Counter Cyclicality of Gold Stocks

The capitalization of industrial, commercial, and financial stocks is vastly bigger than that of precious metals stocks. As the bulk of investment capital is in the general market the trend in these stocks must be considered the main trend of the market. Generally, precious metals stocks are counter cyclical – they move in the opposite direction of the main market trend.

This inverse relationship is confirmed statistically by calculating the correlation between an index of the market, for example the S&P500, and an index of gold stocks over a period of decades. This shows a strong inverse relationship. This does not mean that when the one index rises the other falls, but generally, over time, the one will rise when the other falls. As it is not a perfect correlation, there may be periods of weeks or even months when the inverse relationship does not hold.

Based on the counter cyclicality of golds against the market in general one can seek confirmation of trends. Basically, when the market is making new highs golds should be making new lows; or when the market is making new lows golds should be making new highs. When they fail to confirm each other in this manner then a reversal of trand may be in the making.

This chart, going back 10 years, shows the percentage movements of the Dow-Jones Industrial Average (top) and the XAU gold stock index (bottom).

click to enlarge

Currently the Dow is about 120% above and gold stocks 12% below their levels of 10 years ago.

The large upswing AB of the market in the ’90s corresponded with the AB’ fall in the gold stocks. Then the fall BC in the market coincided with the B’C’ rise in the golds. This was followed by a new market rise CD and fall in gold stocks C’D’.

At this point an interesting divergence took place. The market is currently near the top of its CD rally, so golds should be near the bottom of the C’D’ decline. Instead, we find the gold stocks back near their C’ high. Many gold investors are frustrated that their stocks are not doing better, but the reality is that they are doing far better than they deserve.

In my opinion, as the driving force creating the trend is the industrial and not the gold market, gold stock investors need to wait for the next major decline in the industrial market before they can expect the next major upthrust in the gold stocks.

All those who are bullish on the gold stocks are already invested. There is no money available to drive the market higher. For the market to go higher it needs new money to come in. This will come from the sale of industrial stocks. Investors will start switching into golds when they see the market in general is failing. The gold market needs to be driven by investors in general, not only by gold bugs, and this will only happen once the industrial market turns down.

If the market continues with a sustained move above D then it is quite possible for gold stocks to fall below D’.