What Volume Tells Us about Gold Stocks

Dear Readers,

I'm on a driving tour of Nevada at present, kicking rocks in the desert and looking at the properties of several different companies – all exploring for gold. When gold stocks head back north again, I want to make sure we have the best of the best in our portfolio. But will it head back north? Jeff Clark's article on trading volumes in the gold sector gives us a quantitative way of looking at the current situation… and offers a very optimistic conclusion.

For my own part, I just don't see how any reasonable person can conclude that the gold bull market is over. The US is showing signs of recovery, but still has alarming vital statistics that are off the previous charts; the EU looks one step closer to disintegration every day; and the reports out of China are almost as alarming. This is not encouraging for "commodities" – but gold is not an ordinary commodity. It's not something you buy and use up, like corn or copper. This is why we remain largely out of industrial minerals and metals but are long precious metals.

Everything I can see in the fundamentals for gold keeps me bullish.

Sincerely,

Louis James

Senior Metals Investment Strategist
Casey Research

What Volume Tells Us about Gold Stocks

By Jeff Clark, Senior Precious Metals Analyst

I've read articles from more than one analyst claiming that gold stocks are down on low volume, implying there's a lack of interest in precious metals. While on the surface that seems like an obvious statement, their point is that most of the recent volume has been coming from sellers and thus exaggerating the recent decline.

I decided to test this hypothesis, because if correct, it has investment implications, starting with the fact that at some point you run out of sellers; and if and when buyers return, the ensuing rise could be spectacular.

I also wanted to compare volume now to the waterfall decline in 2008. If volume is starting to spike now like it did then, it might give us some additional clues about our current environment and what to expect going forward.

So let's take a look. The following chart shows the average weekly volume of the 10 largest gold producers that trade in North America, along with the daily price movements of GDX, the Gold Miners Index.

(Click on image to enlarge)

While the number of shares trading hands every day fluctuates a great deal, the first thing that jumps out is that the current correction in gold is indeed occurring on relatively low volume. You can see how GDX has sold off since its peak last May, but also that, in the larger scheme of things, volume hasn't really changed.

This fact indirectly confirms the premise that it's been mostly sellers providing the recent volume. If there were equal interest from buyers, prices would be flat; or if they were pushing harder, prices would be rising.

The second thing that sticks out is how low the volume is now compared to the selloff in 2008. It's roughly half what it was then, signaling that equities aren't being dumped en masse like they were four years ago. This meshes with a recent observation by Doug Casey, that as steep as the current correction is, we're not seeing the raw panic we saw in 2008.

So what might this mean going forward?

First, at some point the sellers will tire or we'll run out of them – especially if gold prices hold up at or near current levels. At that point, even without any major changes in our market fundamentals, interest from buyers could swamp out the sellers; this is what is meant by a "consolidation phase" or a "regrouping" before the next surge upward. And if buyers become the dominant player in the market, which could easily occur once gold heads north again, stock prices could push dramatically higher.

Second, regardless of the sellers' reasons, they've managed to make gold equities incredibly cheap. The stocks of the better gold miners have become nearly as undervalued as they were during the worst of the financial crisis – without the same level of crisis and uncertainty. Stock prices are not at the same level they were in 2008, but relative to the price of gold they are. These facts point to an extraordinary opportunity. Unless you think gold has peaked for this cycle and it's downhill from here, this disconnect cannot and will not last.

Here's another way of looking at it. Caesar Bryan, portfolio manager of the Gabelli Gold Fund and speaker at our Recovery Reality Check Summit last month, recently relayed an interesting point he'd heard from Don Coxe. For a $1,000 investment right now, you can get about 0.6 ounces of gold. However, for the same $1,000, you'd get four ounces of gold by buying shares of Goldcorp… or more than five ounces buying Eldorado Gold.

This represents incredible value if you're a gold equity investor. These kinds of opportunities only come along rarely in a bull market. The last time was four years ago – with a lot more risk amidst the crash. That didn't last forever, and neither will this window of opportunity.

When this imbalance between gold and gold stocks corrects itself, the returns will be positively smile-inducing, perhaps life-changing.

Are you hearing the message that volume is sending right now?

[As a reminder to our subscribers and friends, Casey Research will host a pavilion at the next World Resource Investment Conference in Vancouver. Hear Doug Casey, Louis James, Marin Katusa, Jeff Clark, and Ed Steer in various presentations, panels and debates. We welcome everybody to join us; it will be a great opportunity to get an update on the current challenges and opportunities from our senior analysts and editors.]

Gold and Silver HEADLINES

Japanese Pension Fund Switches to Gold for First Time Ever (Zero Hedge)

Okayama Metal & Machinery has become the first Japanese pension fund to make public purchases of gold, in a sign of dwindling faith in paper currencies.
…
Initially, the fund aims to keep about 1.5 percent of its total assets of Y40bn (US$500m) in bullion-backed exchange traded funds, according to chief investment officer Yoshisuke Kiguchi, who said he was diversifying into gold to "escape sovereign risk".

So far, institutions in the US$3.4-trillion Japanese pension market have favored traditional assets. According to some sources, bonds accounted for 59% of industry assets in 2011, the highest ratio in the world, and only 6% was invested in alternative assets such as property, hedge funds, or private equity.

This year, Japan's baby boomers begin turning 65 and become eligible for payouts. With the domestic interest rates remaining near zero, the pressure on pension market will be increasing in order to meet their promises.

"If you look at assets over the past couple of decades, equity has been a loser, while fixed income offers tiny coupons," says Yoshio Kuno, Japan head of Newedge, a futures broker. "Gold is becoming an acceptable currency substitute."

If other pension funds follow Okayama Metal & Machinery – and the Japanese pension market, the second-biggest in the world, turns to gold for diversification – demand for gold will explode and send the metal's price skyward.

South Africa Gives Gold a Break as It Moots Mine Tax Hikes (Reuters)

The marginal tax rate in South Africa, the continent's largest economy, was lowered from 43 to 34 percent. The change will save Gold Fields about US$120 million.

Although the new measure came with strings attached, the net result of it should be a reduced tax burden on gold miners operating in the country, according to the article:

The companies' gain will cause some shareholder pain as the burden has been partly sifted to dividends, but analysts generally agree that the Treasury's revenue stream from the gold sector will be less as a result.

The measure is seen as a sign of disagreement between the ruling party and the government and gives hope that, if not a complete turn, this is a sign that the country's administration can consider pro-mining policies and support the industry.

Gold Demand Trends in Q1 2012 (World Gold Council)

According the latest release of Gold Demand Trends by the World Gold Council (WGC), global gold demand in the first quarter of 2012 was 1,097.6 tonnes (35.3 million troy ounces), marking a 5% decline from Q1 2011. The major fall was due to the drop in jewelry and technology sectors, which were hit by higher prices (average prices were up 22% from a year earlier), but investment demand and central bank buying helped cushion the fall.

China kept its status as the world's top gold consumer for the second quarter in a row. The country's consumer demand grew 10% to a record 255.2 tonnes (8.2 million troy ounces).

India was disappointing with 207.6 (6.7 million troy ounces), which is a 29% decline year-on-year. Among the main factors that caused this were introduction of import taxes, high gold prices, a volatile and weak rupee, and the three-week nationwide jewelers' strike. The tax was eventually withdrawn, so now the expectation is that the Indian market will recover this quarter as investors adjust to the new legislation and tax structure.

Central banks kept up the trend of net purchasing, though they bought less than a year ago: 80.8 tonnes (2.6 million troy ounces) in 2012 vs. 137 tonnes (4.4 million troy ounces) in 2011.

The first quarter was good for ETFs and similar products, with demand totaling 51.4 tonnes (1.7 million troy ounces). This was in stark contrast to the first quarter of last year, when the sector experienced net outflows.

Overall, the quarter was mixed. Analysts expected some decline because of events in India, though the average quarterly gold price rose year-on-year.

This Week in International Speculator and BIG GOLD – Key Updates for Subscribers

International Speculator

• The CEO of one of our exploration-stage companies announced his resignation last week. Read our comment and conclusion.

BIG GOLD

• The last of the quarterly reports from BIG GOLD companies were filed this week – get the results and our comments on the portfolio page.