Gold and Oil Go Their Separate Ways

02/25/2009 12:00 pm EST

Focus: MARKETS

John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, notes divergences between gold and gold stocks and oil and other energy commodities, and discusses its implications.

Gold is up, challenging its July 2008 highs, after which the March 2008 high (above $1,000 an ounce—Editor) is the next reference. Gold stocks, [however,] are lagging dramatically.

The equal-weighted gold stock index has retraced less than half its decline while bullion has retraced more than three-quarters of its decline. We find this divergence very worrisome.

Confirming our concerns are silver, which has retraced 45% of its decline; platinum, which has retraced less the 25% of its decline, and palladium, which has retraced less than 15% of its decline. In short, this sector looks terrible and our plan is to sell into strength.

In chatting with my old friend Mike Epstein—retired trader and market maker, now working in the MIT Lab for Financial Engineering—the other day, I noted the gold/gold stock divergence and he suggested that one or the other needed to be sold, i.e., buy bullion and sell the stocks or sell bullion and buy the stocks.

When I posited that one might sell both and perhaps consider shorting, he pointed out that I sounded like a nervous long. Bull’s eye! The truth is that I hate these sorts of divergences, and when sitting on a 10% gold allocation, two-thirds of which is in gold stocks, they do make me nervous.

Speaking of divergences, the energy stocks have stopped going down. They made a momentum low last October [and] a final price low last November and have been building a base ever since. Over that period, the crude oil price has slipped approximately 50%.

We have two different kinds [of divergences] here. In the first case, gold bullion is working its way higher without much confirmation from the gold stocks, even less confirmation from the related precious metals, and none from the industrial metals. In the energy market, crude oil has continued to work its way lower accompanied by heating oil and natural gas—despite a very cold winter, while gasoline has stopped falling and is performing roughly like the stocks.

The late Jim Alphier often talked about divergences. He said a divergence is a divergence is a divergence. His point was that it didn't matter what got out of gear or in which direction it was out of gear, [but] when divergences occur you ought to pay attention. In the current situation, the divergences suggest being alert for weakness in gold and strength in oil and the oil stocks.

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