by Kevin Klombies, Senior Analyst

Thursday, July 12, 2007

Chart Presentation: Gold

The chart at top compares gold futures prices with a Rate of Change indicator for the combination of bond and commodity prices from 1985 into early 2005.

Since gold- unlike base metals- is part money and part commodity it tends to trend with both bond and commodity prices. An ideal back drop for gold includes falling interest rates and rising commodity prices while any scenario that features rising rates and weaker commodity prices is obviously quite negative.

We originally set this chart up years ago after finding that the best measure of the trend for gold prices consisted of a Rate of Change indicator based on prices from three years previous. When the sum of the U.S. 30-year T-Bond futures and DJ AIG Commodity Index was higher than three years earlier the trend for gold was also positive and vice versa.

The ROC indicator tracked gold futures prices up and down through the twenty year time frame shown on this chart. Major ‘buy’ signals occurred after the ROC indicator moved below the ‘0’ line for a couple of years and then moved back into positive territory. The chart shows a ‘buy’ for gold in late 1985, the end of 1992, and during the first half of 2000.

Based on this and other work we were positive on gold back when it was considered investment ‘toxic waste’. However by 2004 we were starting to move away from the metals theme and it was our conviction that commodity prices should top out around the middle of 2005. That, of course, was not our best call.

With the benefit of hindsight we wanted to revisit this chart and then spend the next page sorting through one or two of the reasons we got so well and thoroughly ‘hooked’ by the commodity markets.

Based on the ROC indicator the peak for gold prices ‘should’ have been put in right around the middle of 2005. For the first time in more than two decades the trend for gold futures diverged from the ROC indicator as gold prices rose through 450 and then 550 on the way to 700. Perhaps the most we can write here is that we look forward to the indicator moving below the ‘0’ line so that it can help set up the next ‘buy’ signal some time later this decade.



Equity/Bond Markets

The chart at top compares the sum of copper and gold futures with the U.S. Dollar Index (DXY) futures.

The chart is set up to help show where and how we were caught wrong footed by the sharp rise in metals prices. It was our view that the sum of copper and gold futures was tracking higher and lower within a fairly well defined channel and that the top for metals prices would go with a bottom for the U.S. dollar and vice versa.

In 1995 as the DXY moved down towards 80 the sum of copper and gold futures prices reached a peak. As the dollar swung higher the metals trend turned negative and remained that way into 2001. While the 3-year ROC indicator signaled a positive trend for gold in 2000 metals prices did not begin to improve until the dollar began to decline towards the end of 2001.

By late 2004 we were back to a dollar positive view so our interest in the metals and mines began to fade. We showed chart after chart that supported the idea that the dollar should swing higher and given that it was our conviction that a stronger dollar should go with weaker metals prices we turned negative on both copper and gold.

The dollar pivoted upwards in early 2005 and all was right with the world- or so it appeared. The sum of copper and gold futures held right near the channel top but as mentioned our forecast of a mid-2005 commodity markets peak implied that metals prices were going to resolve lower.

The chart below shows the DXY futures, the sum of copper and gold futures (with copper in cents and gold in dollars), and the stock price of Genentech (DNA) from 2004 to the present day.

We have argued on many occasions that the biotechs are a cyclical sector that tends to trend with the dollar while the metals represent a sector that trends inversely to the dollar. The basic point is that getting the dollar ‘right’ is critical to getting the markets right as well.

Back in 2005 the dollar began to rally and its strength was nicely confirmed by the positive trend for Genentech. The only fly in the ointment was the lack of weakness in gold and copper futures prices.

Towards the end of 2005 the metals price ‘sum’ broke to the upside as the dollar started to weaken. DNA reached a peak after more than doubling in price during the year.

Roughly eighteen months after the dollar pivoted lower we find that we are still struggling with our markets view. The DXY has moved all the way back to 80, the biotechs have been flat to lower for the last year and a half, and capital continues to chase one mining story after another.

Our basic view is that if, as, or when the dollar finally shows strength it should go with metals price weakness and a return to relative strength by the biotechs. For this reason we feature stocks like Genentech and Amgen on a regular basis as we try to find some way to separate all the false turns from the real thing. The ROC indicator that we used for the trend for gold on remains negative so in a sense the only thing we need to get ‘right’ now is the direction of the dollar.