THE TREND IS GOLD BULLION´S FRIEND / BARRON´S MAGAZINE ( VERY HIGHLY RECOMMENDED READING )

Getting Technical

 WEDNESDAY, MAY 18, 2011

The Trend Is Gold Bullion's Friend

By MICHAEL KAHN 

For the long run, the charts suggest that ETFs tied to the yellow metal should outperform mining stocks. 

Before the financial crisis of 2008, gold bullion and the companies that mine the yellow metal enjoyed a more or less stable long-term relationship.

While there were periods of several months when either the hard asset or the mining stocks outperformed the other, the overriding pattern over the prior two decades was steady.

But that all changed in 2008 when the ratio of gold futures compared to the Philadelphia Gold & Silver Index, a proxy for gold miners better known by its ticker, XAU, smashed through the upper border of its range (see Chart 1). This confirmed that a long-term rising trend for the ratio, and thus for the metal itself, was now in place.

Chart 1

GOLD/GOLD STOCKS RATIO

Three years later, the trend is still intact.

Thus, investors looking to play the gold boom for the long term using stocks may be somewhat disappointed. They should instead buy exchange-traded funds that own gold bullion directly such as SPDR Gold Trust (ticker: GLD) and the iShares Gold Trust (IAU).

While trading in all markets, from stocks to bonds to commodities, was volatile in 2008, the amount that the gold-metal-to-gold-miner stock ratio moved was spectacular. What is more important than a simple spike during times of duress is that even after the markets calmed down the ratio found a floor at the top of the range from which it just broke free.

In technical parlance, the ratio successfully "tested" the breakout to add more proof that the trend of better performance by the metal was in place and likely to last for many months, if not years.

As if that were not enough, earlier this month the ratio once again made an upside breakout from a smaller trading range to confirm that this trend remains healthy.

To be sure, there will be periods of time when individual investors will have the opportunity to buy gold-mining stocks for the shorter term. This week, the Market Vectors ETF Trust Gold Miners (GDX) landed on the bottom of its own seven-month trading range and buyers responded (see Chart 2).

Chart 2

MARKET VECTORS ETF TRUST GOLD MINERS

This ETF moved as much as 20% in both directions several times since last October, so it is not unreasonable to expect another swing of similar magnitude is coming. With technical indicators such as the relative strength index notching extreme low readings, conditions are ripe for a rebound over the short term measured in weeks.

Another ETF in the sector, the Market Vectors Junior Gold Miners (GDXJ) covering smaller-capitalization stocks, has a similar look to its larger cousin on the charts. It also has a similar relative performance to gold so there is not much to add here in that regard.

But it does add a bit more volatility into the mix as its swings within its respective trading range were several percent larger. Investors able to tolerate a bit more risk may prefer this ETF to play short-term swings.

The bottom line is that any advantage gold stocks enjoy now in the short term is merely a fluctuation within a long-term trend. Gold is in a long-term bull market and shows no sign that it will cease outperforming its related stocks at this time.

.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com

.

Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved