Sunday, November 11, 2007

The fallacy of Canadian gold stocks

A few weeks ago, I was asked to post something about the Canadian dollar. The only thing I had to say about that currency was that it is in a powerful bull trend. Given that we may be at a critical point in the Canadian market, I wanted to "clone" the latest analysis I did on my own blog believing that this might be of interest to the readers of the TSX Trends blog followers. I would like to thank Brian for the invitation to post here from time to time.

Most people will believe that investing in Canadian Gold stocks is the way to participate in the rise of Gold. This is a myth. It is not true all the time. For this to be true, gold needs to rise, of course, and the economics need to be conductive to growth. Furthermore, value (the price of a stock) is created only is profit margins are stable or increasing when a commodity increases in price. When the price of the commodity or the price of profitability falls, the price of the stock will follow. I suspect that the costs to produce gold are rising faster than the price of gold thus creating pressures on margins.

Another falsehood that I have read on the Internet in the past month or so is some people finding precious metals somewhat “overbought” on a technical basis and thus recommending shorting Canadian gold stocks. That may be the right course of action but fundamentals are the right reason to short Canadian gold stocks not the price of Gold.

Agnico Eagle is currently trading at a double bottom support around $50.00. After reaching a high of $55.00, it has been building a triangle where the short term downtrend line has been resistance. The triangle was broken down and we have the potential for a sell signal which would also break the next short term uptrend line.

Please “Click” on the image for a larger view

This set-up looks like the TSX composite index set-up of a few days ago. A break below the low of $47.00 would confirm an intermediary downtrend with 2 lower highs ($55 and $54) and 2 lower lows ($47 and $46).

The conflict between the fundamentals of a firm and the price of the commodity it sells is illustrated in the following chart which relates the price of the stock to the price of gold.

Please “Click” on the image for a larger view

It is quite clear to me that fundamentals have taken over recently as investors are no longer willing to pay premium prices if they believe the economy is going into a recession.

This phenomenon is not unique to Agnico Eagle. Here is the picture for other Canadian gold stocks:

Please “Click” on the image for a larger view

For those who prefer to invest in a diversified portfolio of Canadian gold stocks, the Barclay’s Gold iShares provided the following tracking error to Gold!

Please “Click” on the image for a larger view

If you are using Horizon’s Gold Bull and Bear funds as a tool to participate solely in the rise and fall of the price of Gold, you will be sorry. This is tracking the performance of Gold stocks, not gold. You need to be aware of the fundamentals of the industry as well in order to make the correct bet.

Please “Click” on the image for a larger view

And the correct bet may soon be available to you in a not too distant future. Wait for a breakout at $14.25.

Please “Click” on the image for a larger view

There are two links on the right side of the page which will send you to Danny Merkel and Merv Burak’s web sites. They do a great job of following precious metals although Merv has another site where he posts his gold thoughts. I highly recommend these sites for a more thorough analysis of that sector.

In Conclusion:

Canadian Gold stocks have been leading the pack in the recent market uptrend. Even though the market appears to be topping into a new downswing, gold stocks have been resilient as their relative performance is still positive. That may be starting to change.

The Word

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