The Golden Bottom

 

I’ve told you before that gold is showing relative
strength to other commodities, and I expect it will
lead the next rally. Are we seeing gold bottom right
now? And if so, how should you play it?

Let me show you two charts. First, a weekly chart
of gold, as tracked by the SPDR Gold
Trust (GLD):

Looking at the chart, you can see that the GLD hasn’t broken its uptrend — in fact, it is still stepping higher along its 20-week moving average.

An interesting factoid is that the GLD spends an average of 19 to 20 weeks above its 20-week moving average before touching it again. It’s only been above it for 13 weeks this time.

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Now, a more cautious investor would wait for the GLD to touch support before buying it again. And you can certainly wait. But if you can stomach risk, there’s nothing wrong with buying it now. By the time the GLD touches its 20-week moving average, that average might be much higher.

And a clue that gold may be about to head higher comes in what’s happening in gold mining shares. Take a look at this chart of the Gold Bugs Index — a basket of leading gold miners — divided by the GLD:

The green line on this chart is the GLD, the black line is the Gold Bugs index divided by the GLD.

For the past few months, this miner/metal ratio has nose-dived. But now it’s turning higher. When that has happened in the past, it has signaled that both miners and metals are about to head higher.

The reason is simple: Miners are leveraged to the underlying metal. Investors start snapping up gold miners, or the best ones anyway, when they start to think that gold itself is going higher.

So, this is an indicator of more bullishness spreading through gold and gold mining.

Charts are nice, but many of us need fundamentals before we put money to work.

So, here’s a quick run-down of just five of the forces I’m watching:

5 Forces Lining Up for Higher Gold Prices

1. Gold coin sales are soaring. Bloomberg recently reported that in the month of May, sales of gold coins are on track for their best month in a year. The last time sales reached that level, the price of gold rose 21% in the next year.
2. The United States hit its debt ceiling of $14.3 trillion on Monday. The budget deficit this year alone is set to be a record breaking $1.5 trillion. Difficulty in hammering out a budget agreement erodes the faith of the foreign banks we need to buy U.S. Treasuries. Bookkeeping maneuvers will allow the Treasury to continue auctioning debt for another 11 weeks. Still, our country’s appalling fiscal state is one reason why gold and silver remain important investments for any portfolio.
3. Threat of Greek debt default. One of the main guys who was working on a solution to the Greek debt crisis — Dominique Strauss-Kahn, the director of the International Monetary Fund — is now cooling his heels in a cell on Rikers Island, facing rape charges. With the IMF in disarray, the already boiling Greek crisis could explode. Portugal is next. These crises affect the stability of the euro, and the last time Europeans got scared about that, they rushed into gold.
4. Central Banks are buying gold hand over fist. Mexico’s Central Bank just spent $4.6 billion buying 93.3 metric tonnes of gold. Russia bought 18.8 metric tonnes of the yellow metal, Thailand’s Central Bank bought 9.3 metric tonnes, and Belarus bought another 2.5 metric tonnes. Central Banks seem to be picking up the pace of their gold buying. That’s probably bullish for prices.
5. Gold ore grades are falling fast. A new U.N. report on resource depletion shows how ore grades at gold mines have fallen off over the past century:

One hundred years ago you could find around 20 grams of gold per metric tonne of ore at mines in Australia, Brazil, Canada and South Africa. Now, there are mines going into production with less than a gram per tonne of gold, and they’re quite profitable!

It’s not for lack of looking that ore grades are going down. In fact, the latest data from Metals Economics Group shows that spending by gold explorers rose by $1.9 billion to $5.4 billion last year.

It’s simple math: Lower grades and higher mining costs should mean higher gold prices.

How to Invest

I think select gold miners have already bottomed and should head higher from here. One I like is Goldcorp (GG). Its latest earnings report was excellent:

• Gold sales for the first quarter totaled 627,300 ounces on production of 637,600 ounces.
• Revenues increased to $1.2 billion dollars, a jump of more than 69% from the year-earlier period.
• At the same time, earnings per share more than doubled to $0.82 from $0.32.
• Operating cash flow increased 180% to $586 million from $282 million a year ago.

You can also buy physical gold or one of the funds that holds physical gold. What exactly you should buy depends on your own investing needs and your appetite for risk.

Right now, I’d say gold’s risk is to the upside. Sure, we could see more consolidation here, especially if the U.S. dollar continues to rally in the short term. But the longer-term trends are much higher for gold and gold miners.

Yours for trading profits,

Sean

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