Gold stocks could add shine to your portfolio

By Prieur du Plessis, on June 18th, 2007 posted in: Commodities, Economy, Equities, Finance, Gold, Investment, Markets, Money, Stocks 2 people had their say - chime in!

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Gold bullion is like children – unpredictable. You never know with what inconsistent action the yellow metal is going to catch you next, making it notoriously difficult to predict the short-term price movements. Many traders have to their detriment seen their pockets being emptied as a result of unwelcome margin calls over the years.

In my experience the best that most of us can hope to do is to attempt to assess the primary direction of the gold price and ride the big waves. It was precisely this “big picture” framework that I tried to get a grip on in last week’s article on bullion.

My conclusion was that “bullion was experiencing a normal bull market reprise and was set to resume its upward path in due course albeit in fits and starts. The exact tailwind pushing gold northwards would probably only become apparent after the fact …”

One such tailwind could be the oil price, which I believe is experiencing a multi-year bull market. I base this outlook on the simple premise of rising demand meeting inelastic supply. In other words, it could become increasingly difficult for the continuously growing demand from the new economic power houses to be met by the rather problematic supply situation, characterized by geopolitical risks in unison with reduced reserves.

It is particularly interesting to see how the oil price typically behaves from July to October – traditionally a period characterized by rising prices as more cars hit the road for the summer months. The following graph from Chart of the Day clearly illustrates this pattern: 

Stronger oil prices may just turn out to be central bankers’ worst nightmare in an environment already being threatened by higher inflation.This could provide a favorable backdrop for the yellow metal should its fairly good historical relationship with oil hold.

Source: MarketMaster

Interestingly, gold stocks very often lead the gold price higher and it is precisely such a situation that has perhaps started manifesting itself again. The graph below shows the Philadelphia Gold & Silver Index in the top section, displaying a largely sideways movement. But look at the behavior of this Index relative to the gold price in the bottom section. After a prolonged period of gold stocks underperforming the gold price, we may just be witnessing the first signs of this trend being reversed.

Source: MarketMaster
Even Newmont, faced with its specific problems, seems to be trying to turn the corner – in absolute and relative terms.

 
Source: MarketMaster

It is early days still, but gold stocks have often in the past served as an excellent leading indicator for the gold bullion price itself. In my assessment one could do worse than switch some overbought S&P 500 stocks for a basket of neglected gold stocks, thereby hopefully adding some shine to one’s portfolio.