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Gold/XAU Ratio Signals Buy for Gold Stocks
09/03/2008 Ratio is now 6.36 the highest level it has been since 1984. Gold bullion today is $797 and the XAU index is 133.65 (a new 12 month low).

To put some historical context on this measure, since 1974, the Gold/XAU ratio has been greater than 5.0 about 15% of the time. When the ratio has been this high, the XAU has followed with annualized gains of 89.6%, on average, a figure that remains high even if the data is split into multiple samples. When the ratio has been greater than 4.0, the XAU has followed with average annualized gains of 27.4% (though the finer profile of returns has been sensitive to other conditions such as interest rates, economic trends, and inflation). In contrast, when the ratio has been less than 3.0 (meaning that the gold stocks are very elevated relative to the actual metal), the XAU has declined at an annualized rate of -36.6%, on average.

Importantly, the return/risk profile for precious metals shares is strengthened further if the economy is experiencing weakness like it is presently. For example, when the Gold/XAU ratio has been greater than 5.0 and the ISM Purchasing Managers Index has been less than 50 - (indicating a contracting U.S. manufacturing sector - which is presently the case), gold shares have appreciated at an average annualized rate of 125.6%. In contrast, when the Gold/XAU ratio has been less than 3.0 and the Purchasing Managers Index has been greater than 50, precious metals shares have plunged at an average annualized rate of -49.9%.?

Such strong periods for gold are also generally associated with weakness in the U.S. dollar which has been the case for sometime now and is expected to fall substantially further in the months ahead. Something to think about as the economic picture evolves in the months ahead.

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