Gold Stock to Gold Price Ratio

One of the blogs I follow, World of Wallstreet, in his post Obvious (But Original) Thought About The Gold Stock To Price Of Gold Ratio, showed the graph below, hypothesizing that since stock indices have declined 40%, the fact that the gold stock:gold price ratio is down 40% doesn't mean that they're undervalued. He points to the ratio's September 2000 trough (0.15) as evidence that they may decline further.

It's a good thought, certainly suggesting that in the short term this "reversion to mean" may not pan out the way some people are hoping. That said, I'd like to see a longer term chart - it looks to me like the early end of this chart was also up around the .5 range, and that dropped right up until September 2000. That is - the $HUI:$GOLD trough coincides perfectly with the TSX peak during the tech boom. While the NASDAQ isn't as perfect of an inverse correlation, as it was already off its March 2000 peak, its catastrophic decline also significantly accelerated in September.

The ratio then rose through the recession that followed the tech crash. This suggests to me that the ratio's decline was due to money moving into trendy tech stocks, not an overall stock market decline.

My guess - stocks are leveraged against their underlying resource price, since they have a production cost that's more or less fixed. The fact that they're trailing the recent precious metal recovery suggests that investors are concerned that precious metals may once again decline.

Also, I'd point out that while some of the decline in indices is panic selling, some of it reflects reduced profit from individual companies. But a gold miner's profit is entirely related to the price he gets for gold, so at a minimum their decline relative to the gold price should be lower than the decline of the whole index.

I've never professed to be an expert at this. And I've certainly lost a fair bit of money making bad calls on where things are going. But it still seems to me that precious metals - whether producer stock or bullion - should hold up until financial volatility dies down.

Ups and Downs

I have concluded that markets are psychotic. I suppose this was obvious before, but this is the first time I've had money in more volatile investments where it becomes really obvious.

So, my three holdings up to today were First Majestic Silver (FR), Wavefront Energy (WEE), and iShares Gold Index Fund (XGD). Yesterday, the market was expecting the US Fed to cut interest rates by 100 basis points, and it only did 75. This seems to have caused some kind of major overcorrection in gold prices, and XGD has dropped significantly over the past couple of days. FR has been going downwards ever since it made a private placement a couple weeks ago, and today dropped below 4.60.

On the flip side, WEE announced a major sale of its technology to a Texas oil company, and went from 2.59 at open to 3.56 at its peak today. It's now bouncing between 3.22 and 3.30. While this one was great for me - it hit my sell price of 3.18 around noon and leaving me with a $600 profit on a $1600 investment - in just two weeks - I think that perhaps this is my greatest confirmation of market psychosis. None of the news releases that I found seemed to indicate the value of the deal, but I'm having a hard time picturing it increasing the company's worth by 50%. More if you note that it also posted some hefty gains yesterday.

So here's what I'm trying to figure out - when do you bail on a losing investment. I'm still confident that FR will come back once the market's had a chance to digest 8.5 million shares, but XGD I'm iffy on. I bought it based on some discussions that while gold was in record dollar territory, it was a long way off its inflation adjusted highs. However, because gold is so high, I'm not confident that holding it will come back if I hold onto it in the longer term.

I'm having a hard time pegging exactly what makes gold tick. I would have thought a rate drop of 0.75% would have been good news for gold. But it's dropped a lot in the wake of it. So I've got some reading to do, and if I actually have any readers, would appreciate anyone's thoughts on where gold is going from here.