Why gold and gold shares are diverging

[HenryTo]

Good Peter Brimelow article from Marketwatch.com on why gold and gold shares are diverging. On a related note, the oil to gold ratio hit a high that was not seen since late 2000 (when gold was trading only at $275 an ounce) only a couple of months ago. So I guess this only means two things: Either gold will go up substantially here or oil will crash big time (perhaps giving a boast to gold shares as well if the U.S. dollar doesn't go up).

Oh my, we do live in interesting times.

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MarketWatch
Why gold and gold shares are diverging
Monday May 2, 1:37 pm ET
By Peter Brimelow


NEW YORK (MarketWatch) -- Gold and gold shares are diverging.
Why?

Last week was grim for gold shares -- but not bad for gold itself. Both the Philadelphia Gold and Silver Index and the usually more sensitive AMEX gold bugs index lost 6%. Bullion actually rose $1.80.

What does this disparity mean?

One thing it means is gloom and fear in goldbug land. As James Turk notes in his current Freemarket Gold and Money Report:

"The XAU Index of major gold mining stocks broke its 4-year uptrend line... Think about where gold is at the moment. It's only $21 (less than 5%) from a new 17-year high. Everyone should be shouting from the rooftops, but instead, gloom prevails... the bull has done a very good job of emptying the train."

The poor performance of the gold shares was egged on by rotten results last week from the major mining companies, particularly Newmont (NYSE:NEM - News) and Placer Dome (NYSE:PDG - News).

Alert observers have also noted the failure of the big miners generally to reduce their disastrous hedge books last quarter.

This raises the possibility that these may be more intractable ("toxic") than generally realized - a.k.a. they pose financial risk.

The gold share situation now reminds me of the literature that arose in the late 70s, evaluating the 1973-4 stock market crash.

All of us who lived though that miserable experience were well aware things were bad. As a new Stanford MBA, I had no money at risk. But I did note virtually all my peers lost their Wall Street jobs.

Still, exactly how bad took a little time to sink in.

The point was that while the 1929-34 crash took place against a background of almost a 50 percent decline in the wholesale price level. So the "real" losses in the stock market were not anywhere as near as nominal numbers suggested.

But the early 1970s decline was accompanied by serious inflation. In real terms, the losses stood comparison with those the old timers kept boasting about.

What has happened recently in gold shares is a microcosm of this. Gold is up 8% since the November 2004 peak in the HUI - yet the index is 30% lower.

Reading the company results, the reasons are obvious: explosions in oil and steel costs, and a surge in commodity currencies, indirectly a comment on the curious way gold has lagged overall price changes recently.

In other words, gold shares may have detached from their normal tracking of the gold price for legitimate, if unpleasant, reasons of their own.

Some feel this has gone too far. James Turk has a chart showing that the Gold/XAU ratio has only been lower - slightly - in the last couple of desperate bear markets.

Taking the view that extreme unhealthiness in the gold mining industry signifies a bottom, Turk thinks this could be encouraging.

Others might prefer to follow the Gartman Letter's example and shelter in the new Bullion ETFs, GLD (Vancouver:GLD.V - News) or IAV.