Sunday, September 16, 2012

A Look at One Chart Should Be Enough...

16 September 2012

I know that ratio charts are confusing to many.

Let me explain. The above chart depicts the ratio of the market value of the Toronto Gold Mining Stock Index (SPTGD) to the US dollar price of gold. That is, the value of the index is divided by the price of gold, on a daily basis, to create what is known as a "ratio chart."

What this chart is telling us is that the SPTGD index used to be valued at 0.723 times the price of gold (roughly 3/4 of the gold price) at its highest point, which was over 10 years ago, in May 2002. As you can see, physical gold has been a better investment than Canadian gold mining stocks for over ten years. And, despite their recent strong recovery, no real impression has yet been made on the long-term chart (as gold is rising rapidly too).

The funny thing is, gold mining is a much more profitable business now than it was back then, though arguably the 2002 ratio showed excessive early optimism. That is, as the price of gold rises, the margins of the gold miners increase, so their profits climb at a faster pace than the rise in the price of gold (though their costs are also escalating, to a lesser degree in most cases, for exactly the same reasons that the price of gold is rising).

However, if this ratio were simply to return to its longest-term stable value, which persisted from early-2003 to mid-2007, then we would be looking at a range of .40 - .55 in the ratio. Let's call its stable value ".50."

In other words, should the SPTGD:GOLD ratio recover its median value, it would appreciate 150% from where it is now (.195 as of September 14, 2012). That would be no small potatoes.

I think it will - because the deflation trade is now "over" (see previous posts).

Mark my words.

Though the trend has fallen from its stable value level for 5 years, I think we'll be back there within only about two years. What makes me say that? Look at the uptrend from 2000 to 2002 in the above chart (not the lower one). When this ratio climbs, that is the angle it tends to follow (you can see fractal slices of this same behaviour in the above ratio chart in later 2003, and in later 2008 to early 2009). For complex reasons, charts tend to repeat such patterns (the study of these patterns is known as fractal analysis).

So yes, in 2014, I expect to see a ratio in this chart of .50. Given that I am correct (only time will tell), where might the SPTGD index then be valued? (The chart of the SPTGD index itself is immediately below.)

I think it is conservative to suggest that gold, which is now on a "tear" due to announcements of global quantitative easing, is likely to be at the $2500 level in 2014. I believe a lower gold price than that in 2 years is unlikely, and that an even higher price is quite possible. But at $2500 gold and a 0.50 ratio in this chart. the SPTGD would be valued at more or less $1250. Where is it today? $346.60. That would represent an appreciation in the SPTGD of 261%.

Anything even close to this would also be no small potatoes.

What do bull markets do? They disappoint the impatient and amaze the persistent.

Think that's unlikely? Well, look at the SPTGD chart movement (second chart) between May 2005 and May 2006. In exactly one year, only 7 years ago, this index gained a full 122%. And earlier, between late 2000 and May 2002, the SPTGD index gained 180%, this time in 1-1/2 years. So what I'm saying is that a similar uptrend, persisting for 2 years, could very possibly lead to appreciation of more than 200%.

Again, why is this possible? Because the deflation trade is over. It changes everything for gold and gold mining investors.

Don't get shaken off by volatility, which isn't going to go away....

My advice: Persist, and prepare to be amazed.

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