Trader’s Narrative

As I ponder the dollar reaching its long term support levels, I can’t help but wonder how things look for gold stocks long term. My favourite indicator for the precious metals sector is the k-ratio.

It is the price of gold stocks divided by the price of gold. I prefer to use the AMEX Gold BUGS Index (HUI) since it is a true gold stocks index. BUGS is a pithy acronym that actually stands for “Basket of Unhedged Gold Stocks”. In contrast to other gold indices like the Philadelphia Gold and Silver Index (XAU), HUI is neither hedged nor has any exposure to other metals like silver and copper.

k-Ratio
Anyway, the price of gold closed at $684.70 and the HUI at 370.23, which gives us a ratio of 0.541

While the longs may be happy when gold stocks go up, if gold itself doesn’t move in proportion to equities, there can be no serious rally in the sector. In fact, the higher gold stocks go without a concomitant rise in the price of gold itself, the more probable that they are riding on fumes and carving out a top.

While the spot price of gold has yet to reach the swing high in April 2007, the Philadelphia Gold BUGS Index (HUI) has just surpassed it. If this sort of disconnect continues, either the price of gold has to run up to catch up, or the gold stocks will fall to realign with the commodity.

Anything is possible in the market. Precious metal equities could pop higher. But at these levels, if you’re a long term investor, it is time to take profits, not put new money to work. That time was at the turn of the millenium, when the k-ratio made an all time record low: