Gold – more than a safe-haven play » Investment Postcards from Cape Town

What’s up with gold? The dollar gold price would appear to be in pause mode of late, but somewhat deeper analysis shows a few interesting aspects.

On August 9 the bullion price was slaughtered by $12 together with an avalanche of selling across just about all financial markets, with the exception of government bonds. Whether is was simply a question of massive liquidation across the board, or whether it suited central banks to orchestrate a lower gold price as they started pumping cash into markets, is an open question. However, with the motion sickness caused by markets’ gyrations it is easy to overlook how well gold has actually performed relative to equities in general.

The following chart makes for interesting reading. Firstly, the top section shows the gold price steadily clawing its way higher since a low of $642 towards the end of June. Secondly, the rising line in the bottom section shows how well gold has fared relative to the S&P500 Index, outperforming by almost 7% since the start of the credit squeeze.

Source: StockCharts.com

And let’s not fail to mention that throughout gold’s many whiplash movements, it is still holding above its 200-day moving average, often used as a gauge of the primary trend.

Another bull point in gold’s favor is that it is not only making headway in US dollar, but also in most major (and minor) currencies as illustrated by the following table:

Source: Plexus Asset Management (based on data from I-Net)

Of particular interest are the graphs of gold in a number of currencies of countries where the central banks are pursuing a policy of increasing their gold reserves relative to fiat currency reserves.

Gold in Chinese renminbi

Source: Fullermoney.com

Gold in Saudi riyal

Source: Fullermoney.com

Gold in Russian rouble

Source: Fullermoney.com

Gold in Indian rupee

Source: Fullermoney.com

The above chart is the only one of the four not showing a clearly upward trend over the past year as it was mapping out a triangle. This did not deter the Indians from stocking up at perceived good buying levels. In actual fact, the consolidation came as a welcome reprieve from the almost vertical rallies in 2005 and 2006.

So much for the outlook for gold bullion, but what about gold stocks? These notoriously volatile babies have not only underperformed the gold price by a mile during the credit market crisis, but have also done badly relative to the S&P500 Index. Although gold stocks have by and large been moving sideways since the beginning of 2006, it would appear that some short-term oscillators have started entering the territory from where a rally could start. But in order to ignite a powerful move in the stocks gold bullion will probably have to make headway towards the roundophobia number of $700.

The three-in-one graph below shows the follow: (1) top section: the Philadelphia Gold & Silver Index attempting to consolidate after a sharp correction; (2) middle section: gold stocks underperforming gold bullion since the advent of the market turmoil; and (3) bottom section: the histograms of the MACD oscillator of gold stocks relative to the gold price approaching the zero line.

Source: Market Master

Breaking through the zero line would constitute a phase of outperformance of gold stocks versus gold bullion. Needless to say, relative outperformance can come about for a number of reasons, but the most likely in my opinion will be gold stocks rising faster than gold bullion.

It was Mark Twain who said: “A gold miner is a liar standing beside a hole in the ground.” It may not be as bad, but until gold stocks have confirmed an upward move relative to the gold price, I would be inclined to put the emphasis on the yellow metal with, say, a 75% exposure, with the balance invested in a basket of stocks such as the Merrill Lynch Gold and General Fund.

Statistical analyses show gold bullion to have had a poor correlation of almost zero with the S&P500 Index over the past 15 years (representing about seven bull market and eight bear market years for gold). This would argue that gold, together with cash and bonds, is a good safe-haven play in times of stock market fear. However, do not be surprised if gold bullion and its high-beta cousin, gold stocks, over the next few months provide more excitement than what battle-weary investors are expecting at the moment.