Tuesday, February 19, 2008

Gold's Green Light is flashing a buy signal

Ah, Don’t you love mechanical buy signals? Could it be true? Is there a proven indicator, a green light, that tells us when it’s time to buy?

For the past 25 years the XAU/Gold ratio has been right on the money. Buying gold shares anytime the XAU/Gold ratio has fallen below 0.20 over the past 25 years has been a slam-dunk. And that trend is continuing even today as we speak. Anyone buying gold at the previous dip below the 0.20 mark which would have been Feb 5th is now enjoying a gain of 3.77% in 10 trading days.

For those that are new to this modern day gold rush, the XAU is an index of gold mining stocks. And as most gold traders will tell you, gold stocks typically lead the bullion. However, in the last few weeks the opposite has been happening. Gold shares have lagged the metal sending this XAU/Gold ratio down to a low of 0.1945. This doesn’t occur very often and to illustrate that point I have plotted the XAU as a ratio to GLD, which is a gold ETF. GLD is one of the easiest ways to own gold bullion in the market. Because it trades at 1/10 the price of spot gold, I have multiplied GLD times 10 to preserve the ratio.

As you can see, the ratio has dipped below 0.20 three times in the last 4 years that GLD has been available for trade. Twice in May of 2005 and then again in August of 2007 and each time the gold bullion (gold line on chart) takes off for a nice gain. You may have also noticed that the ratio has dipped again in the last few days!

What is most interesting is that GLD has had a huge run-up in the last few months and yet the indicator is signalling a buy. Since Aug 2007 it has gained over 40%. Is there room for more growth? Many think so and the market certainly wants gold to hit $1000/ounce.

With the large gains over the last few years, I am a little leery about adding anymore to my current GLD position. I also cringe at the tax implications of GLD. Long term gains for gold is taxed at 28%.

After a little research, I now know that gold is actually a better deal if you plan to make a short term trade! The taxes on gold gains held less than one year are at your income tax rate. It’s not a big break, but it is something to think about.

Why is the ratio low? The value of gold stocks is heavily weighted to the price of gold bullion. But with the large gains in bullion and weak overall stock market, the stocks have not been keeping up. Gold bullion has been pummeling every sector of the market, even the gold mining stocks.


  1. Nice PFBlog! You're a woman after my own heart! <3 =) Saving over 59% of your income is quite an impressive feat.

    In the current economic conditions, I think gold is just getting started and any pullback is an opportunity to add to one position. The Fed fears a recession more than inflation and seems intent of continued rate cuts and adding more liquidity. These moves point to a declining dollar and rising inflation.

  2. Thanks for the comments. I hope to increase my savings rate very soon with my upcoming raise.

    Yes, it appears the Fed is ready to print all the money they can to keep the economy "expanding".