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From Gold Bear to Gold Bull

Tuesday February 18, 2014 14:01

Bluer Skies over Gold Country?

Feb. 18, 2014

On Jan. 14, I switched from gold bear to gold bull as explained in my commentary; Gold’s Wild Ride Down May Soon Be Up. Gold was at the $1,240 per ounce-level then after recovering some from its devastating sub-$1,200 low at the close of last year. 2013 had been a horrible year for the yellow metal which experienced not only a severe downturn in U.S. dollar price but also bearish value destruction relative to key commodities and equities. My bullish call came from a shifting relation with global commodities oil and copper. In the first two-weeks of the 2014, Comex gold began to vigorously regain value with respect to West Texas Intermediate (Nymex WTI) crude and Comex copper although the relation to U.S. equities was less clear. By late-January gold dollar price trended up as the S&P 500 began a 6% pullback. By February, the tarnished store-of-wealth was shining again on all fronts.

Friday Comex gold briefly touched $1,321.5 before closing at $1,318.6 per ounce, both above the 200-day average - the yellow metal had not risen above this key metric in more than a year. It’s also noteworthy that the long U.S. weekend moved prices above $1,330 and ever closer to $1,345 – the average gold price since the Lehman Brother’s bankruptcy filing on Sept. 15, 2008. This nearly 5 ½-year mean is significant because it includes the worst market extremes of the financial crisis and all three Federal Reserve quantitative easing cycles - the latter having a significant impact on metal prices as documented in my two-part commentary, Copper & Gold – The Long Ride from Lehman Brothers (Part I, Part II).

A review of gold valuation relative to commodities and equities together with their respective Lehman Brothers’ means provides some important clues to the nature and sustainability of the present gold rally.

Gold Valuation Comparison

Fig. 1 is a chart of important gold ratios from November 9, 2012 through Friday’s close:

Figure 1 – Gold Valuation Comparison (Nov. 9, 2012 to present)

Gold’s reversal in fortune occurred in late-2012. Within 5-market days, gold peaked in value relative to copper, WTI and the S&P 500. Nov. 9 was the beginning of that period and thereby chosen to normalize the respective gold ratios in Fig. 1 – on ounce of gold on that day bought roughly 500 pounds of red metal, 20 barrels of WTI and the gold-to-S&P 500 ratio, or AUSP, was 1.25. By contrast, on Friday an ounce bought only 400 pounds of copper, 13 barrels of oil and the AUSP had fallen below parity to 0.71.

The ratios (red trace is gold-to-copper; gray, gold-to-WTI; purple, AUSP) descended at the beginning of 2013 and gained considerable momentum to the downside with the April 12 gold price downdraft (red dashed arrow). The valuation lows are shown by red triangles together with the relative loss in value – the oil gold ratio lost 40% of value by early-July with copper and AUSP dipping 30% and 48% on the  last day of trading.

Using the 20%-or-greater decline rule to denote a bear market, all three ratios closed in deep bear country for 2013 relative to the high valuations of  late-2012.

Comparison to Lehman Brothers’ Means

Fig. 2 super-imposes onto Fig. 1 three gold ratio means (dashed lines) calculated from the Lehman Brother’s bankruptcy filing on Sept. 15, 2008 to Friday’s close:

Figure 2 – Gold Valuation Comparison with Lehman Brothers’ Means

Interestingly, all the so-called “Lehman Brother’s Means” fall within a fairly tight range when normalized by the Nov. 9, 2012 valuations (0.80-0.86): Copper, 401.3 pounds per ounce or 0.799; WTI, 15.83 barrels per ounce or 0.787; and AUSP, 1.0738 or 0.856.

The 5 ½-year means demonstrate that gold transitioned from trading at a premium (to key commodities and the S&P) to trading at a deep discount in 2013. As 2014 began, the copper, oil and S&P gold ratios all trended higher from the lows of 2013 (red, gray and purple arrows).

Although the normalized means are clustered, the individual ratio responses are quite different with respect to their means.

The copper ratio suggests reversion to the mean with Friday’s closing just above the average (403.9 versus 401.3) together with numerous prior cross-overs occurring from late-June to late-November, 2013. The Lehman average Comex copper price is $3.3509 per pound compared to the $3.2645 Friday close - like gold, not far from current prices.

On the other hand, the oil ratio and AUSP, while trending up, are still well below their Lehman means (13.14 versus 15.83 and 0.7172 versus 1.0738 respectively). The oil ratio, although achieving its low well ahead of either the copper or AUSP ratios, demonstrates the shallowest recovery. Neither oil nor the S&P appear in any hurry to revert to their longer term means. If either were to mimic the red metal’s reversion behavior, Friday’s closing gold price would require the S&P 500 to plummet to 1,230 and WTI to drop to $80 per barrel – a stretch for all but the most bearish market participants.

So what’s up (or down)?

It’s not unreasonable to expect gold and copper to respond in a more classical manner with respect to their Lehman means – both are metals. The S&P 500 and oil are outside markets that may influence metal prices but have their ownindividual character. If U.S. equities have indeed entered a secular bull market and future gold prices are flat or rise less aggressively, the AUSP will trend lower not higher over time. For this case, tracking deviations from a linear model would be superior to simple mean analysis over multiple years (to a lesser extent the same can be said of gold’s value relation with copper and oil as explained in Gold’s Wild Ride Down May Soon Be Up)

Oil is at least in the commodity space and its gold ratio has trended higher since July by about one barrel per ounce. Presently both WTI and Brent futures are in backwardation so lower oil prices are in the wind. If the April contracts are compared to December, the gold-to-WTI ratio gains another barrel per ounce moving it back to the historical range of 14-16 barrels per ounce which includes the present Lehman mean of 15.8. Although such future comparisons are tenuous, it does suggest that the gold-to-WTI ratio is converging to more normal levels, albeit slowly.

Reasons to be bullish

Whatever the technical caveats, the gold ratio comparisons to the Lehman means do illustrate the bearish value destruction of 2013 as gold transitioned from trading at a premium to deep discount. Furthermore, the value reversals for all three ratios imply “the lows are in” and bluer skies are likely for gold in 2014.

The next price challenge for the yellow metal will be the $1,350-level which lies just above the Lehman mean and also represents significant chart resistance. After that achieving the $1,430 August high would be a most welcome development.

From the heart of North American Gold country – Cheers!

By Richard Baker, CP Value Analytics
Eureka, Nevada



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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