The Bull Market is Back – at Least in Non-USD Terms

The gold price most traders are focused on is the dollar price of gold – this is no wonder, as the COMEX is the most important price setting market for gold, and gold is internationally mainly traded in dollars. It is often useful to abandon this dollar-centric view, as for the rest of the world’s population gold’s trend in local currencies is obviously of greater importance.

Since gold is primarily a monetary asset, the main question for someone residing in a European or Asian country is whether the purchasing power of gold is increasing against the purchasing power of the domestic fiat currency. Interest rates (better: real interest rates) naturally play an important role in this, as their height determines the greatest portion of the opportunity cost of holding gold (the remainder is related to storage costs and where applicable, insurance costs).


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As the chart further below shows, due to the recent combination of dollar and gold strength, gold has broken out, respectively entered an uptrend, in euro and yen terms over the past year. In dollar terms, a similar breakout over lateral resistance has yet to occur. However, experience shows that the gold price in foreign currency terms often leads the US dollar gold price, which is why it makes sense to keep an eye on such developments.

Even in USD terms a few higher lows have been put in recently and the 50 day moving average has turned up after declining for several months, so the technical picture has improved somewhat, if in fits and starts. It is still too early to rule out an eventual final washout to the “technical attractor”, which is the 2008 high near $1,040, but the probability of this happening in the near term has decreased significantly.

This is also suggested by the recent trend in gold’s “real price”, i.e., its trend relative to commodities. Gold has bottomed against commodities in April of 2014, and the new uptrend in this ratio has recently accelerated. This is important for two reasons: for one thing, it is a subtle sign of declining economic confidence, which is quite in contrast to the performance of the stock market, but seems to be confirmed by the action in treasury bonds. Secondly, an increase in the gold price relative to commodities usually indicates that the profit margins of gold mining companies are rising as well. The gold sector tends to exhibit a long term negative correlation with the stock market (even though the two can often trend in the same direction over shorter time horizons) precisely because the earnings of gold mining companies tend to rise just as the earnings of other companies are coming under pressure.


1-Gold in various currenciesGold in dollar, euro and yen terms. In dollar terms the recent uptrend still looks quite weak, but in terms of euro and yen it looks like a solid reversal has been put in place – click to enlarge.


2-Gold vs commodities
Gold relative to commodities: the “real price” of gold has been in an uptrend since April 2014, and this has recently been confirmed by a breakout in the ratio above a consolidation area that it has spent several months in. The most recent move higher was mainly a result of the decline in crude oil prices – click to enlarge.


Gold Stocks Closing in on Resistance

Last year we discussed the squall of panic selling in gold stocks in late October /early November more or less in real time in great detail (see: “An Anti-Bubble Blow-Off in the Gold Sector”). As we pointed out, the decline had all the hallmarks of a capitulation, and in hindsight it has turned that at least “a” low was indeed put in right then and there. This was followed by a retest in December – the time when retail tax loss selling in weak sectors is most pronounced. The early November low was established shortly after the bulk of institutional tax loss selling was done.

Since then, the gold sector has recovered somewhat, exhibiting relative strength versus gold in the process. It is now approaching a zone of resistance formed by the 2013 and early 2014 lows. Obviously, a move above this resistance zone would be a good sign, but it is probably going to involve some backing and filling, even if it does eventually happen.

We want to briefly comment on the fact that a number of gold stocks have recently received downgrades. To our mind these downgrades are probably a late cycle contrarian phenomenon, mainly because they make no sense at this juncture. We should rephrase that: they only make sense if one not only assumes that gold will resume its decline, but also that the decline will exceed the expansion in gold mining margins that has been underway in recent quarters and has noticeably accelerated in Q 4 2014.

Energy is a major input cost in gold mining (especially for open pit mines) and the cost of energy has just declined rather precipitously, concurrently with a recovery in the gold price. Other input costs are falling as well. The once tight labor situation in the mining sector has become a lot more relaxed due to the decline in gold and commodity prices since 2011. Demand for inputs like industrial tires, chemical reagents, timber, steel, etc. has decreased with the softening of the global economy and the prices for these items have come down as a result.

Let us just say that there have surely been better moments to downgrade gold stocks. The potentially most useful of these opportunities were not recognized at the time they presented themselves. On the contrary, we recall that in the weeks just prior to gold’s 2011 peak, numerous upgrades were dispensed.


3-HUIThe HUI Index and the HUI-gold ratio. The lateral support/resistance lines are derived from highs and lows further in the past – click to enlarge.



Since gold has not broken above resistance in dollar terms yet and gold stocks still have to achieve a solid breakout as well, the signs that a medium/ long term bottom may be in are still tentative. However, the technical backdrop has clearly improved in light of gold entering an uptrend in major foreign currencies and against commodities. This is more or less in line with what happened at the beginning of the bull market in 2000-2001 (incidentally, the ratios of gold stocks to the broad stock market and various other market sectors have recently returned to the levels of 2000 and turned up from there).

The fundamental backdrop for gold is not unambiguously bullish yet – just as some indicators have turned more bullish, others have turned more bearish, leaving an overall neutral situation in place. So there is still a wide range of possible outcomes, but considering the capitulation-like declines seen late last year, it seems to us that short to medium term strength in the sector is more likely.


Charts by: Stockcharts




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