Trader’s Narrative

Unless you’ve been hiding under a rock lately, you know that gold has been on a tear, hitting multi-decade highs and that gold stocks have been one of the highlights of the stock market. So, you might be pondering, should I buy some gold stocks? or is it too late?

Well, I’m here to tell you… it depends.

On your time horizon, that is. If you’re a nimble trader and will be in and out within a short timer period, then sure, go ahead. Follow your methodology (you do have one, right?) and don’t forget risk management.

If, on the other hand you’re more of an investor and less of a twitchy trigger fingered trader, then based on the k-ratio, I would recommend you stick to watching reruns of Goldfinger. What’s the k-ratio you ask?

It is the ratio of gold stocks divided by the commodity itself. the “k” stands for Kaeppal since it was put forward as a timing indicator for gold stocks in 1993 by Jay Kaeppel in The Technical Analysis of Stocks and Commodities magazine.

In that original article, Kaeppel used Barron’s Gold Mining Index and the Handy & Harman price of gold. Both can be found each week deep in the entrails of Barron’s. But eventhough he used the GMI, you can use any gold equity proxy like the AMEX or CBOE gold indices or even an individual gold stock. I would recommend against using the XAU Phili index since it has a lot of base metals mixed in.

So anyway, why does it make sense to look at this ratio as a timing tool? Well, think of it this way. Gold stocks and gold should have a more or less stable relationship. After all, a gold stock is more or less just a gold mine plus some digging and refining expenses.

By looking at the the ratio we can see when this relationship is out of sorts. For example, if buried gold (gold stock) is being priced less by the market than dug up and refined gold (commodity), then being the smart contrarians that we are, we should take the other side and buy stocks instead of gold.

Using this simple tool you would have gotten in on every single major gold stocks bottom. The last one was in 2000-2001, by the way, just as most market participants’ attention was focused on tech stocks. At that time, the k-ratio hit an unbelievable value of 0.80!

Which bring us to the question, where is the k-ratio now? And what is it telling us?

In a nutshell, it is saying that the time to ride the gold bull market is pretty much over. There is a time and a season for everything. And the time to buy gold stocks for a long term hold was when they were being thrown out by a market enamoured with routers, fibre optics and switches. Not now, when gold prices and gold action is splashed in the front pages of magazines, newspapers and blogs everywhere.

Here’s a chart of the k-ratio using the AMEX gold index:

Kaeppel’s original article outlining the k-ratio. (Reports & Articles)