Gold Versus Paper

Turning paper into Gold June 12, 2011 INTERIM UPDATE Just another data point to let you know why I am so confident that there is an imminent low in the Gold stock indices (I would favor it being this week). This should be a great trade and I am excited about it. I wanted to share with you a piece of sentiment data that has been pure Gold over the past several years. This data point is related to the total assets held within the Rydex Precious Metals mutual fund (ticker: RYPMX). Now, this fund is nothing special. It performs about in line with the GDX ETF. I am not recommending that anyone invest in this fund, although I also am not trying to disparage it. The reason this data point is useful to traders is simple: the fund has been around since 1993 and they freely publish their daily assets under management on the web. When this fund receives fresh inflows of money, total assets go up and when people withdraw money from the fund, total assets go down. Other mutual funds may publish such data, but this fund makes it easy to review and mine the historical data at no cost (other than your time). If you are interested in perusing this raw data yourself, here is the link (you have to select Precious Metals when searching by product [it is near the bottom of the long drop down list] and then you want to de-select all but the Investor share class]: http://www.rydex-sgi.com/products/mutual_funds/info/navs_historical.rails However, I have already done the leg work for you and I present it below. First, here is a chart (created in Excel and admittedly not the prettiest) that shows the total assets of the Rydex Precious Metals mutual fund on a daily basis between late 2008 and Fridays close:

The current nadir/low in total assets for this fund (i.e. below $100 million) was last seen during the Great Fall Panic of 2008! Not only that, but before the fall crash in 2008, the last time the funds total assets dipped below $100 million was in 2003. Now, I am going to let you guess whether the people that invest in this Rydex mutual fund tend to be right or wrong about the pending direction of Gold stocks. In other words, when the herd pulls their money out of this fund, do you think they are guessing correctly that Gold stocks are about to tank? Well, of course, the herd is rarely right. But heres a more scientific look at just how poorly the herd does. The chart below is of the $HUI Gold Bugs Mining Index starting in March of 2009 and extending thru Fridays close, using a linear scale chart. Every time the funds assets got below $106 million (this seems to be the magic cut-off number for whatever reason), I have placed an arrow on the chart to correspond roughly with the subsequent day of the low in the total assets held in the Rydex Precious Metals Fund. This low sometimes occurred on the first day the funds assets dropped below $106 million and sometimes a few days later.

Not a bad indicator, eh? We are now below $100 million in total assets in the Rydex Precious Metals Fund and undergoing a prolonged double signal. Technically, it cannot be known when the day of the buy signal is generated until once the market closes several days after the signal is given (no way other than hindsight to confirm the low in total

assets is in place). So, this isnt useful in real time to give exact timing on buying the low in Gold stock indices. Thats where I believe I can offer some assistance. The fact that the last time the Rydex funds assets got below $100 million was during the Great Fall Panic of 2008 (and no, the herd did not sell out in advance of this panic, they sold after the price had significantly dropped) is very interesting. This tells me that the public sentiment on Gold stocks is near record lows. In a bull market, the goal of the bull is to scare you out or wear you out. I think the grinding underperformance of Gold stock indices relative to Gold over the past 2 years has worn many bulls out and finally caused them to throw in the towel. Though I am not bullish on common equities longer term and though I dont rule out a replay of the 2008 debacle later on, it is way too early in the common equity cycle for the herd to be showing this much fear and/or lack of interest related to Gold stocks. And although I realize that times are tough, I dont buy the whole the retail crowd is broke and it is simply withdrawing all money from the stock market argument, as the fund was near record highs in total assets as recently as December, 2010 (see 1st chart above). In my opinion, this single indicator suggests that it is already pretty much time to buy Gold stocks. I think this indicator is right, but well simply fine-tune it in order to guess the exact day of the low. Additionally, I never rely on only one indicator. Having said these things, this level of non-participation by the retail Gold stock herd fits in nicely with my hunch that the Gold stock low is coming this week. The other thing that makes me think the low in Gold stocks will be this week is some data related to the general stock markets that show the bottom is at hand for the general equity markets as well. A rising tide lifts all boats, after all. Now, this doesnt mean we cant have a day more of panic in the markets before the bottom we can and this is my preferred scenario. In fact, an opening tomorrow morning where the U.S. Dollar rockets higher and sends stocks (including Gold stocks), Gold, silver, and commodities lower is the scenario I am envisioning. However, only Mr. Market knows for sure. But here are the two data points that I think are important regarding the general equity markets. The first is the equity only put to call ratio ($CPCE). I like using the 10 day exponential moving average (EMA) of this data, as the daily data is too noisy when plotted directly. The higher the put-to-call ratio, the more puts are being bought relative to calls, which means more bearish bets. When the number of bearish bets gets to an extreme, it is time to get bullish. Here is a chart of the 10 day EMA of the $CPCE over the past 4.5 years, with a plot of the price of the S&P 500 above it to show how well this indicator sometimes works:

Next up is a plot of the percentage of New York Stock Exchange stocks below their 50 day moving average ($NYA50R). When this number gets real low (cant get below 0 or above 100), there is too much bearishness, although where the lows should be depends on where you are in the cycle (i.e. can get lower lows in a bear market relative to a bull

market). In any case, I think the current reading is useful. Heres a daily plot of the $NYA50R over the past 6.5 years:

Thats it for now. I will send you an email trading alert once I think the Gold stock low has arrived. I will be recommending a purchase of the NUGT ETF (double bullish/levered Gold stock ETF) at that time. Adam P.S. I have decided to share more background information with subscribers rather than posting it to my blog (though I reserve the right to post this information later as a marketing ploy). I wasnt planning to send this many written pieces per week to subscribers, but I want to make sure you get your moneys worth and are satisfied with the service. I am also excited about the pending Gold stock low/Gold stock trade, as it is entirely possible that this will be the start of a major leg higher in the Gold stocks (dont know yet and the trade will work out either way). Once we buy Gold stocks, we will likely stay in the trade for at least 4 weeks. As always, feedback of any kind is welcomed.