The above quote comes from Mark Twain, the pen name for American author and humorist Samuel Clemens. While it is true that no point in time is exactly the same as another, there can be some uncanny resemblances that, as Mr. Twain pointed out, appear to mimic the past. It appears that 2009 is doing just that with 2002-2003. Today’s article is an update to the two prior articles listed below on gold and the USD, in which the seasonality of both gold and the USD were analyzed.
- Gold & Gold Stocks Setting Up for a Strong Second Half? (07/29/09)
- The Sacrificial Lamb? (08/05/09)
Seasonality
In the two articles above, the seasonality for both gold and the USD Index were analyzed this decade, and it was shown that gold typically has a strong second half while the USD Index’s seasonality pattern is mixed. To bring further clarity to the USD Index’s seasonality, the years in which the USD finished positive and negative were then separated and averaged, with the data normalized to 100 at the start of the year. What was seen is that the USD Index’s path for 2000-2008 does not appear to diverge much from year to year until mid way through the second quarter. It is from this point that it appears the USD Index’s fate for the year is decided, with the bullish years averaging a 10% gain for the year while the bearish years averaged a 10% decline as seen below.
Source: Bloomberg
The 2009 path of the USD was then analyzed compared to the bearish years and a clear resemblance was seen with 2002 and 2003, a period in which the reflationary campaign of the Federal Reserve appeared to be taking root as the stock market was bottoming and the economy was showing signs of stabilization and actual growth. As seen below, the USD Index’s pattern in 2009 is following quite closely to the 2002-2003 average path, pointing towards further USD weakness into the end of the year. Interestingly, the seasonal path of gold is also closely following its average 2002-2003 path and may have to wait until the middle of October before it undergoes a sustainable advance above ,000/oz.
Source: Bloomberg
Source: Bloomberg
When History Doesn’t Repeat…
While the USD and gold appear to be following the same pattern as they did in 2002-2003, how do they compare to their historical action after the end of recessions? This was the question that the always insightful Brian Pretti from ContraryInvestor.com was asking earlier this week in his article, “Dollar Daze.” In the article Mr. Pretti points out that the typical pattern in the post recession environment for the USD has been either flat to positive twelve months out. As shown in the table below, the 2001 experience stands as a clear outlier. Conversely, a strong USD post recession conclusion typically leads to weak gold prices as investors shun gold for equities. This was the case after the conclusion to the 1973 and 1981 recessions, with 2001 showing how gold along with the USD diverged from prior post recessionary norms.
Price Performance of US Dollar in Post Recession Environments
Source: ContraryInvestor.com
Source: Kitco.com
The key for why the USD was weak post the 2001 recession compared to the four prior recessions is pointed out by Mr. Pretti in an excerpt from his article below.
Dollar Daze
Very quickly, what accompanied historical post recession strength in the dollar in prior economic recovery cycles was that debt relative to GDP was either falling modestly, or essentially not rising for a time in post recession environments. The following chart attempts to document this a bit. Again, we’re looking at total US credit market debt relative to GDP from the early 1970’s to early this decade, but this time we’ve shaded in with red bars the twelve month periods following each recession, to match the quantitative dollar price performance periods we detailed in the prior numerical table. And what is the constant in the periods that showed post recession dollar strength?
Source: ContraryInvestor.com
Easy, the constant is a lack of immediate acceleration in US debt to GDP in post recession environments prior to 2001. We think it is more than very fair to say that “it’s different this time”, no? If the dollar continues to decline in the “headline” post recession US economic environment to come and gold prices move higher, potentially ignited by an all-hallowed and very meaningful technical breakout, we believe they will be exactly telling us it’s different this time. And they will be “telling” the Fed/Treasury/Administration that there are indeed limits to borrowing and money printing. Imagine that. Is this unfolding scenario in part why China announced last week that they’d be buyers of B of IMF bonds? Of course that’s B that won’t be directed at buying US Treasuries. Is this a tangential reason as to why Hong Kong all of a sudden wants its physical gold shipped home from London? And could a potential dollar and gold historical price performance divergence ahead be in part reflective of the political change in Japan that is not necessarily as favorable to US financial interests as has been the case in the past? In the three dimensional chess game that is the global financial markets and economies, the chess pieces are moving…
Without reaching for melodrama, we just can’t shake the gut feeling that we are smack in the midst of what will ultimately be seen as a period of secular change in global financial market and economic relationships. As such, we believe that the most important messages of the moment that will be guideposts to the future lie in the divergences of key economic/financial market relationships of the moment relative to prior cycle experience. Gold and the dollar are both hinting at exactly this right now.
Room to Run
Gold could very well be discounting a further bloating of US debt levels relative to GDP. Is gold sniffing out a second stimulus package? Whatever the cause, it appears that gold has plenty of room to run as it has been quietly coiling over roughly the past two years since its first ascent into the ,000/oz arena. Two long term indicators I’ve developed show that gold is a long way from being overbought and has plenty of room to stretch its legs before any red flags begin to emerge. As seen below, gold either corrects sharply or undergoes a period of consolidation once the FSO Gold Indicator #1 reaches levels north of 2, which was the case after the 2006 peak and early 2008 and 2009 peaks. Since the early 2009 peak, which saw the indicator reach the most overbought level since the 1980 peak in gold, the indicator’s overbought condition has been resolved by time rather than price as gold simply consolidated and recently reached a level that has marked major bottoms in gold in the past.
Source: Bloomberg
The same can be said for the FSO Gold Indicator #2 that also reached significantly overbought readings earlier in the year that have since been worked off over the last six months to levels that have also marked major bottoms. As can be seen in both indicators, gold has a long way to run before reaching overbought territory, which would not likely occur until gold leaves the ,000/oz mark firmly behind it as it assaults new all-time highs.
Source: Bloomberg
What is also interesting to note is that the gold to S&P 500 ratio underwent a perfect 38.2% Fibonacci retracement of the 2000-2009 secular bull market before its recent rally. In terms of hard versus paper assets, gold appears likely to breakout relative to the 30-Yr UST bond as it assaults the 1980 high. So the gold to S&P 500 ratio holding at its 38.2% Fibonacci retracement level as well as a breakout in the gold to 30-Yr UST bond would be signaling that the secular bull market in hard assets relative to paper assets is alive and well.
Gold to S&P 500 Ratio
Source: Bloomberg
Source: Bloomberg
Gold Stocks Set to Outperform Bullion
If gold is to continue to follow the 2002-2003 path and finish 2009 on a strong note, then precious metals stocks are likely to fair even better given their leverage to gold and silver. The Philadelphia Gold & Silver Index (XAU) to gold ratio shows that precious metal stocks still present attractive value relative to bullion despite their sizable advance since last October’s lows. The XAU to gold ratio is still roughly two standard deviations from its historical average and even below the level seen at the 2001 bear market lows.
Source: Bloomberg
What is also encouraging to see is that gold stocks are already outperforming bullion which is bullish, and what would even further solidify a strong move in precious metals would be participation by the juniors which have begun to gain relative to their larger market cap brethren. The FSO Junior Gold Index began to underperform the Amex Gold Bugs Index (HUI) in late 2007 and into 2008, warning that precious metal investors were becoming more risk averse and moving more towards the safer larger cap producers. However, the tide appears to have turned as the juniors relative weakness to the HUI appears to have ended earlier in the year and the juniors have been holding their own as the ratio of the FSO Junior Gold Index to the HUI has remained flat over the last few months. A breakout in the junior to large cap ratio would be quite bullish as it would indicate a healthy appetite for risk is growing in the precious metals arena.
Source: Bloomberg
Another positive sign for the precious metals sector is that both cumulative advance-decline volume and issues are confirming the recent rally high in the Market Vectors Gold Miners ETF (GDX), which wasn’t the case in early 2008. Back in late 2007 and into 2008 the cumulative advance-decline line for the stocks within the GDX was diverging with price, a clear warning sign of an impending top as fewer and fewer stocks were advancing while the overall ETF made new highs.
Source: Bloomberg
While the cumulative advance-decline volume for the GDX did not show the same erosion as the cumulative advance-decline line in 2008, it failed to make higher highs with the GDX as volume diverged with price.
Source: Bloomberg
As seen in the figures above, both the cumulative advance-decline line and volume are confirming the rally and have broken above the June highs. Until either measure begins to show divergence with the GDX it appears the path of least resistance for precious metals is up, with minor corrections along the way. If the USD and gold continue to follow the path of the 2002-2003 average, then gold may finish solidly in the green for the year. As the analysis of Brian Pretti above highlights, gold’s strength may continue into 2010 if the US government continues to expand its debt levels relative to the economy. And from what we know already, it doesn’t appear the fiscal deficit is about to shrink any time soon as trillion dollar deficits appear the name of the game over the next few years. As Mr. Pretti said, “the chess pieces are moving.”
