Gold stocks are near their most expensive level relative to the price of bullion in 14 months, a sign that they may start to underperform the metal, according to WJB Capital Group Inc. Gold traded at 11.5 times the level of the Philadelphia Stock Exchange Gold and Silver Index in October 2008, the most ever, as the financial crisis caused by Lehman Brothers Holdings Inc.'s bankruptcy sparked a stock market retreat and spurred investors to buy bullion as a haven. The gap has since narrowed as the mining index more than doubled to catch up with the metal's gain, beating gold's 48 percent advance. The ratio, which never surpassed 6.4 from 1984 until September 2008, dropped to less than 6 in September and was 6.3 today. Its return to the level prior to Lehman's bankruptcy signals that bullion is likely to begin outperforming its producers, said John Roque, managing director in technical analysis at WJB in New York. – Bloomberg
Dominant Social Theme: Things get tricky at the top?
Free-Market Analysis: Ah, technical analysis! So according to numbers that go back to 1984, the ratio between bullion and mining stocks is getting toppy. There is only one thing wrong with this analysis in our humble opinion. It does not go back far enough. To be truly useful it would have to take into account the 1970s. In fact, let us throw out this question: Why on earth would any technician of any sense utilize 1980s numbers when analyzing what is evidently and obviously a 1970s market? (In contemplating this question, we return to a previous thought – that Bloomberg doesn't really "get" the gold market. This article would certainly seem to indicate that.)
The 1980s were many things, but they were not a decade of gold and silver. The 1970s were almost exactly like this decade however in so many ways. That's because we are in approximately the same part of the business cycle (according to free-market but not Keynesian economics) that we were back in the 1970s.
In the early 1970s, President Richard Nixon (pictured above left) delinked the dollar from the final remnants of a gold standard and the entire system suffered from a crisis of confidence and began a decade-long purge of mal-investments that had developed during previous decades of fiat-money overprinting The result was a big devaluation in Western stock markets, rising oil and gas prices, a terrible double-dip economic downturn, and finally rip-roaring price inflation that was only damped, in America, anyway, by 20 percent interest rates.
We've already had a good dose of the 1970s, and we believe that we still have a further ways to travel in the 2000s. Whereas the 1970s was a 10-year shakeout of economic distortions – thanks to central bank overprinting of money – we believe the current purging of mal-investments may last 15 years or even longer if the powers-that-be keep propping up bad businesses with bailouts. We figure this current cycle started in 2000 or 2001 by the way.
Thus we can see that the 1980s, with their securities orientation, the big run-up of the stock market and sharp selloff, the purging of inflation and a rip-roaring economy has little to do with 2000s. The 2000s are the 1970s writ much larger, and if one is to do any technical analysis, the 1970s is the place to start. We would argue that ratios between gold and gold mining stocks that encompass the 1980s, 1990s, and even the 2000s until now, are of little use because they do not include the time period most relevant to what is occurring today, the 1970s.
How does it work? Like this ... During the time in a fiat-money economy such as the West has got – when gold and silver are ascendant and the system is working out the mal-investment of the previous 20, 30 or 40 years – the prices of precious metals eventually go much higher. When this happens, people start buying all sorts of paper gold. Specifically, they buy shares of gold and silver mining companies because the producers will still be relatively cheap. Toward the tippy-tail end of a metals bull market, when prices are really out of control, even the small junior exploration stocks (the last part of the market that's not entirely bid-up because no one trusts them) start to be overbought as well. There's no rhyme or reason to it. It's a mania. And fortunes are made for those lucky enough to get in at the right place and at the right time.
Conclusion: In the junior mining bull market to come, the stocks that do the best will be the best promoted, and it has little or nothing to do with the underlying asset and everything to do with whether the market, and its increasingly credulous and greedy investors, have heard of the play or not. This is simply a fact of life, and we present it to you without any moralizing. Technical ratios and analysis have as much to do with what's going on now – and what is to come – as Ben Bernanke's perception that the economy was in fine shape in 2006. You can analyze trends and ratios from the 1980s and beyond as much as you want. But this is a 1970s market and it will be one right to the top, wherever that is.
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