Investment Strategy Gold & ASX (17/7/07)

                 By Neil Charnock
http://www.goldoz.com.au/

 

Gold and silver are currently cheap by several separate definitions; this will soon affect demand to a greater degree and very shortly.  Before I get to these reasons let me point out that this is a very current statement not just re-hashed commentary – the time is right for a break out for many reasons now.  This is likely to be slow at first and to gradually build over the next few months.

One must also consider the time factor and investor sentiment because these two metals have been trading at these higher levels since the end of April 2006 and the market has simply adjusted expectations to these levels and above.  These are the new base valuations of the precious metals in my humble opinion. There are many investment ramifications.

Relative valuation

Definition 1 – Relative valuation:  Firstly, after the heavy falls on the USD, gold & silver have dropped back considerably against most of the global currencies since the beginning of January 2007.  For instance gold hit $AUD930 in May 2006 and it now sits at $AUD765 – not important news for most of the world however we are the 3rd largest producer of gold and silver last time I looked.  The divergence between the price of gold in the two currencies is clear in the chart below, look at the picture since the beginning of this year.  Less volatile, settled at a higher plateau and relatively cheap in AUD at present.  This picture is duplicated in several currencies.

The same story applies for the Canadian dollar – I have chosen these two currencies because they are both low sovereign risk nations that are key global producers outside the USA.  I invite you to go to the charts found in the exchange rate section of the Kitco main page.  Forget the Yen as it has also been devalued via massive monetary creation and is therefore distorted.  The Pound / Euro are important however, 600++ million potential investors - and India is in exactly the same boat as Australia – check the Rupee chart!  Both of these are key investment sources for the precious metals and the price of gold has dropped compared to the USD in relative terms.  Then you have the Middle East and China – not as pronounced due to their currency management policies however there is some divergence; as these respective currencies appreciate against the USD.

Speaking of the US Dollar I saw an interesting development forming 6-8 weeks ago and there is clear danger of this coming to pass in the short term now so I urge you to take a look at this past essay in review - just in case you are one of the millions watching and planning to trade a down side break. http://www.kitco.com/ind/charnock/may072007.html

Monetary inflation - rampant

My next point is the level of currency creation that has occurred since that May 2006 which has been well covered by some of my colleagues on these sites – lets just round the number off at 10% - that could be factored as a further discount to the current precious metal prices in terms of current money supply.  This would take the current value back about 10% in mid 2006 $US terms indicating a current price of gold is equivalent to around $US600 – not necessarily realistic as a useful benchmark - however it is an interesting exercise to monitor the deterioration of the Greenback and other fiat currencies in terms of gold.

Risk - Reward

Now in terms of risk – once again we are sitting at cheap levels in relative terms – now the precious metal prices have stabilized at these levels for over 14 months the risk to the down side is diminishing… despite the bearish sentiment and flood of additional supply the prices have held.  If down side risk is low then the upside potential must, by inference, be high.  Some may wish to wait for the break out to continue for confirmation and nothing is certain in investing so this is another way to manage risk.   Speaking of low risk to the down side - we are also very close to the 300 day moving average which held again in June.

Many short term traders who are adept and quick on their feet are on top of this trading opportunity already.   My portfolio is up strongly since the beginning of July as the ASX stocks are in excellent condition – we do not have the same seasonal break for summer over here as this is our winter.  The sun is shining out in the deserts of WA in more ways than one though. 

Since the Australian currency has appreciated from US77c to US87c since March 07 (and up from 70c in Mar 2006) there may be some currency risk for US investors in the ASX now.  That is if share price gains do not offset a bounce off the current level of the USD – but note - a word of caution.  The AUD could continue higher short term however it is looking a little overbought on the RSI and the MACD is rounding over as if it might be ready for a correction of some kind.  The overhead resistance for the AUD is at about $US 89.7c.  Of course the USD may cut down through the 80 level however this has held for a long time and there is likely to be considerable support down here.  Euro, UK, SA, Canadian and other strong currency investors need not worry about this current risk factor in the ASX.

Then there is the issue of Sovereign risk – how many times have I heard about country risk being an issue and given socio-economic and political trends in many parts of this globe you can expect further trouble.  I am very careful about this issue when investing - where companies operate - with my precious capital and tend to keep only small speculative positions in higher risk areas.  Canada and Australia, which is less understood in the US and around the world, are leading mining Nations with very low sovereign risk ratings so they are ideal for investment in this regard.

Time

Now in terms of time – this point in time, right now, reminds me of July 2003, and 2005 – near an end point of a long consolidation.  If you pull a weekly gold chart and look at the overall pattern from July 2005 to the end of June 2007 it looks almost identical to the time period from July 04 to July 05.  These patterns of strong rises followed by longer consolidations are a feature of gold's weekly chart and it looks like we are at the end point of the correction right about now.  One of my favorite analysts Adam Hamilton just released an excellent essay on seasonal factors and this should be read by all investors – his essay is also relevant to this time factor.

ASX Resource Stocks

Selective investment and patience are key strategies now.  These Aussie Resource stocks are mixed and likely to stay that way for a few weeks at least yet.  When I say mixed – this has been pronounced, some of our larger cap plays have been awesome – especially the large cap and low PE – those diversified producers.  I have just gone through a PDF chart set (that I send to subscribers) of my spreadsheet product and the technical picture is still mixed too.

 I could not yet recommend a general breakout in prices at this stage so the strategy is still, buy the dips and pick carefully as Colin Emery keeps on saying.  Colin did warn our Newsletter subscribers, only last week that a short term correction in our S&P 300 Metals and Mining Index was likely and that it was most likely to affect the big cap plays – and this is coming to pass right now.  This is time to buy the dips for the next round of profits if I am right – keeps stops close though – at least until we get clearer break out confirmations in these markets.

Timing this sector is tricky at times however some stocks appear ripe for significant movement in the short term – others still have some more to fall before their inevitable turning points.  There have been some unusually large orders on the mid and smaller cap producers and developers – and also some very strong price movements on explorers leading me to compare this behavior to mid 2003 and mid 2005.  That behavior preceded a magnificent general resource rally in each instance.

As always - a good knowledge of the sector is essential so that you have a good range of quality stocks in your watch list from which to choose.  I have deployed trading capital into an oversold play during June and sold into the 30% rally that followed only to reinvest the funds into a range of different stocks – some that have obviously finished their bottoming process and await a breakout.  This is a low risk play.

One last point here – as the coming / present rally really kicks into gear, and moves out of this preliminary phase, it will usually be the larger stocks that break first.  I am talking about the group in the AUD$100M + category – but you would need to include special situations that can be identified by their technical setup.  A good knowledge of charting and technical analysis is required for this – even some back up advice from a mining / charting expert like my Gold Oz Weekly Newsletter contributor Colin Emery.  I have recently added a Newsletter accuracy page to www.goldoz.com.au in order to highlight Colin's skills.

If I am wrong about the intensity of the initial part of the rally and your risk profile allows – there may be a situation like 2003 in force… one by one the speculative juniors & mid tier stocks jumped and rallied hard.  I see this at present in the current market and wonder if it will continue.  Most of the PM and Resource complex rallied in excellent fashion that year and anything is possible.  But we are concerned with probable - so prudence is the wiser move – perhaps some speculative money in the smaller caps if you are careful and experienced enough.

The New Spin to expect

As the price of gold continues to rise - the spin machine of the CB's and in the media will hose down the importance of gold as an indicator of inflation.  This is just an interesting theory but it would make sense – when they can no longer manage the price with monetary policy they will go on the big spin sell.  I can hear the pitch coming already – gold has nothing to do with money these days because it no longer backs the system so the old "inflation indicator" theory does not work anymore.

The price will work its way higher and some sort of soothing message will surface and be pumped into the already confused minds of the monetarily uneducated masses, such that even a post $1000 gold price will be explained away.  Perhaps they don't even have to after all - look at the 10 fold increase (approx) in house prices since 1980.  Perhaps they can bring up a house price: gold price ratio for the past 25 years – that would make a convincing argument for any gold price rise looking tame!

We are still running a top value introductory discount special on the new GoldOz Weekly Newsletter at this time and the response has continued to be excellent – we intended to run this for the first few 2-3 months and details are on our web site at http://www.goldoz.com.au/ .  We now post this announcement that this limited offer is coming to a close in the next few weeks.  The details about the Newsletter author Colin Emery are directly below my signature and before my disclaimer. 

Good trading / investing.
Regards,

Neil Charnock