John Hussman: Gold/XAU Ratio Signals Buy for Gold Stocks

Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

In the Strategic Total Return Fund, we continue to hold a short-duration investment stance, mostly in Treasury Inflation Protected Securities. The Fund also holds about 20% of assets in precious metals shares. It's worth noting that the fairly simple but generally useful Gold/XAU ratio is now pushing close to 5.0, though it has not breached that level.

To reiterate my remarks on the Gold/XAU ratio from the May 2, 2005 comment:

“To put some historical context on this measure, since 1974, the Gold/XAU ratio has been greater than 5.0 about 15% of the time. When the ratio has been this high, the XAU has followed with annualized gains of 89.6%, on average – a figure that remains high even if the data is split into multiple samples. When the ratio has been greater than 4.0, the XAU has followed with average annualized gains of 27.4% (though the finer profile of returns has been sensitive to other conditions such as interest rates, economic trends, and inflation). In contrast, when the ratio has been less than 3.0 (meaning that the gold stocks are very elevated relative to the actual metal), the XAU has declined at an annualized rate of -36.6%, on average.

“Importantly, the return/risk profile for precious metals shares is strengthened further if the economy is experiencing weakness. For example, when the Gold/XAU ratio has been greater than 5.0 and the ISM Purchasing Managers Index has been less than 50 (indicating a contracting U.S. manufacturing sector), gold shares have appreciated at an average annualized rate of 125.6%. In contrast, when the Gold/XAU ratio has been less than 3.0 and the Purchasing Managers Index has been greater than 50, precious metals shares have plunged at an average annualized rate of -49.9%.”

Such strong periods for gold are also generally associated with weakness in the U.S. dollar. Something to think about as the economic picture evolves in the months ahead.

Editor's note: An ETF exists that track the gold mining stocks -- the Market Vectors Gold Miners ETF (GDX). Two ETFs track the price of gold: the streetTRACKS Gold ETF (GLD) and the iShares COMEX Gold Trust (IAU).