Gold and the Dollar

Gold Stock Seasonality

The various markets exhibit tendencies to be strong at certain times of the year and weak at other times of the year, and some market participants place enormous importance on these seasonal tendencies. Our experience, though, has been that while 'seasonality' works more than 50% of the time, if you rely heavily on it you will be wiped out. This is because the deviations from the 'normal' seasonal patterns are sometimes very large. Therefore, rather than deferring to seasonal patterns we think a more sensible approach is to consider 'seasonality' to be one piece of a large puzzle. For example, it wouldn't, in our view, make sense to sell in response to impending bearish seasonality if most of the other pieces of the puzzle were decisively bullish.

With the preamble out of the way, let's now consider one aspect of gold stock seasonality. What interests us right now is the strong tendency demonstrated by gold stocks to reach an extreme during the October-November period. As shown in the below table, gold stocks have made either an important low or an important high during October-November in 8 of the past 11 years with the three highs occurring in October and 4 of the 5 lows occurring in November. 
 

The above-described gold stock seasonality suggests that the October-November period this year will provide us with either a major peak or a major trough. Given the surge in gold stock prices over the past several months the only way that October-November could turn out to be the time of a major low would be if gold stocks crashed over the next several weeks. At this stage, however, a crash is not an outcome that appears at all likely as far as the next 1-2 months are concerned. Therefore, the seasonal pattern suggests that a major peak will occur during October-November this year. Such an outcome, by the way, is consistent with much of our other work.

Taking the seasonality one step further, gold-stock lows have tended to occur in November whereas highs have tended to occur in October, which, on the surface, suggests that October is the most likely candidate for a gold-stock peak. However, many seasonal patterns have been reversed over the past 12 months. For example; October is often a month where an important low occurs in the overall stock market, but the way things are currently shaping up there is a much greater chance of the stock market making a major high than a major low during October-2003. Given the likelihood of gold stocks peaking a few weeks after a peak in the overall stock market we therefore think November is actually the better candidate for a major gold-stock peak.

Valuation comparison of 3 gold/copper producers

Below is a table comparing the amounts that investors at today's prices are paying for gold-equivalent reserve ounces when they purchase shares of Wheaton River Minerals (AMEX: WHT), Northgate Exploration (AMEX: NXG), and Northern Orion Resources (TSX: NNO). The table shows that the most value and the most leverage is obtained via NNO and the least value/leverage is obtained via WHT. What the raw figures don't show, however, is that most of NNO's value comes from its ownership of the Agua Rica project in Argentina, a project that is years away from production. If we make an allowance for the amount of money it will take to bring Agua Rica into production then NNO's price/ounce would move into line with that of NXG.

Out of these three stocks NXG appears to offer the most value when downside risk as well as upside potential are taken into account while WHT appears to offer the least value. NXG has the distinct advantages that all of its resources are located in one location in a country that offers relative political safety (Canada) and that a large portion of its resources will probably soon be converted to the reserve category. In fact, we can't see a good reason why NXG should sell at any discount to WHT, let alone the huge discount at which it presently sells.
 

Table notes:
1. Enterprise Value (EV) is equal to market capitalisation plus net debt
2. Copper resources, reserves and production have been converted to gold-equivalent figures for the above comparison.
3. "Adjusted Reserves" is equal to reserves plus 50% of resources

Currency Update

Reuters, September 20: "U.S. Treasury Secretary John Snow claimed a win on Saturday in his campaign to make flexible currency rates a global standard as key industrial nations agreed trade benefits from less government involvement.
 
 A closing statement from a meeting of the Group of Seven finance ministers -- the United States, Britain, Canada, France, Germany, Italy and Japan -- said a flexible currency rate "is desirable for major countries or economic areas" in order to let markets smooth out economic ups-and downs.

The groundbreaking commitment was clearly aimed at showing disapproval of countries that use pegged currency rates, or that intervene heavily in markets to affect their currency's values, in order to keep their export prices low. Snow traveled through Asia earlier this month, making the same case virtually word-for-word in a trip to Japan, China and Thailand that was seen as a bid to pressure China into letting its yuan currency trade beyond its current decade-old peg of about 8.28 yuan to the U.S. dollar."

The Japanese Yen broke above major resistance on Friday, perhaps forewarning of the agreement on currency exchange rates described in the above Reuters article. Furthermore, if the G7 is serious about letting the markets determine currency exchange rates then the Yen is going to move sharply higher over the next few weeks because it was only massive intervention on the part of the Bank of Japan (BOJ) that had kept the Yen from breaking higher much sooner. The BOJ's previous 'line in the sand' was around the 115-116 Yen per Dollar level. The rate was around 114 Yen per Dollar at the end of last week and if the BOJ stays out of the way the exchange rate will probably move to around 100 Yen per Dollar by year-end.

We expect that a sharp upward revaluation of the Yen by the market would initially be positive for gold, but could eventually turn into a negative if it results in a large downward move in the Swiss Franc relative to the Yen. As explained in a previous commentary, one of the trends that has characterised the financial market environment over the past few years has been the upward trend in the SF against the Yen (see chart below). A decisive break of this upward trend, something that would be likely to occur if the Yen were permitted to respond to natural market forces over the coming months, would possibly be a sign that the financial market environment was about to turn bearish for gold for a while.

Below is a chart of the British Pound in terms of the euro. Pound/euro tends to move in advance of US$/euro, that is, the Pound tends to turn higher or lower against the euro prior to a similar turn in the US$ against the euro. Therefore, we watch the performance of Pound/euro relative to its 60-day moving average for signs that the trend in US$/euro is about to change.

The US$ has recently been very weak, but late last week Pound/euro moved back above its 60-day MA. This, in turn, suggests that the next major decline in the US$ is not about to commence. Rather, what appears to be underway is a period of consolidation similar to that which occurred between November of 2001 and April of 2002. And this period of consolidation will almost certainly be followed by a drop in the Dollar Index to well below 90 (we expect the Dollar Index to drop to around 80 over the coming 6-9 months).

Gold

Below is a long-term chart of the gold price. Our 3-month target is the major resistance in the $405-$425 range, a resistance range that is unlikely to be overcome on the first attempt. In fact, we doubt that a sustainable move above this resistance will occur during the coming 12 months, although a short-lived spike up to around $450 wouldn't be surprising. Our expectation is that the gold price will move up to this resistance over the coming few months and perhaps briefly spike above it, but will then spend at least 12 months consolidating in the $350-$420 range before resuming its ascent. This consolidation, if the story unfolds roughly in line with our expectations, would allow the large speculative position in COMEX gold futures to be worked off and would coincide with a major counter-trend rally in the US$. Note, though, that our gold price expectations are not set in stone and are dependent on, amongst other things, the action in the currency and debt markets.

Current Market Situation

Earlier in today's commentary we discussed the cyclical behaviour of gold stocks which might, this year, result in a November peak. Once again, this is not an expectation that is set in stone but is something that will be at the forefront of our minds if gold stocks move to new highs in November.

Currently, gold stocks are overbought and would be unlikely to move higher in straight-line fashion between now and November. A more likely scenario is shown on the below chart of the AMEX Gold BUGS Index (HUI). Note that if gold stocks do move higher over the next few weeks, rather than pulling back as projected on the below chart, it would probably mean that a major peak was going to occur earlier than November.

Below is a chart of the gold price in terms of the euro. For some time our medium-term target for the gold price has been the top of the major channel shown on this chart, which would correspond to a price of around 370 euros if the channel top were reached before year-end.

Update on Stock Selections

We have been bullish on the Japanese stock market and added Japan iShares (AMEX: EWJ) to the Stocks List in early June to reflect this view. However, the recent surge in Japanese stock prices has significantly increased the short-term downside risk. Therefore, although we remain long-term bullish on Japan we are going to exit EWJ now for a profit of about 33%.

We plan to send out a Stock Selection Update e-mail to paid-up subscribers on Monday or Tuesday of this week.

Stockbrokers

We strongly suggest that you do not let the limitations of your current stockbroker restrict your ability to participate in the gold-stock bull market. Many of the most interesting junior gold/silver stocks only trade on the Canadian exchanges and you should therefore have an account with a broker that can trade the Canadian stocks. (Most of the Canadian juniors also trade on the "Pink Sheets" market in the US but this market should generally be avoided due to the very wide buy/sell spreads that typically apply).  

In the 20th August Interim Update we mentioned 2 US-based brokers (Barry Murphy and Co. and Pennaluna and Co.) that could be used for trading stocks on the Canadian exchanges. There are no doubt many others, but based on what we know from our own research and the experience of people we trust we are confident that both of these companies will offer our readers with a high level of service. Barry Murphy and Co. (ph: 1800 2212111 or 617 4261770) will execute orders on Canadian exchanges for a flat rate of US$29.95 per trade, but please note that you need to identify yourself as a TSI subscriber in order to get this rate.

Opportunity to participate in non-brokered private placements

If you are a private investor with liquid assets in excess of US$1M or a professional money manager and would like the chance to participate in private placements of shares in junior mining companies, please let us know and we'll put you in touch with a company that is in the business of arranging such equity financings. The company we have in mind has been involved in many private placements of equity over the past year, the vast majority of which have proven to be successful as far as investors in the placements were concerned. Your name would go on a list of potential investors and you would be notified of opportunities as they arose.

We stress that this opportunity is only suitable for experienced investors who a) have liquid assets of more than US$1M, b) have a medium-term time horizon (since the new shares are often subject to a mandatory 4-month hold period), and c) can tolerate the volatility of the junior mining sector. The minimum amount of an investment in each placement would typically be around US$50K.

The advantage of participating in the private placements is that you would have the chance to take sizeable positions in small companies at below the current market price (the discount is usually around 20%). 

Copyright Reminder

The commentaries that appear at TSI are copyrighted material and may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentary at other web sites (for example, at discussion boards) without our written permission is a breach of copyright.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/
http://bigcharts.marketwatch.com/