Gold looks fantastic. It is breaking away from a consolidation which could be called a running correction. Two weeks ago Gold broke to a new high. Last week Gold retested the breakout and then advanced to another new high at the end of the week. Its textbook bullish action. Yet the gold shares have really struggled.
Last week the shares failed to make a new high and underperformed badly. GDX never broke to a new high and is below its December high. GDXJ did break to a new high but is now at its December high. Gold is nearing $1500. Its December high was $1425.
There are real reasons for these divergences. Some peers think its the hedge funds shorting the shares or manipulating the market either intentionally or unintentionally. Some think its manipulation by the powers that be. The fact is, these assertions have not been proven and there are some fundamental reasons for the divergence.
The price of Oil comprises about one quarter of the cost of mining. Remember 2007-2008 when the gold stocks badly underperformed? Part of that was because Oil went from $60 to $150. Sure the Gold/Oil ratio is now well above its highs from 2000-2008, but since the summer of 2010 its decreased from 17 to 13. That will cut into margins this year.
Secondly (and we’ve written about this before), the Canadian gold price is up only 13% since its peak in February 2009 and up only 7% since last June. Most gold companies are Canadian companies. Its the Canadian price that is more important to them. Thus, a weak US dollar eventually negatively impacts gold producers.
The gold shares have underperformed a rising price of Gold in the past. We saw it in 2004 and also in 2007-2008. It generally precedes corrections and that is a reason to be cautious beyond the short-term, which looks positive. It is not manipulation or intervention. The proof this time is that all gold shares (seniors, mid-tiers and juniors) are now under-performing.
We’ve noted the fundamental considerations but maybe the market knows something else we don’t. Perhaps the market senses a top in equities? Perhaps the market sees an intermediate term top ahead for Gold and Silver? Perhaps the market thinks the shares will struggle in the seasonally weakest period of the year?
We are short-term bulls but cannot be too bullish with the broad divergence between the shares and the metal. In this bull market, this divergence has always resolved itself with a correction in the sector. Sure it could be different this time but we think not.
