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Australian Gold Sector Are We There Yet?

Commodities / Gold and Silver Stocks 2014 Dec 02, 2014 - 02:11 PM GMT

By: Neil_Charnock

Commodities

The Australian gold sector index (XGD) topped during the week of 15th April 2011 at 8498.9. The first fact to consider from this article is that this occurred nearly 5 months ahead of the peak in gold when the king of metals had just reached the high US$1400. As you well know gold went on to rise to US$1920.8 approximately $430 higher than when the gold stocks peaked. To make the same point again this index reached a previous top at 8448.4 in the week of the 12th November 2010 when gold closed at US$1368.5. That was approximately 10 months ahead of the top in gold. This is a critical point to understand as we grind through the remainder of this painful correction in gold.


This index is dominated by our leading gold stock NCM however it does offer an insight on the rest of the sector too. I make this point because the index tends to move more on the outlook for NCM as a proxy for the XGD. The dominance creates distortions as NCM has had its own issues and I cover this in detail from time to time for clients.

Nick Laird at Sharelynx offers a fantastic service which out performs the XGD as a representative of the sector as a whole. He provides a small sample of this in my GoldOz site under the 'gold charts' button on my top tool bar if you have interest. Nick is a quiet achiever and one of the gems of the industry and provides a valuable and vast asset base of charts in my opinion.

Pathway down

The local gold sector went into decline ahead of the gold top and just kept falling to the dismay of gold stock investors. The fundaments for gold had not changed and still have not. The risk created by the ludicrously high sovereign debt levels is loaded into bond funds, insurance funds, sovereign wealth funds and most disastrously the banking system. Alarmingly we have abundant signs of debt stress despite the fact that interest rates are at record lows and in an extreme bubble. Imagine the distress in the system as investors fail to purchase bonds or continue to redeem from the major Funds. Having a proportion of your capital out of the system has never been more essential.

The reasons to hold gold have not changed only the price and that is more to do with price technicals and the strong USD in which gold is measured. The "overbought" lesson is there for all to learn from, along with the limitation of fundamental analysis as a reason to stay heavily invested in such a circumstance. Mainstream investors have that learning opportunity to come and probably worse.

Shorter term gold investment strategies were crushed. We have been able to provide some guidance to help investors to protect their capital, for those who stuck with the sector. By the time I backed off regular promotion in April 2013 the sector was pushing down through 4000 and leading gold dramatically. By the time gold first hit US$1180.3 mid way through 2013 this sector had plunged to a low of 1984.4. For the record I clearly stated this promotion "back off" was a measure taken for longer term credibility. This period has ended now it is time to get investors prepared.

Shares usually lead the way on the economy both up and down. This was indeed the case as the Australian gold sector was already pushing down through the 4000 level by that time gold broke important support at the US$1540 area. It only took another 11 weeks for this sector to reach the next important low of 2000 on the 28th of June that year. The 24th of June 2013 (4 days before that low) was where I released my next article. The thesis at that time was that the opportunity was to trade the swings in the sector and that down side risk had diminished at that time.

The next article I released was January 13th 2014 after telling clients (over one month earlier):

4th December 4:40pm what an opportunity with the XGD at 1700! Who could have predicted this outcome? I am about to update the Funds and go shopping in earnest. This should offer profit opportunities in the first quarter of next year.

In June 2013 the original thesis was to trade the range and initially we saw a swing of +50% back to 3153 in August 2013. I also warned this bottom was going to be long, unlike the 2008 low. Other local commentators boldly and incorrectly claimed the low was in. There were continuous calls that gold had also bottomed however I spoke to the Financial Review then and was quoted on record that gold was headed lower due to a rising USD. It is nice to be right sometimes and credible to admit mistakes.

The end of 2013 article release was equally well timed a few weeks after I provided the heads up to clients in my Members only live commentary section. The index ran from 1700 to 2724 by mid-March 2014, also a +50% rally. I was warning clients of a pending top by mid-February as the index reached the top of the range for that rally. Again the thesis had been to invest in the large swings made possible by the oversold deeply discounted share prices at that time.

My last article release was the 8th April 2014 where I stated:

"One purpose of this article is to offer a heads up that the model now indicates we are headed for new lows on the USD price of gold this year. My next target to horizontal supports off the 2008 high at US$1030 has come into play at this time. We will see a test at the lows of 1180 as well. My last target from April 2013 was US$1170 which was missed, only just."

We have not reached the $1030 support as yet and this is increasingly looking unlikely this year. Well at times we do make mistakes and I also believed there was more in the rally that followed shortly thereafter as well. I partially bought the last top in late August however with only limited capital. My capital position had almost recovered back to the original starting position near the highs in 2011. And that was after writing the above; I proceeded to outsmart myself.

This mistake led me to some of my most important research directions so far since beginning of my investment in this gold bull in 2001 and silver in 2003. The exact top was defined in all its glory and I will do my best not to miss the final low now I have improved my timing systems.

Conclusions and current circumstances

The last rise in gold came in October and then early November this year. It is probably finding a new slightly lower range; according to my long term model for the next several months. The October rally in gold was particularly interesting because it had zero beneficial effect on the gold stocks here. The reason behind this was that offshore Funds were literally being forced to sell as commodities were sold off.

As one MD I spoke to last week said (correctly) the Funds sell when they have to not when they want to. This caused the index to push below the December 2013 low of 1703 with the next drop in gold reaching a new record low of 1642.2. This was achieved with dominant stock NCM well above the low price it reached back in late 2013. That means the other leading gold producers here reached a significantly deeper low.

They earn their revenue in AUD (and in some cases other currencies) which is likely to come under further pressure as the USD rises to final highs (corresponding with the final gold lows). The USD is correcting off an overbought level at present to provide some relief for US producers however the difference is more marginal on the profits of some of these beaten down producers over here in Australia. That is our local stocks actually have an important advantage. My point is that the Australian lower cost producers will benefit from a higher AUD price of gold if indeed gold in USD terms does push lower as expected. That is a benefit to margin risk for these producers and we have some stellar examples of this that have seen their share prices absolutely smashed on Fund selling. One such stock may earn nearly 33% of their market cap as an operating margin this quarter alone as they mine an extremely rich deposit.

There have been some other stronger share price performers that failed to reach new lows at the 1642 level which may never be matched over the coming bull market. I am not saying the sector has bottomed as yet as I believe a base forms here again with large trading swings on offer. Individual stock lows will depend on their individual performance, and the Fund selling (or not) should more clients redeem capital during these lows.

The rush for liquidity due to Fund selling, mainly oil and gas, coal and iron ore has been significant. The PIMCO event and the other redemptions in the bond markets are also causing a wave of capital assisting the rush for liquidity exacerbating the destruction of gold stock share prices. This is a huge opportunity now sub-2000 for the longer and medium term, provided you select carefully from the lower cost producers. The rush for liquidity last occurred in 2008 to this degree highlighting the importance of capital flow analysis. That is market conditions.

Gold may not have bottomed and yet the gold stocks may be finding their lows right now, some may have already done so in the last low. This is now time for me to begin to ramp up my article writing after this long 20 month pause. I am moved by words from a prominent Australian Kerry Stokes who suggested that the time to work the hardest is when nobody wants to - for this is the hallmark of a successful man. His words are being quoted second hand only but they were to this effect. I am putting this into effect researching harder than ever and presenting value to clients more than ever. There has not been a greater potential benefit since I started GoldOz in 2006.

The gold stocks topped 10 and 5 months ahead of the high in gold. Will they also launch well ahead of the gold price? This is a strong possibility due to the same reason the shares always move ahead of a market. They usually behave in this manner.

The largest investment books out there can only accumulate slowly. Therefore they move ahead of time and accumulate providing a floor or ceiling to price to some degree. This is the only disadvantage that the uber-rich and very large Funds have over smaller investors especially in an age of high frequency trading and other such tricks designed to keep the playing field tilted in their favour . Just try to load +$2B into this small sector in Australia ahead of the low and see what I mean. Especially when there are other large players trying to do the same and get their capital out of Europe, Japan, the USA and the banking system across the globe.

The savvy buyers may already be entering this sector ready to take advantage of the highs that will occur in the next decade and longer. It is about market share but enter too quickly and you can shoot yourself in the foot pushing up share prices too far and ruining the early buyer advantage. Smaller buyers have that now and during any coming lows over the next several months. This is why I am back on the air so to speak. I am offering a Christmas special of only $59 for three months subscription as present if you wish to joins us you will be made welcome.

Good trading / investing.
Regards,

Neil Charnock

www.goldoz.com.au

GoldOz has now introduced a major point of difference to many services.  We offer a Newsletter, data base and gold stock comparison tools plus special interest files on gold companies and investment topics.  We have expertise in debt markets and gold equities which gives us a strong edge as independent analysts and market commentators.  GoldOz also has free access area on the history of gold, links to Australian gold stocks and miners plus many other resources.

Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.

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