These are unprecedented times for investors in gold and other precious metals. Gold is nearing its lows again, and combined with a TSX Venture Exchange which seems to be looking for the bottom, the capitulation phase could be near. However, when we were looking at some charts, some interesting facts popped up.
First of all, in a phase of panic, one would think the mid-tier and junior producers would be falling faster than the more senior gold producers because of the assumed higher risk profile. Surprisingly, that’s not the case in this downturn as on the next chart it’s clearly visible that if you compare the two listed ETF’s GDX (the senior producers) and GDXJ (the junior and mid-tier gold companies), the ratio GDXJ/GDX hasn’t actually changed much in the past two months.
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Source: Stockcharts
Granted, the ratio is currently lower than in April last year when the gold and silver prices started to slide, but it’s surprising to see that since July of this year, the GDXJ/GDX ratio has been moving in roughly the same band with as you can see when you zoom in on the chart:
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Could this mean the risk perception of investors has changed? Maybe, as even the larger producers definitely haven’t been immune to a volatile gold price and in some cases they had to put several large multi-billion dollar projects on hold and write down the book value of its assets.
Is this phenomenon limited to the gold sector? If you’d compare the Junior Gold Miners ETF with the ETF which is tracking the global silver producers, a surprising fact pops up. After a decline of three years in the GDXJ/SIL ratio decreased from 5 to just 2.8 this winter, the ratio has been increasing again, lately.
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Does this mean the gold sector is in a better shape than the silver sector? Not at all, but we think the Gold/Silver ratio is the main culprit here.
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At a ratio of in excess of 70, the Gold-Silver-ratio is extremely high and is actually at its highest point since 2009. We have been digging a little bit deeper, and have come to a very surprising conclusion. The last two times the Gold/Silver ratio was higher than 70, the market was at the verge of a huge break out pattern in the mining stocks. If you look at the next chart, you’ll see the Gold/Silver ratio of the past 15 years, and during that time frame, the level reached a peak of 70 (and a bit higher) just two times.
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Source: goldprice.org
And this is an extremely interesting fact. When the Gold/Silver ratio hit 80 in 2003, the HUI was getting fired up for a major move. Whereas the HUI (also known as the Gold Bugs Index) was at 120 points in H1 2003, it reached a high of in excess of 500 points in 2008 (+257%), at a level where the Gold/Silver ratio has been relatively low.
The same pattern emerges at the height of the commodity crisis. In Q4 2008 the Gold/Silver ratio peaked at more than 80 whilst the Gold Bugs Index was trading at 200 points. And guess what? The index tripled by the time the Gold/Silver ratio took a nose dive and seemed to be on its way to 30. And yes, as the Gold/Silver ratio started to increase again, the HUI was going down again. In fact, the Gold Bugs Index is currently trading at a level close to the lows of 2008 (during approximately two weeks the Index was trading lower than the current level), and now the Gold/Silver ratio is spiking again, we might be looking at a next upward move in the Gold Bugs Index.
However, as the previous leg up was only facilitated after a capitulation phase, it will be interesting to see how the HUI will behave over the next few days and weeks. A rebound isn’t and cannot be guaranteed, but the history likes to repeat itself. And the past two times in just 15 years the Gold/Silver ratio was above 70, the Gold Bugs Index started a move up of at least 200% within weeks.
This strengthens our belief that the current action on the markets might be the last part of the ‘shaking of the tree’ whereby the final weak hands will be selling out. It’s unimaginable that with all the Central Banks which are trying to beat each other to print money at a faster pace, that the gold price will continue to tumble. On top of that, the junior and mid-tier gold mining segment isn’t currently being seen as exceptionally riskier than other moments in the past few months, as the GDXJ/GDX ratio has roughly been in the same trading zone for several months now.
Based on historic evidence, the general state of the markets and the underlying money-printing issue, we remain confident in the future of gold.
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