January 29th, 2009

Cramer’s Take on Gold and Gold Producers

Trading nearly any commodity is now available to the average investor through a wide range of ETFs. By one count, there are currently 70 commodity ETFs available on US markets of which 13 are shorts and 13 are “double” ETFs (meaning they’re designed to move twice the action of the underlying ETF).

But some commentators, both “talking heads” and bloggers, rationalize that a move in the underlying commodity should be reflected in the sales and profits of the commodity’s producers. They suggest that one or the other might be “cheap” or “expensive” as measured by the price action of the other. As a result of this “imbalance”, they forecast the gap being closed and recommend either a paired transaction (buy one and sell the other) or only the sale/purchase of one of them.

Take, for example, the action in gold (GLD) as contrasted with the price move in gold producers (as represented by the GDX ETF) representing stocks like Yamana (AUY), Goldcorp (GG) or Agnico-Eagle (AEM). As Cramer said the other night on his latest rant against technical analysis:

“The stock [AEM] held firm after hitting its 200-day moving average. Then last week, AEM broke out of its trading range on a high-volume rally, which was further confirmation for technicians. Chartists like AEM all the way down to $44.

[I], on the other hand, need more than Agnico-Eagle’s sudden popularity to recommend the company. Favorite stock in the sector or not, and AEM is his top pick, there’s no fundamental reason for hiding in gold, a traditional hedge against market chaos and inflation. If anything, it’s deflation that’s the problem, with virtually every other asset losing value. And while you could definitely call this market chaotic, investors who buy now will be doing so at too high a price. Think about it: AEM is trading at 80 times earnings.

If you own Agnico-Eagle, cash out. If you missed the trade, don’t bother trying to catch up. Just wait for a pullback – down to under $44, actually….The technicians’ sell price is [my] recommended entry point. Only then does AEM make sense as a defensive play against market volatility.”

To prove his point, Cramer went on to displayed a chart comparing the GDX (the gold miners’ ETF) relative the S&P 500. I wanted to see whether Cramer was making an unbiased presentation so I did my own analysis and concluded that trading the gold miners (GDX), like everything else, depends on your comfort level in various time horizons (see Use Various Time Horizons to Read Charts Better).

More importantly, when ever you see or read some recommendation, always ask yourself “What time horizon are they referring to?” Cramer, attempting to look in some profit on a recommendation he made last October to buy AEM displayed the following chart:

True, the gold mining group out performed both GLD and the S&P 500 over the period since last October. But does that fact indicate that the miners are over-valued and that gold, based on performance relative to the S&P 500 is over-valued? Let’s look at the same graph but zoomed out a bit, back just 4 months to June 30, just before the market really tanked:

You get a much different picture. Remember how the $US skyrocketed last year? Gold and its producers, along with most other commodities and their producers, took a much worse beating than the general market. But commodities were over-valued back in June and that’s why their decline was so much more severe than the general market. What would the above chart look like if we zoomed out again, this time to the launch of GDX in summer, 2007:

Based on this perspective, the miners have performed similar to the rest of the market but have a long way to go to maintain relative parity with the price of gold.

The fundamental issue is whether the factors driving the price of gold are different that those driving stocks? If yes, will there be a reversion to some parity and, if so, will gold price drop or stock prices rise? If not, will gold producers continue to outperform other stocks to be more in line with the price of gold?

I don’t have the answers but my preference is always to take a longer-term perspective as the safer and more profitable route over the long-run. What do you think?

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