compares the returns over 200 days for gold and the 10 year Treasury bond yield Index (the TNX).  As you can see through the early part of the chart there is some inverse correlation, which is what you would expect.  As we’ve noted in the past, relative levels of real interest rates between different jurisdictions have a huge impact on fund flows (think Yen carry trade) and Gold gets treated as a non-interest bearing currency in this equation.  Higher “risk free” yields effectively increase the carrying cost o f bullion. Note however, that this can be a short term effect and if he movements in interest rates are due to changes in inflation the picture gets a bit more complicated, and more favourable for the noble metal.  We’ll talk about this relationship a more in the next Kitco column.  For now we’ll leave things with the comment that some of the gold sales during this period were traders who were getting scared off by the rapid rise in rates evident you can see on the right side of the chart.  Gold was getting sold along with everything else, including t-bills when traders got jittery in May.

So what about that most dependable of inverse trading relationships, gold to the US Dollar; has that gone out the window too?  Not according to the last chart pictured below.  You might have to squint on this one a little because the volatility of the Dollar has been so much smaller than gold’s lately, but that’s part of the point.  By and large, the inverse Gold/Dollar relationship has been holding. You can view that as either good or bad news depending on which side of the market you’re on. 

On the one hand, this dependable relationship has been a boon for gold many times this decade.  Given our negativity about the Dollar medium and long term we are happy to see this trading relationship intact.  That’s good news for most of us, but for those waiting on a major breakout of the yellow metal it’s a bittersweet message. The last major move in gold back in 2006 was very much a case of gold gaining against all comers. That will probably have to be repeated for gold to see new highs unless the Dollar really breaks down.

In the short term, we see enough support for gold and weakness for the dollar that the rally that began early this month may have some legs, particularly if there is more terrorist trouble. We obviously don’t hope for that sort of problem its worth noting that the reaction to the foiled bombings in London is the first strong “political move” in gold that held for some time. That alone may be sufficient evidence that a trading bottom is in.

In closing, we wanted to point out that we know we’ve been (very!) tardy getting columns up on Kitco lately.  As some of you already know, Robert Bishop, legendary editor of the “Gold Mining Stock Report” ceased publication at the end of June and chose the Hard Rock Advisories as the successor publication to GMSR. Administrative load based on that, and a bunch of project tours kept us busier than usual. We’ll get back on track with the articles now.

Eric Coffin
HRA Advisories.

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David Coffin and Eric Coffin are the editors of the HRA Journal, HRA Dispatch and HRA Special Delivery publications focused on metals exploration, development and production stocks. They were among the first to draw attention to the current commodities super cycle and have generated one of the best track records in the business thanks to decades of experience and contacts throughout the industry that help them get the story to their readers first. Please visit their website at www.hardrockanalyst.com for more information.

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The HRA – Journal,  HRA-Dispatch and HRA- Special Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing timely and factual analysis of junior mining, resource,  and other venture capital companies.  Companies are chosen on the basis of a speculative potential for significant upside gains resulting from asset-base expansion.  These are generally high-risk securities, and opinions contained herein are time and market sensitive.  No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer, solicitation or recommendation to buy or sell any securities mentioned.  While we believe all sources of information to be factual and reliable we in no way represent or guarantee the accuracy thereof, nor of the statements made herein.  We do not receive or request compensation in any form in order to feature companies in these publications.  We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form for other than for personal use without the prior written consent of the publisher.  This document may be quoted, in context, provided proper credit is given. 

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