Schaeffer: The Case for Gold

11/07/2003 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

In 2002, Bernie Schaeffer was recognized as the best among the 50 analysts polled in the BusinessWeek  forecast survey.Timer Digest ranks him as the #1 long-term stock timer for the last three years and the #1 gold timer for the past 10. Here, he lays out the technical and sentiment case for a continued bull market in gold.

"The fundamental backdrop for the economy is very uncertain and if anything, tending towards an acceleration of inflation. This is very bullish for gold. But to really understand the bull market, we need to understand the charts. I am a technical analyst and I specialize in the study of investor sentiment. That’s what I focus on for my trading and my timing. For gold, the technicals and sentiment are at a very compelling point, favoring a continuation of the bull market for gold.

"The Amex Gold Bugs index ($HUI NYSE) has appreciated since July 2000 from about $35 to $213. That is a six-fold gain in a three-year period of time. That is a huge rally. Where is Wall Street now on gold stocks after that huge rally? According to Zacks, if we add up the recommendations of all the key analysts on the major gold stocks there are 20 buy recommendations compared to 48 holds or sells. Let’s contrast that to the tech stock rally in the late 1990s. Many stocks had appreciated five, 10 times, just as the Gold Bugs index. You couldn’t find a sell recommendation. You might have found a few holds, but essentially everyone in the analyst community was on the buy side. However, Wall Street has not bought into gold or gold stocks as an alternative investment.

"Another way to look at this would be in terms of market capitalization. As we’ve seen, we have an index that has appreciated over six-fold over three years. If you take the total market cap of the top six gold stocks you get about $50 billion. In contrast, the market cap of Dell Computer is $90 billion. The market cap of Microsoft is $300 billion. In 1980 at the boom in the gold mania, there was more money invested in gold bullion than there was in the US stock market. Now, the market cap of the top tier of the gold sector trades at less than half the value of just one computer maker.

"To determine a technical buy signal, we also look at relative strength and compare the performance of the Gold Bugs index with the performance of the S&P 500. And not only has the HUI index been rallying sharply, but it has been rallying sharply relative to the S&P–even since October of 2002 along with the big bull phase of the S&P 500. As a technician, I say that absolutely and relatively, gold stocks are clearly in an established bull market and it has been behaving in a very orderly manner, which tends to be quite bullish in its implications.

"The answer is not only in the technicals. We also assess emotions–investor sentiment. Humphrey Neil, who wrote a great work entitled The Art of Contrary Thinking, said: ‘The public is right during the trends and wrong at both ends. In other words, the public is going to be seriously wrong at the bottom and wrong at the top. But they will be right in the middle stage of a move. What do you get in the late stages of a decline into a market bottom? Despair. What do we get at market tops? Euphoria. In the middle stage, we see acceptance.

"The sentiment backdrop on gold remains one of disbelief, which is  what we would expect to see in the early stages of a bull market. Investors have not jumped on the bandwagon. We are still in the disbelief stage. We haven’t gotten to the acceptance stage yet, so you don’t have to particularly worry about a top; we are certainly a far, far distance from euphoria. Until we get into that acceptance stage and until we even remotely approach the euphoria stage, then you are pretty darn safe investing in this uptrending market. In sum, I would recall Humphrey Neil’s comments when he said, ‘The crowd is most cautious when it should be prudent, and most fearful when it should be bold.’"

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