Gold: Buy, Hold Or Sell? Update #25

1980 to 2011: From bear to bull

In 1980, the price of one ounce of GOLD reached $ 850. Today, the purchasing power of the US dollar is substantially less than in 1980. The price of one ounce of gold would have to rise to $ 2,300 to reflect the value of the US dollar thirty years ago.

The bull market of the gold price started towards the beginning of 2002. On the way from $ 252.20 to the recent high of $ 1435 (an increase of 470%), several significant corrections took place, the most severe one in 2008 when the gold price sank by 29% only to jump 102% to a new  all-time high. The bull market is not over! Furthermore, we only reckon with a modest corrections within the up-trend as we cannot yet make out any overbought market condition.

Extremes never last but no extreme is an absolute extreme and there is no guarantee that the extremes of 2006 and 2008 will actually be repeated. To demonstrate our point, we need to go back to 1980 when the indicator shown below went far above present levels.

It is important to note that we have NO extreme at present.  In the past, excluding 1980, it would have paid off to play the extremes, always assuming that one can buy back at the right moment which is far from easy. A long-term investor may feel better simply remaining invested as he believes that prices will eventually go much higher.

The medium-term picture of the gold price

Critics of technical analysis include well known fundamental analysts. For example, Peter Lynch once commented, "Charts are great for predicting the past." Warren Buffett has said, "I realized technical analysis didn't work when I turned the charts upside down and didn't get a different answer" and "If past history was all there was to the game, the richest people would be librarians." However, as the circles show in above chart, selling and then buying when prices crossed the Moving Average, would have been a valid strategy.

The gold/silver ratio

In times of economic slow-down, the gold/silver-ratio reverses dramatically as can be seen in 2008. As the next economic crises will hit again – sooner or later, the present level of the ratio favours an investment in gold rather than silver.

Should you own gold rather than gold shares?

Gold and gold shares do not always move in a parallel fashion. At times, gold is leading, at times the gold shares. From 2000 to 2006, the Gold&Silver Index ratio fell by 40%, telling us that gold and silver shares outperformed the price of gold.

In 2006, the trend started to reverse as the ratio continued to increase and reached a lever of 5 points or 33% higher than in 2006. The crisis of 2008 hit gold and silver shares hard as the index spiked to 11 points. Gold and silver shares were sold across the board as investors were forced to sell to create liquidity. This extreme, created by panic selling, created a once in a life time buying opportunity. Few however were able to benefit from this situation as the worst fears dictated investors’ behaviour.

The ratio has since fallen back to 6.6 points but is still roughly 25% higher than the long-term average.

Gold shares should continue to fare better than the price of gold.

Conclusion

Gold should perform better than silver over the coming months but gold shares should outperform the price of gold!

Peter Zihlmann

The Timeless Precious Metal Fund