Gold was in the headlines this week when it traded at an all time high in U.S. and Canadian dollars.
On the other hand, gold stocks on both sides of the border strengthened, but failed to approach all time highs. Where do gold equities and related Exchange Traded Funds go from here?
One of the reasons for failure of gold equities to move to new highs is a lack of favour-able seasonal influences. The period of seasonal strength is approaching, but is not there yet.
According to Thackray's 2010 Investor's Guide, the sweet spot for gold equities is from July 27 to September 25. The trade, based on the Philadelphia Gold and Silver Index, has been profitable in 16 of the past 25 summers. The average gain per period was 6.8% versus a loss of 0.6% for the S&P 500 index.
Gold benefits from greater demand by refiners that use the gold to make jewellery for the Christmas and Indian Diwali wedding season in late October or early November. This year Diwali occurs on Nov. 5. India is by far the largest purchaser of gold jewelry in the world.
Chances of a seasonal trade in gold and gold stocks this year are better than average. India's economy is booming. It currently is one of the fastest growing economies in the world. Demand for gold jewelry is expected to be exceptional this fall despite the high price of gold.
Supply and demand factors are expected to influence gold and gold stocks favourably this summer and fall. Upside potential for gold currently is capped by gold held by the International Monetary Fund. Last summer the IMF received international approval to sell 400 tonnes of gold.
Last fall it sold 200 tonnes to India and has announced intentions to sell its remaining 200 tonnes. Funds from the sales are needed to finance the financial bailout of Greece as well as to provide support for emerging nations that were damaged by the recent recession.
The IMF has been slowly liquidating its remaining 200 tonnes under the Bretton Woods agreement reached by central bankers last summer. The effect of this action will remove important overhead resistance levels for gold and gold stocks.
Currency fluctuations also are expected to influence gold and gold stocks this summer and fall. Historically, gold and gold stock prices have moved inversely with the U.S. dollar.
The accelerated printing of U.S. dollars during the past 10 years has triggered a flight to value, such as gold. Since 2001 the price of gold in U.S. dollars has more than quadrupled.
That relationship disappeared temporarily in December 2009 when the euro's financial crisis first became apparent.
Since then, the U.S. dollar has strengthened relative to the euro and gold and gold stocks have moved sideways. However, the historic inverse relationship between gold and U.S. Dollar is expected to return when the euro eventually stabilizes.
Unlike European nations that have announced in recent weeks plans to reduce government spending and deficits, the U.S. government is intent on increasing government spending and deficits.
Ultimately, accelerated printing of U.S. dollars to finance the federal government's deficit will lead to a return to weakness in the U.S. dollar and strength in gold and gold equity prices.
On the charts, gold equity indexes have become more interesting in recent weeks. The Philadelphia Gold and Silver Index (XAU), AMEX Gold Bug Index (HUI) and the S&P/TSX Global Gold Index have strengthened with gold prices during the past two months.
However, gold equity indexes have been underperforming the commodity itself. In addition, the short term momentum indicators currently are overbought, suggesting limited short-term upside potential.
The preferred strategy is to place gold equities and related exchange-traded funds on the radar screen for a possible seasonal trade this summer. Please be patient, do your homework before choosing an investment in the sector and watch the charts for an opportune time to enter as July approaches.
- Jon and Don Vialoux are authors of free daily reports on equity markets, sectors, commodities, equities and Exchange Traded Funds. Reports are available at www.timingthemarket.caand www.equityclock.com