"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Thursday, August 18, 2011

Mining Share ratio to gold back at pre QE1 levels

The following ratio chart says in a picture just how severely undervalued the gold stocks are in relation to the price of bullion.

You might recall that as the credit crisis erupted in the summer of 2008 with the failure of Lehman Brothers and subsequent meltdown of other large financial firms, stocks and commodities plummeted as the Yen carry trade unwound and deflationary fears escalated.

The rumors began to circulate as the crisis deepened that the Federal Reserve was getting ready to implement some unorthodox policies in an attempt to stave off the deflation and prevent a credit market lockup. That was when the phrase, "Quantitative Easing" first began making the rounds in the markets.

So confident were traders that the Fed was not going to sit idly by while the entire US financial system imploded that they began covering shorts and bidding up the price of equities and commodities ahead of what was then announced with certainty in November of that year.

Look at the chart and you can see that while the HUI/Gold ratio is not at the depths it reached during the peak of the credit crisis, after today, it is now at levels last seen just before the QE1 was actually implemented.

If you look across the chart to the left and note the blue line reaching back to the end of 2001, you can see that the mining shares relation to gold had actually plummeted to levels last seen near the VERY BEGINNING of the now decade + long bull market in gold. That is how cheap the shares had become to gold bullion in the third quarter of 2008.

Quite frankly, we are not all that far off from levels seen at that time with today's round of selling across many of the mining shares. This has occured in spite of the fact that we have spent more than $2.5 TRILLION between QE1 and QE2 and seen the gold price leap from $700 in November 2008 to over $1800 as of today's close.

Based on this fact alone, either the price of gold is going to have to plummet quite sharply from current levels or the shares are going to be at levels last seen in relation to the price of gold bullion when the bull market in gold began and that was at a price level of $270-$290 gold. While gold may correct at any time from its strong rally, why in the world would the gold price be the one moving lower given the current state of the global economy and particularly with all the implications regarding the integrity of the currencies of many nations in the West? The only way to correct this glaring imbalance is for a very sharp and incredibly swift rally in the mining sector.

I have been detailing the ratio-spread trade being employed by the hedge funds across the mining sector for some years now. As a trader I understood the rationale behind that trade - why risk issues related to mines such as management changes, labor disputes, environmental lawsuits, hostile laws and regulations, aging mines, etc. when you can get leveraged exposure to gold by using the ETF's instead. One could buy the ETF or Comex gold and sell short some of the weaker gold shares and laugh all the way to the bank. As an investor myself in the gold shares, I was not happy to see this trade but I could understand it.

I must say that it has now reached a point where those who ply the trade are treading on very thin ice. There is no longer a fundamental case that can be made to justify the trade at current levels of the shares in relation to the price of gold. Smart traders will run a trade as long as they can but they will leave the last 20% for the foolhardy and the novices who think that they are clever enough to pick exact tops or bottoms in markets. The pros do not practice such stunts - if they do, they do not remain pros for much longer but soon become, "EX" traders.

The first hedge funds out the door of this trade are the ones who are going to make the money in it. They will take their profits and they begin looking for another golden goose that may lay yellow eggs for them. The ones that stick around and think they are quick enough to exit before getting run over by all the rest of the funds in such a crowded, lop-sided trade will be the ones who overstayed their welcome and end up losing big when they could have retired the trade with decent profits had they not been so mindlessly greedy.

The first inkling we get of any acquistions by a major gold mining outfit of a quality junior and it is game over for this trade.

Wake up hedgies - the trade to have been in for the last few months was to be long the miners and short the broader markets. There was your money maker. How many times on this site did we mention this trade and urge you to get out of the wrong one? Stop relying on your damned computers and do some thinking and analysis on your own.


  1. sleep well, Trader Dan

    yer a good man

  2. Thanks Trader Dan. Good to hear the game of trashing mining stock prices will soon be over. I can see the said turning point - when a quality junior is acquired by a senior - materializing within the next 30 days. Detour Gold or Osisko comes to mind.

  3. Great post as always Dan. Maybe this is why Kinross Gold loaded up on Capital the other day,an acquisition?

    Thank you as always Dan

  4. Thanks Dan! Great post as always! I think it is wise to keep accumulating these mining shares at discounted prices. When the market dips, buy a little and get an average cost basis. The window of opportunity is closing! Patience is the companion of wisdom.

  5. well, ive been patiently waiting for a long time with many calls of "its about to be over". i think you saw in the morning today a real war with shorts eventually winning the daily battle. i can only imagine how many shorts there are to keep the prices below 680.

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  7. Some large player should squeeze the shorts out of the miners. Would be a great play with low risk long term and potential huge profits short and long term.

    Could work if gold corrects after going parrabolic, a larger drop in gold than the shares could be possible, squeezing them out. especially if miners correct further with the general markets over time.

    (Amateur thoughts)

  8. The paper trade is playing havoc with all kinds of markets. Isn't that why the world is in this economic mess, because the derivatives markets have gotten so much bigger than the value of the underlying assets.

    If all the paper chasing the assets was wound up overnight, the price of Gold would already be circa $40,000/oz

    I read a piece some years back that calculated that if all the gold in Fort Knox was divided up amongst all the available dollars in circulation, then the gold price would be $38,400ish (If my memory serves me well)

    As the number of dollars printed has been added to with QE1 and QE2 and QE's 3/4/5 somewhere over the horizon, then the price of Gold would be priceless, or rather the dollar would be value-less and the prices of commodities would be reduced to barter.

    The trouble right now is politicians like Hugo Chavez, Robert Mugabe, and no doubt others who have been elected with no real understanding of worldwide integrated manufacturing systems, and commodities supply chains stretching around the globe, and who are still trying to fight yesterday's battles with out-dated political tinkering.

    If Chavez is followed by other power mad politicians, then their respective people won't just be going hungry. The Horn of Africa will be like a chimps tea-party by comparison.

    And Silver and Gold will be the only currency.

  9. I just had a thought too... WHAT actually IS money?

    If money originated from promissary notes (i.e. the holder of gold deposited gold and or silver in the bank vaults, and was given a receipt in the form of a promissary note to the effect of "I promise to pay the bearer the sum of £100", (or whatever the currency is) then any notes held overseas are claims against not only the country's gold and silver in its vaults, but it assets such as Factories, Roads, Bridges, Energy Infrastructure etc. etc.

    So if China alledgedly holds - is it 1.2trillion or billion(?) dollars and Japan a similar sum, then if all the assets of the U.S. are divided by the number of dollars in circulation, that means your U.S. based home, or business could theoretically be up for grabs... Which is where the French got to in the early 1700's when that Scot - John law was at the financial helm.

    And you can read here, how THAT particular episode ended...


  10. I have a theory why this mis-pricing exists.

    Ggold companies are unique (from other equities) as the price of gold is going through the roof. This is having a positive impact on earnings forecasts, but general market sentiment and the price people are willing to pay is lower.

    Accordingly, we see the current situation where Gold producers have decreased, but are now flat or moving up slightly.

    As a little more risk comes into the market this and the POG continues it's march north, this mispricing will begin to correct. At the end of the day, those who like to buy when everyone else is fearful should be getting long gold producers.

    There's a more detailed post of my thoughts on my blog - http://microtrader.com.au/post/9119121874/theory-price-of-gold-vs-gold-producers


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