We are in a huge bull market in precious metals that — in my opinion — began in 2001. Now here we are in 2009 and gold and silver are in steep uptrends, especially gold. I know there are a lot of people who think they are late to the party and wondering how to get on the train.
I think the real opportunity is in the gold and silver mining stocks. They’re cheap and I’m going to show you why.
However, before I do you should know there are some difficulties in owning the miners. First of all, they don’t trend well — or at least they haven’t yet.
Here’s the gold and silver mining index (XAU):
Sure, it has gone higher. But notice all the nasty, erratic whipsaws along the way. Not fun and tough to trade. It’s even tougher to buy and hold.
Also, the mining stocks are notoriously difficult to analyze from a fundamental perspective. Not only can the costs of mining gold and silver vary from company to company, but there are many factors within the industry affecting profits that are darn near impossible to predict.
And if all of that’s not perplexing enough, you can also get in situations where gold and silver are going higher while the mining stocks are going down. After all, they’re just stocks. And like the stocks of other industries they’re subject to whims of the stock market.
On the other hand, mining stocks can be great investments because they are a leveraged play on gold and silver. The costs of mining gold and silver — even though they vary among companies – are relatively fixed within an individual company. So when the price of gold and silver goes higher, profits can soar at a far greater percentage than the percentage gain in the metals.
So the bottom line is, if you know when to buy them, you can make a lot more money in the miners than you can in the metals themselves. The key is knowing when to buy them.
Fortunately, I’ve learned how to tell when the mining stocks are a good deal and when they’re a bad deal.
The Gold/XAU Ratio
It’s the gold/xau ratio –the price of gold divided by the price of the gold and silver mining index (XAU). For example, if the price of gold is $500 and the XAU is $100 then the gold/xau ratio is 5 to 1.
Here’s what you need to know. When the gold/xau ratio is 5 or above it has always been a good time to buy the mining stocks. And when the ratio is below 4 — I use 3.75 to be exact — it has always been a good time to sell the miners.
I have data for XAU going back to 1984. I’m going to demonstrate how powerful the ratio has been. And it hasn’t mattered whether there has been a bull market for precious metals or a bear market. A 20+ year bear market for precious metals began in 1980. It didn’t end until the bull market began circa 2001. The ratio still worked.
So here we go…
On 4/28/86 the gold/xau ratio closed at 5.02. XAU closed at 68.45. The ratio is telling us that mining stocks are a buy. Now remember, we’re not going to sell until the ratio closes below 3.75.
On 3/27/87 the ratio closed below 3.75. XAU closed at 115.77. Time to sell. Bought at 68.45. Sold at 115.77 — a 69.13% gain.
On 10/26/87 the ratio closed above 5. XAU closed at 92.29. Time to buy.
On 8/3/89 the ratio closed below 3.75. Time to sell XAU. It closed at 99.85 — a profit of 8.19%. Certainly not great, but better than a kick in the pants.
On 4/8/92 the ratio again closes at 5. XAU closed at 67.55. It’s a buy.
On 4/23/93 the ratio closes below 3.75. XAU closed at 94.86. Sell for a 40.43% profit.
On 8/27/98 the ratio closed above 5. XAU closed at 54.22. That was a long wait to buy, but it pays to be patient.
On 5/5/99 the ratio closed below 3.75. Selling XAU at 79.62 — a 46.85% profit. I know this is getting monotonous. But that’s precisely the point. Making money in the markets is boring because, done right, it’s systematic.
On 4/11/00 the ratio closed above 5. Once again, time to buy. XAU closed at 56.09.
On 5/21/02 the ratio closed below 3.75. XAU closed at 84.97 — a profit of 51.49%. The profits are going to start getting even larger from now on because now we’re in a bull market for precious metals.
On 7/23/02 XAU closed above 5. Buying XAU at 59.24.
On 11/25/03 XAU closed below 3.75. Selling XAU at 104.62 — a profit of 76.60%.
On 4/26/05 XAU closed above 5. And — you know the drill — we’re buying XAU at 87.05
Then on 1/31/06 the ratio closed below 3.75. So we’re selling XAU at 154.19 for a profit of 77.13%.
On 3/13/07 the ratio closed above 5. XAU is a buy at 128.54.
And that’s where we are right now. The ratio hasn’t closed below 3.75 since then. But let me show you how history was made in 2008 as a result of an unprecedented wholesale forced liquidation of assets.
Uh oh…did it stop working?
What’s going on here? This isn’t working the way it always has in the past. The ratio closed at an astronomical 11.37 on 10/27/2008 (the highest it had ever been before is 6.35) and XAU was all the way down to 64.36 — about half of what it was on 3/13/07 when we got a buy signal. Mining stocks — according to the formula — were supposed to be cheap.
I’m thinking to myself, is this thing broken? Is the buying at a ratio of 5 and selling at below 3.75 formula still going to work? I decided that, yes, it is still going to work. What happened in 2008 was an anomaly.
Here’s where we are now:
On 12/2/09 XAU is up to 197.00, a 53.26% profit from the last buy signal. And look at the ratio. It’s way down from where it was in 2008. It’s at 6.17. Still historically very high. It tells me that mining stocks are still a great buy and if the ratio eventually gets down to 3.75 again — and I think it will — big profits are still to come.
Summary
To summarize our little walk through history…
| 4/28/86 | Buy | 68.45 | |
| 3/27/87 | Sell | 115.77 | +69.13% |
| 10/26/87 | Buy | 92.29 | |
| 8/3/89 | Sell | 99.85 | +8.19% |
| 4/8/92 | Buy | 67.55 | |
| 4/23/93 | Sell | 94.86 | +40.43% |
| 8/27/98 | Buy | 54.22 | |
| 5/5/99 | Sell | 79.62 | +46.85% |
| 4/11/00 | Buy | 56.09 | |
| 5/21/02 | Sell | 84.97 | +51.49% |
| 7/23/02 | Buy | 59.24 | |
| 11/25/03 | Sell | 104.62 | +76.60% |
| 4/26/05 | Buy | 87.05 | |
| 1/31/06 | Sell | 154.19 | +77.13% |
| 3/13/07 | Buy | 128.54 | |
| 12/2/09 | Open | 197.00 | +53.26% |
If you had just bought XAU on 4/28/86 and held it until today you would be up 187%. Not very good. The mining stocks have not been very good investments over that period of time.
However, if you had bought when mining stocks were cheap and sold when they were expensive you would be up 423%. Much, much better. And you would have only been in the market part of the time.
How I use the ratio
But that’s not the way I use the gold/xau ratio. I use it to tell me if I want to be focusing on mining stocks or if I should be focusing on other sectors. And now is still a very good time to be focusing on the miners.
Both the ATR Trading strategy and the Long Term Timing strategy have substantial positions in the gold mining ETFs. And will continue to trade them as long as the gold/xau ratio says they’re good buys.
In the future, I’ll post the gold/xau ratio chart for members in each Weekly Report so you can track what it’s doing.
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Great analysis.
So we should combine the ratio with ATR & Long term or we can use the ratio on its own.
Thanks for good work.
H Singh