Gold to Crude Oil Ratio indicates profitability of Gold miners

Following are two separate charts tracking the ratio of  the price of gold to the price of crude oil.

The first is Brent Crude, the global benchmark for crude prices and the second is WTI crude, which is the Nymex benchmark and the one most often quoted by American wire services and news organizations.

The reason for the charts is that which Eric King and I discussed on this past Friday's KWN Weekly Metals Wrap where we talked about the severe undervaluation of the gold mining stocks. The point we were discussing was the direct impact that lower energy costs have on mining operations. The rise in the price of gold with a simultaneous fall in the price of crude oil, is lowering input costs for mining companies at the same time the price they are receiving for their finished product is rising rapidly. That is a surefire recipe for increased profitability moving forward. Given the fact that one of the arguments against buying the miners has been that their input costs have been rising at the same rate that gold has been rising, this effectively kills that argument.

It does seem from the price action of today's session, that some of the market players are finally catching on to this. If even one or two of the major shorts in the gold shares begin covering in size, the resultant buying wave will take prices of many of these shares through technical resistance levels on their price charts, resulting in further short covering as the hedgies which foolishly overstayed their welcome and attempted to squeeze the last 20% out of an otherwise profitable trade, begin to get snared by their own greed.

A closing monthly push through the all time high marked on the chart should see the miners do some rapid catching up to the gold price and reverse the downward trend in the HUI/Gold ratio.

Trader Dan on King World News Weekly Metals Wrap

Please click on the link below to listen to my regular weekly radio interview with Eric King on the KWN Weekly Metals Wrap.

http://tinyurl.com/454trh7

 

Silver Stuff

I wanted to post a few comments about the Silver market for some of those who have been asking me to do so. As mentioned in previous posts here, silver is finding itself caught in a war between those running out of risk trades who are selling commodities and equities, and those who are buying it as a safe haven metal.

That tug of war has prevented it from surging alongside of gold but nonetheless, even in the face of such selling, it has been attracting enough buyers that its technical chart picture is slowly but steadily improving.

I want to first note that it has regained its footing above the 50 day moving averaage having bounced firmly off of that key technical level last week. Since then it has established a nice little uptrend which has taken it back to the region where it has encountered selling resistance over the last month or so. I am speaking specifically about the region near and just above the $40 level.

If you will also note, all four of the major moving averages that I use in tracking this market, are now moving higher with the silver price ABOVE those ma's. That is bullish. What I would like to see and what it appears that we are likely to soon get, is for the 10 day moving average (blue line) to move up and crossover the 20 day moving average (red line). That would put the market solidly in an uptrend as it will take some stability at these current price levels for such an event in the moving averages to occur.

If, and this is an important "IF" from a technical perspective, silver can close out the week tomorrow on a firm note, preferably with a push through the $41.30 - $41.50 level, it will enter the following week on very solid technical ground and set up a run to the $44 level for starters.

It still has some downside support first near $39.50 which is followed by another level of support near the $38 level. It would have to breach that latter level for a move towards $35 again.

At some point, as gold continues to move sharply higher, silver will become increasingly attractive to value-based buyers as it is still very affordable if one considers the current options in what can be termed "precious metals", platinum ($1845), palladium( $758), and gold ($1835). None of these metals are cheap any longer ( in the sense that the common man on the street can plunk down some loose change for an ounce) making the little grey metal, "poor man's gold", likely to outperform on a percentage basis in the coming months.

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.

S&P 500 Technical Analysis

Stocks have embarked on a relief rally ever since it appeared that the Fed was going to keep interest rates at an ultra low level and the ECB was going to step in and buy up Spanish and Italian Debt. While such actions tend to keep investor fears subdued it does nothing to actually genarate true economic growth. That requires structural reform which includes looking at the tax code, cutting excessive and burdensome regulation, andgetting the central governments to actually exercise some spending restraint.

Traders are of the opinion that the Central Banks will intervene to prevent any worsening of the factors that have precipitated the move away from risk but at the same time, they all realize that serious problems are still lurking in the background and have not really been dealth with.

I am not sure what trigger might set off another round of broad based equity selling but if the market were to move back down towards the recent low near 1075 and fail to hold there, it will drop at least another 100 points before any technical support will surface based solely on the price projection given by the pennant formation.

Equity bulls really need to get the index above the 1250 level to spook the bears and preferably above the falling 50 day moving average at 1275. That seems a tall order given the state of the US economy. Perhaps the best that they are hoping for is to settle for a draw with the bears and bounce the market back and forth in a wide range trade giving the economy time to improve on its own. Then again they might be crossing their fingers waiting for Uncle Ben to give them some sweet whisperings about another dose of QE when he gives his speech at Jackson Hole near the end of this month.

Given the political firestorm that would set off, I doubt we are going to get anything quite that drastic at this point. We would need to see an equity market debacle to given them the courage to do any such thing as that would basically be the last nail in the coffin of the US Dollar. The Fed has been roundly and rightly criticized for the effect that its two previous doses of QE had on the greenback and the subsequent spike in gasoline and food prices which negated any stimulative impact that the easy liquidity might have had, if any.

Gold - 4 Hour chart update and comments

The ability of gold to push past $1780 set the stage for its test of the $1,800 level. The two lines of technical resistance are noted on the price chart. As you can see, the initial approach to $1780 saw gold encounter some resistance from sellers trying to defend that level. After they were unsuccessful, they then retreated towards the $1800 level from which they are attemping to absorb the bids coming into the Comex gold pit. 

Technically, the gold market is now at a crossroads of sort for the short term price action. Volume has been shrinking as it nears $1800 which is not particularly a good sign for the bulls as it reflects hesitancy on their part to get too aggressive at this point. They will need to stand firm here to prevent the bears from getting emboldened.

If the bulls can push price past $1800 and hold it above that level, they have a very real chance at moving back to the all time high. If they falter, then gold will sink back towards $1780 where the bulls will need to step up to prevent it from dropping back to the $1740 level.

The bears are attempting to create a short term double top on the price chart by digging in and holding price near current chart levels; however, to actually validate such a formation, the price would have to be taken down below $1730 and held there.

The big problem for the bears however is that they are running "out of season" for the seasonal chart pattern. Gold tends to strengthen as it moves into the latter part of the third quarter and into the early 4th quarter as the Asian festival season begins, not to mention the Western Christmas season. The sort of physical demand associated with this time of the year then becomes a headache for the shorts in the market, particularly if the conditions which are bringing safe haven flows into the metal continue to worsen.

The bears are going to be hoping and praying for a strong equity markets rally and a lessening of the "fear factors" driving gold higher. Whether they get that or not is unclear.

I should note here that the Continuous Commodity Index ( CCI ) will simply not go quietly into the night. Every time it appears that this index has topped out and is going to validate the deflationists' arguments, it rebounds and moves back up again. By and large, the complex as a whole was higher today bringing the index back up towards the 650 - 655 level which has been acting as a resistance zone on the chart.

The index has been in a very gradual trend lower on its daily price chart but has not confirmed a solid trending move. It still remains a very good gauge of the risk trade vs the fear trade in this regards. When traders are comfortable with risk, the index moves higher. When traders are running on fear, the index moves lower.

With this CCI Chart in mind, take a look at the following silver chart and you might see the type of connection that exists between the two. The CCI peaked in late April; so too did Silver. The fear trades knocked the CCI down; so too did these trades knock down the price of silver. In effect, silver has been held hostage to the broader climate of risk aversion that has been dominating the market for the last few months.

There is a difference however. The CCI has been in a broad consolidation pattern with a weaker bias; however, Silver has been in a broad consolidation pattern with a friendly bias. If commodities were to start another broad based rally, silver would accelerate up and out of its congestion type pattern very quickly as it continues to hold together better than the overall sector as a whole. It will not matter what the stimulus or triggering factor might be -the chart says it wants to go higher given enough impetus or momentum to break it free from its confines over the last month.

Lastly, I once again need to comment on the failure of the HUI to take out this incredibly stubborn 580 level and hold it. It took out that level early in the session today but then failed to build on its gains and moved lower retreating away from the number almost as if on cue. As a trader I must marvel at the obvious footprint being created on this price chart. I can only surmise at the amount of short selling that is being required to hold these mining shares in general from surging higher. One gets the sense that the bears are doubling down and determined to prevent their positions from going underwater. All it is going to take to see a massive short squeeze in this sector is for one or more of these large short sellers to decide that the better part of valor is getting out. The first guy out will win - the rest will get buried. They must all certainly know this.

One last thing - The US Dollar fell down to a major support level (AGAIN) before it bounced slightly higher off of that level. This level near 73.50 is taking on increasing significance. As you note on the chart, it has not spent much time below this area before it moved higher. If, and this is a big IF, the Dollar falls through this level and does not rebound rapidly, things could turn quite ugly for it in a real hurry. I find it rather telling that with all the turmoil and uncertainty besetting the Euro Zone in regards to its debt issues, the Dollar is barely hanging on for dear life. That is not exactly a ringing endorsement of the merits of the greenback in my estimation.

Chavez makes a run at Venezuela's Gold

Both Dow Jones and the Wall Street Journal are reporting this morning that leftist strongman Hugo Chavez plans to nationalize the gold industry of Venezuela. There looks to be little if any influence on the gold price from this news. About the only effect that I can see is on mining companies that have their operations down there.

Gold - 4 Hour chart update and comments

I've moved back over to a 4 hour chart for the time being to try to get a bit tighter view of the recent trading range that gold has been carving out over the last few sessions. The chart resistance and support levels being created detail the range as gold is still finding buyers on dips below $1740 but has not yet been able to clear $1780.

If it pushes through $1780, it looks to me to have enough momentum to try to take another shot up towards $1800. How it reacts there will be extremely important.

The overall chart pattern is still being dominated by that big down day from last week after the market pushed through $1800 but then failed to hold that level after subsequently setting back.

Bulls would not want to see this market spend much time below $1730 or so before rebounding as that would portend a drop towards $1700 initially.

Volume is easing somewhat ( a welcome relief I might add) reflecting a lull in the emotions of traders. After last week's wild ride, a lot of guys are just worn out and glad to be sitting around on the sidelines or trading a bit smaller in size while awaiting some more definitive signals.

One brief note about the action in the HUI in Monday's session. Once again it has pushed right up into a very stubborn and formidable chart resistance level near 580. It has had trouble dealing with this area since May of this year. Going back to the beginning of the year, it had managed to briefly penetrate the level but spent spent less than a month above it before succumbing to selling pressure and failing to hold its hard fought gains.  If it can clear this level now, and if it can hold those gains going into the end of the week, then we should have something to hang our hats onto from a technical perspective. If it sinks back down away from 580 again, it will just further reinforce how significant this level is becoming on the charts. Apparently, there is a lot of pain coming to short sellers if some of the shares rise much further from today's levels and they are making a concerted effort to prevent that from happening.  Any further move higher in gold is going to complicate their efforts immensely.