V-Bottom in place – New highs coming!

Key Points

The past two years have been such an extraordinary time of weak sentiment towards gold and commodities despite the very clear underlying fundamentals that are finally coming into daylight.  Economic data and commodity prices are confirming what was obvious all along.

The major decline from the April 2011 highs in most things commodity and resources stocks has so often shouted irrationality that you really do wonder what drives markets and how can the majority of investors (particularly large investors) be so superficial in their analysis.

The 77% fall in ASX gold stocks (XGD), 70% fall in Small Resources (XSR) and the 55% fall in the major indices like XMM from those April 2011 highs defy rational belief.  Especially given that gold and commodity prices in A$ were as just good as those in April 2011.

It is hard to imagine that such a major capitulation low occurred just because of sentiment rather than a collapse in demand, a major recession or a systemic disaster.  But it has.

And as Dawes Points of 13 August noted, apart from a few minor hiccups, most gold producers and developers are doing just fine.   The pause certainly cleaned out some overpriced services, materials and labour so everyone will be better prepared next time.

The gold price has probably bottomed, and again as noted previously in the 8 July edition, the extremes experienced in the gold shares and their relativities to gold, NPVs, PERs and to general shares have probably provided the enduring evidence that the low is in.

And if the low is in for this correction then the bull market will be continuing and that will mean new highs!!  And probably a multi year bull market with much higher prices.

If the low is in for gold then, my word, what is in store for gold shares!!

Let’s go through the usual graphics here.

We need to start from the basic premise that gold is international and so are better quality gold shares.

So let’s begin with the Philadelphia Gold Index XAU and the gold shares ETFs GDX and GDXJ for the juniors and mid caps.


XAU had a 64% fall from April 2011 into the June low and has had a 35% rally.

GDX had a 66% fall and a 35% rally
GDXJ had a 79% fall and a 59% rally

The gold share ETF (GDX) matches the stocks in the XAU Index so should be the same but the GDX Juniors did an ASX:XGD performance (we were down 77%!) too but has since rallied 59%.  XGD is only up 48%!!

Yes, the XGD was blown backwards to 2002 levels.  All that exploration, development, resources, infrastructure and mines are now free in today’s prices.



And the embattled and dispirited Canadians with their more diverse TSX-V Index (CDNX) were down 50% and are just starting a rally that is showing the signs of the first extended accumulation base since the highs in 2007.

The sector relativities such as XAU vs gold and XAU vs S&P 500 are now very important to follow because they gave the greatest extremes.

XAU is now stabilizing against gold so should begin a major outperformance against gold bullion over the next 3-4 years.

So with the ratio now at 0.80 and hopefully moving back up to around 0.15 within the next four years would mean the XAU would be 210 or 88% higher at today’s gold price.

With a gold price at US$1600 in four years the XAU would be 240 or 114% higher.

If XAU traded at the long term ratio of 0.25 then at today’s gold price it would be 350 or 213% higher.  This table gives values for XAU and gains at a range of gold and ratios.

I would suggest 0.25 will be seen again and that gold will be over US$2,000 as well. That would be XAU at 500 and a 346% gain.

These sorts of gains are well supported in the Eric de Groote long term S&P Gold Shares graphic going back to 1922 (sorry but this graphic is now a little out of date).  The 2013 pull back came down to the 1922 uptrend (who would have thought of a decline of that magnitude would occur!) and XAU should now rally back to around 160, consolidate and then it should move up very strongly.


This next graphic shows the long term outperformance by the XAU against the S&P500.  The 11 year outperformance to 2011 was 600% and 16%pa cgr until the 2011-2013 sell off.   This graphic suggest a rally back to about 0.15, which would be over 100%.


At Paradigm we do the Think Global, Act Local stuff so the global picture strongly suggests higher gold and gold shares and the global funds will be back here chasing local stock so you should get in early and before them.

The stocks to choose are the leaders mentioned last time (NCM, RRL,BDR, KCN, PIR, SBM and SLR) but the really high performances will come from the small plays.  You will need to contact me (bdawes@psec.com.au) for those as they are volatile and time sensitive and besides, those recommendations are just for account clients!

I come back to my hobby horse of the ongoing discussion on Participation in the markets.

The falls in the resources share markets in 2008 and over 2011-13 can only be explained by market sentiment.  Sure 2008 was a bit special and more recently Europe is a bit wobbly still (but growing) and the US is OK but not great but China is still proving the doomsayers wrong and Africa, MENA and Sth America are doing well.  Certainly not bad enough to pull down resources stocks >70%.   Just sentiment really.

And continuing poor sentiment has kept large (and small) investors out of the market.  Market turnovers confirm this. I still can ask audiences at presentations whether they have held gold shares or even, shock horror, if they hold any gold.  The response is invariably muted and only a few even admit to holding either.  So lots of new buyers.

So the volatility is the key feature of these thinly traded markets on the way up and on the way down.

Hence resources stocks will not be properly valued and will remain volatile until the market has more participants.

But I now think that this participation is going to start very soon.  In earnest.

I have generally refrained from commenting on politics but with the election underway and a high probability that we will say good bye to the ALP for a very long time, I think Australia is about to enter into a truly Golden Age.

I have continuously reviewed the Federal Budget and have graphed Receipts and Expenditures for some years now.  The picture has not been pretty and the waste and incompetence has been breathtaking.

Expenditures rose from A$250bnpa under Costello’s last budget to almost A$400bnpa today under the ALP.  You may well ask what we got for it.  The answer would have to be `not much!’

The deficits are between the lines, red above blue. In contrast to Costello’s surpluses of blue above red.

Taxation receipts have climbed, mainly through personal income tax, but company taxes have been flat since 2008.


Resumption of the resources boom will help that and economy-wide company investment and manning plans will quickly be dusted off under a government that isn’t driven by ideologues and union hacks.  And expenditures will be readily cut to weed out waste.

So come 9 September there will be changes.

Overseas investors will also see the changes and with the abandonment of the MRRT and the Carbon Dioxide Tax, Australia’s Sovereign Risk ranking will recover.  So watch this space!

The Think Global gold price will be looking better and the Act Local action will start to really pick up after an extended buyers strike.

Australia has over A$1,500 billion(yes billion!) in bank deposits sitting by whilst its resources industry has massively increased its capacity in iron ore, coal, petroleum and LNG. Much of this was financed by retained earnings and offshore debt and equity.

The local commentariat has universally hailed that the new supply would crash prices and that world demand would fall away.  China’s Asian Century was being studied by the minute for clues whether growth would be +/- 0.1% of targets.  All the history of China’s remarkably successful Five Year Plans that carefully set out directions, pathways and goals was tossed aside in trying to find that tiny issue that would prove China was about to collapse and iron ore with it.

The commentariat (most have not even been to China) ignored the inputs from the mining industry executives who repeatedly confirmed increasing demand for their products.  The comment on 8 August from the ABC’s 7:30 Report is typical.  In response to BHP new CEO Andrew MacKenzie’s advice that the Resources Boom was still in train and that demand for commodities could possibly be 75% higher in the next 15 years, the comment was ` that is obviously a different view to what we’re hearing from the Government at the moment with them saying that the resource boom is basically over’.  Entrenched ignorant Groupthink.   And have you seen Rudd’s advertisements saying the boom is over!

No wonder the more thoughtful economic commentators trashed the two recent economic statements as being lazy and inconsistent.  My own observation after detailed analysis of those statements was that many of the forecast numbers had just been made up.  Just look at the MRRT numbers!  And how much the two statements varied.  No idea.

So the view that the bull market for gold and commodities was over has been well entrenched and a global hell hole was beckoning.  And hence the build up into a massive mountain of bank deposits.  The build up is seen in term deposits of course but look also at chequing accounts, savings deposits and building societies. Over A$1,500,000 million in total.  And of this, A$723,000 million in deposits of all kinds by households!

And Australia deserted the non-Tier 1 players in its resources industry by starving it of capital.   Where are our hundreds of fund managers cashing in on the resources boom and funding the projects? Those that are playing with our A$1,500bn in superannuation funds. So much money chasing so few targets.  If I hear another investor say that a particular project has to be ignored because won’t be able to get funding ………

And recall the swipes taken at resources sector management for adding to capacity when the markets still needed the products.  Look at the prices of most important commodities such as iron ore US$140/t, oil US107/bbl, copper US$3.35/lb and gold US$1,400/oz.    These gold producers will be soon making so much money it will be embarrassing.  And of course the commentariat will soon be wanting more output because of the obvious shortages. Newcrest with its vast gold resource base will become the market darling again.

So the concept of the V- bottom is alive and well and it is likely to be matched on the upswing as it was on the down.

And finally, to those A$ bears, just have a look at this.

Taking a long term view it is clear that the A$ has broken a 90year downtrend against the US$.


Some backing and filling of course, and long term trends aren’t exactly precise now that we don’t have a gold standard, but break out then retracement back to support is normal.

And the driver of the A$/US$ is global commodity investor-related as this graphic shows.
The A$/US and the XAU (Philadelphia Gold Index) have a lot in common.

The V bottom in the gold sector should bring this back into line and be pushing the A$ higher.

A strong currency forces public spending cuts, forces improved productivity, forces down inflation, forces down interest rates and makes Australians wealthier.

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