An update to the Gold Miners / Bullion Ratio Analysis

In February of ’08 I wrote an article titled "When is it Time to Buy Gold Stocks?".

Please read that post for background info as I don’t want to repeat myself, but the ratio of gold stocks to bullion is near all time lows at .86. I used to track this every week for a whole host of commodities (oil, silver, etc). More than anything it can help give perspective to how expensive or cheap a basket of stocks is relative to what a commodity is doing – kind of a "forest from the trees" analysis.

So, either gold has to come down, or gold stocks need to come up. . .a lot. Here is a recent article on the newsletters being bullish on bullion. Hussman uses the gold/XAU ratio which currently is above 7. (Hussman talks about a similar method here and here.)

Historical ratio vs. gold stocks.

Below are charts for the 3,6, and 12 month excess returns (nets out the average return for gold stocks over the time period). There is a nice stair step that you want to see with this type of analysis. The highest ratios (stocks expensive relative to the commodity) result in future underperformance, and vice versa.

The ratio is around .86 – near the lowest reading ever. Absolute returns for this decile have been strongly positive at 14%, 20%, and 43% for the following 3,6,12 months, and up 90% of the time a year later.

A little regression, and the red line is where we are currently. . .