26 Wellington Street East, Suite 900, Toronto, Ontario, M5E 1S2

Phone (416) 604-0533 or (toll free) 1-866-269-7773 , fax (416) 604-0557

david@davidchapman.com

dchapman@mgisecurities.com

www.davidchapman.com

Charts created using Omega TradeStation 2000i.  Chart data supplied by Dial Data

It was only recently that I looked at the Dow Jones Industrials/Gold ratio (DJI/Gold ratio). I wanted now to add another ratio that is often overlooked but is equally important. The Gold/Bonds ratio. The ratio in this case is the price of gold divided by the price of the 30-year US Government Treasury futures. A chart using the 10-year US Treasury would be similar.

Since 2000, gold has generally outperformed bonds just as gold has outperformed stocks. There has been two periods of exceptions. The first was the 2008 financial crash when there was a flight to safety of US Treasury bonds and the US$ rallied as a result. As can be seen the Gold/Bonds ratio fell breaking down under the 18 month MA but fell quite short of the 48 month MA (4 year MA). At no time did the 18 month MA cross down over the 4 year MA. The ratio came nowhere near a very long term MA of 7 years (84 months).

The most recent drop in the ratio was different. The Gold/Bonds ratio tried to regain back above the 18 month MA on couple of occasions but failed each time. Eventually it did break down under the 4 year MA. More recently, the ratio fell to the 7-year MA support. The ratio has rebounded but has run into resistance at the 4 year MA and the now falling 18-month MA that is threatening to cross over the 4 year MA.

The 18-month MA crossing over the 4-year MA has not happened very often. Of course, the history of the ratio only dates from 1977 when the 30-year Treasury futures began trading. Since crossing to the upside in 2003, the 18-month MA has remained above both the 4-year and the 7-year MA. This is not to suggest that gold’s bull run is over. These MA’s can touch or slightly cross over but then turn again in the direction of the long-term market which in this case remains bullish for gold. If both the 18-month and the 4-year MA crossed over the 7-year MA then it would be a signal that the long-term trend has shifted in favour of bonds over gold.

During golds long fall from 1980 to 2001 the 18-month MA did cross over on a couple of occasions both the 4-year MA and the 7-year MA. But the 4 year MA never crossed over the 7 year MA during that long decline for gold. The 4-year MA did finally cross over the 7-year MA in 2004 about 10 months after the 18-month MA crossed over the 7-year MA.

More recently, the Gold/Bonds ratio has been rising again. If the Gold/Bonds ratio were to cross back above the 18-month MA and the 4-year MA odds would favour a resumption of the bull market for gold over bonds. With threats of a debt default and signs that inflation is picking up as producer prices (PPI) have resumed an upward trend of late despite claims that there is no inflation.

The DJI/Gold ratio appears to be acting similarly to the Gold/Bonds ratio. The 18-month MA has crossed over the 4 year MA but neither the 18-month MA nor the 4-year MA has crossed over the 7-year MA. The DJI/Gold ratio has run into resistance of the 7-year MA and a downtrend line from the highs of 2001. During the long decline of the DJI/Gold ratio from 1966 to 1980, the 18-month MA did cross over the 4-year MA in 1976. Gold initially rose from $35 to about $200 by 1974. Gold then collapsed losing about 50% over the next year or so. At the time, every one declared that the gold rally was over and the price would fall back to $35 where it had been fixed since 1933. Instead gold resumed its upward trend and moved into the blow-off phase as gold prices rose from about $100 in August 1976 to $850 by January 1980.

Thus far, the pattern has been at least somewhat similar. Gold rose from roughly $250 in 2001 to $1,900 in 2011 and more recently collapsed back to just below $1,200 in June 2013. Gold fell roughly 37% during this period. As in 1976, there have been numerous calls that gold is going to fall further to $1,000 or even back to $800. No one to our knowledge has called for gold to fall back to $250 once again.

Gold has recently recovered and the DJI/Gold ratio is attempting to turn down after running into long-term resistance. The ratio is currently at 11.5 and needs to fall back under 8.6 in order to confirm that the trend has turned firmly to the downside once again. Breaking the 8.6 on the DJI/Gold ratio would probably suggest that gold is breaking out over $1,625.  These levels should confirm that gold is resuming its long-term bull market once again.

Gold has underperformed both stocks and bonds since September 2011. Both the Gold/Bonds ratio and the DJI/Gold ratio have run into long-term resistance of the 7 year MA. In both instances, the 18-month MA has crossed or is at least attempting to cross over the 4 year MA. Both the 18-month MA and the 4-year MA remain below the 7-year MA. A breakout over that level would signal that the long terms trends have shifted firmly away from gold to stocks and bonds. Until that happens, history and a potential failure at major resistance suggests that the long-term trend should shift back in favour of gold once again.

The US$ appears to be breaking down and the US could potentially default if the debt ceiling is not raised. Given the impasse over the budget raising the debt ceiling is not a given as the showdown could continue. Banks in the US, Europe and Japan remain vulnerable still laden with bad debt stemming from the 2008 financial crisis. No wonder the Fed did not “taper”. If the debt ceiling debate reaches an impasse, the Fed may even have to increase the current level of QE. As well, QE continues in both Europe and Japan. The risk of a systemic failure remains on high alert. Gold remains an essential and could become more important in the event of a US default.

Charts created using Omega TradeStation 2000i.  Chart data supplied by Dial Data

General disclosures

The information and opinions contained in this report were prepared by MGI Securities. MGI Securities is owned by Jovian Capital Corporation (‘Jovian’) and its employees. Jovian is a TSX Exchange listed company and as such, MGI Securities is an affiliate of Jovian. The opinions, estimates and projections contained in this report are those of MGI Securities as of the date of this report and are subject to change without notice. MGI Securities endeavours to ensure that the contents have been compiled or derived from sources that we believe to be reliable and contain information and opinions that are accurate and complete. However, MGI Securities makes no representations or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to MGI Securities that is not reflected in this report. This report is not to be construed as an offer or solicitation to buy or sell any security. The reader should not rely solely on this report in evaluating whether or not to buy or sell securities of the subject company.

Definitions

“Technical Strategist” means any partner, director, officer, employee or agent of MGI Securities who is held out to the public as a strategist or whose responsibilities to MGI Securities include the preparation of any written technical market report for distribution to clients or prospective clients of MGI Securities which does not include a recommendation with respect to a security.

 “Technical Market Report” means any written or electronic communication that MGI Securities has distributed or will distribute to its clients or the general public, which contains a strategist’s comments concerning current market technical indicators.

Conflicts of Interest

The technical strategist and or associates who prepared this report are compensated based upon (among other factors) the overall profitability of MGI Securities, which may include the profitability of investment banking and related services. In the normal course of its business, MGI Securities may provide financial advisory services for issuers. MGI Securities will include any further issuer related disclosures as needed.

Technical Strategists Certification

Each MGI Securities technical strategist whose name appears on the front page of this technical market report hereby certifies that (i) the opinions expressed in the technical market report accurately reflect the technical strategist’s personal views about the marketplace and are the subject of this report and all strategies mentioned in this report that are covered by such technical strategist and (ii) no part of the technical strategist’s compensation was, is, or will be directly or indirectly, related to the specific views expressed by such technical strategies in this report.

Technical Strategists Trading

MGI Securities permits technical strategists to own and trade in the securities and or the derivatives of the sectors discussed herein.

Dissemination of Reports

MGI Securities uses its best efforts to disseminate its technical market reports to all clients who are entitled to receive the firm’s technical market reports, contemporaneously on a timely and effective basis in electronic form, via fax or mail. Selected technical market reports may also be posted on the MGI Securities website and davidchapman.com.

For Canadian Residents: This report has been approved by MGI Securities which accepts responsibility for this report and its dissemination in Canada. Canadian clients wishing to effect transactions should do so through a qualified salesperson of MGI Securities in their particular jurisdiction where their IA is licensed.

For US Residents: This report is not intended for distribution in the United States. 

Intellectual Property Notice

The materials contained herein are protected by copyright, trademark and other forms of proprietary rights and are owned or controlled by MGI Securities or the party credited as the provider of the information.

Regulatory

MGI SECURIITES is a member of the Canadian Investor Protection Fund (‘CIPF’) and the Investment Industry Regulatory Organization of Canada (‘IIROC’).

Copyright

All rights reserved. All material presented in this document may not be reproduced in whole or in part, or further published or distributed or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of MGI Securities Inc.

-- Posted Friday, 4 October 2013 | Digg This Article