EURO AND GOLD TESTING 2004 HIGHS -- XAU/GOLD RATIO SUGGESTS HIGHER PRICES FOR BOTH -- WHY GOLD STOCKS ARE A BETTER BUY THAN OIL

EURO AND GOLD ARE TESTING 2004 HIGHS... The Euro continues to surge against the dollar which is giving a big boost to gold and gold shares. Chart 1 shows the Euro right up against the high reached at the start of this year. The close correlation between the European unit and gold is striking. Gold climbed another $5.00 today and is challenging its 2004 high near $430. Chart 3 shows the Gold/Silver (XAU) Index right up against its spring high. The XAU/S&P 500 relative strength (ratio) line has been rising since June. When the dollar is weak, gold is usually strong. When the dollar and the stock market are weak, gold stocks are even stronger. That's been the case recently. It remains to be seen if the presence of those previous highs provokes some short-term profit-taking. Even if it does, the longer-range picture for the Euro, gold, and gold stocks remains bullish.

Chart 1

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XAU VS GOLD... An interesting way to study the trend of gold and gold stocks is to plot a ratio of the stocks (XAU Index) versus the commodity. That tells us two things. A rising ratio is usually bullish for both. That's because gold stocks usually turn up before the commodity. A falling ratio is bearish. The XAU/gold ratio has been rising since the summer which is bullish for both. The ratio itself can also suggest overbought/oversold parameters. The last two times the XAU/gold ratio rose over .27 (the spring of 2002 and the fourth quarter of 2003), a downside correction in both markets took place. That meant that gold stocks had gotten too far ahead of the commodity and needed to correct downward. Readings under .20 in the spring of 2003, and under .21 this spring, proved to be oversold (or value areas). Overbought and oversold ratio readings can also be found by applying an oscillator. The indicator under the price chart is a 200-day Commodity Channel Index. The CCI can be used to help identify overbought ratio readings (over 100) like the spring of 2002 and the end of 2003. The decline this spring pushed the CCI deeply into oversold territory under -100. I used a 200-day version of the CCI to weed out small price swings. As it stands now, the ratio and the CCI appear to carry good news. The ratio line is rising which means gold stocks are leading the commodity higher. And the ratio hasn't reached overbought territory yet. That means there's probably more upside to come in precious metals and their stocks.

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GOLD VS. OIL STOCKS ... Here's something else to think about. While everyone is looking at oil stocks, the better commodity play right now appears to be in gold. The next chart plots a ratio of the Gold (XAU) Index versus the Oil (XOI) Index. If you think back to this time last year, gold was soaring and was all anyone was talking about. I remember suggesting at the time time that media attention to gold suggested that it might be time to rotate out of gold stocks into energy. The chart shows that rotation starting near the end of 2004. From last November until this March, oil stocks did much better than gold. Since March, however, gold stocks have actually been doing better. A closer look at the recent action shows that the XAU/XOI ratio is on the verge of breaking out to a new six-month high. I've also applied the 200-day CCI to that ratio. Generally speaking, a ratio reading over 100 suggests that gold is getting too expensive relative to oil. A reading under -100 suggests the opposite. Right now, the CCI is rising (which favors gold) and is in neutral territory. Chart 6 shows a bar chart version of the XAU/XOI ratio since mid-April. It sure looks like a bottom to me. The ratio line is moving up for a test of its August high and its 200-day moving average. That suggests to me that gold stocks will be a better place to be than oil stocks for awhile.

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GOLD/OIL RATIO ON A P&F BUY SIGNAL ... Here's another way to look at the gold/oil ratio with a point & figure chart. I explained p&f charts last week as a useful way to identify more precise buy and sell signals. Chart 7 shows the XAU/XOI ratio but in p&f format. The x columns represent rising prices, while the o columns represent falling prices. A buy signal is given when a column of x's exceeds a previous column of x's. Chart 7 shows that the XAU/XOI ratio issued its first buy signal during September. The green boxes represent today's action and shows that another buy signal is being given in favor of gold stocks over oil.

Chart 7