Gold (or bullion) has been the cornerstone of an older generation of investors, for its "safety", for the "next Depression". By holding gold, these investors retain a feeling of security and comfort - who could argue with that? To say that emotion plays a big role in the roller coaster of the gold market would only begin to tell the real story of excitement of gold speculators, miners, geologists and the others inside the mining world when word leaks out of a new major find somewhere in Canada, the United States, Australia or Africa. The quest for this shiny commodity has made millionaires of paupers and, on the flip side, has been the ruin of many wealthy families.

Here we take a look at some of the tools used to analyze gold stocks. The gold players make it look easier than analyzing other sectors, but for those who are not confident in their ability to conduct this type of analysis, we will also analyze the gold price, have a look at the CBOE Gold Index and the AMEX Gold Bugs Index. There has long been a relationship between bullion itself and gold shares of companies that mine the precious commodity.

Tools for Analyzing Gold

In his book "Technical Analysis Explained" (third edition, 1991), Martin Pring explained that an investor can analyze the price of gold itself by using "trend-determining" techniques such as price-pattern behavior, moving averages (MA) and rates of change. For longer term movements, decisive crossovers of the 12-month MA have been reliable. Buy and sell signals using a monthly "know sure thing" (KST) (explained in Chapter 10) have also proved reasonably accurate.

Most investors prefer to own gold by way of buying into a mining company of which some of the larger well-established companies have delivered handsome returns to their shareholders over the years. However, a chartist, before using a mining company, would examine the relationship of gold to gold shares by way of an index like the two mentioned above as the mining group may have silver mines in its portfolio or another facet of business that would skew the bottom line in determining its relationship to gold.

Nature of the Market

Investors tend to lead the market when buying shares in a mining company. Tension rising in politically hot regions of the world will have gold bugs rushing to any one of the top gold producers of the world and buying up shares as quickly as they can - and turning around and selling their positions as tempers cool off and those at CNN and MSNBC tell us that there is nothing to worry about.

Also, As the price of gold rises or falls it may have a dramatic effect on whether a mine is a viable investment. If the cost of mining exceeds the current world price for the metal, the mine will be forced to slow its production or suspend it indefinitely until the price of gold climbs high enough to allow a profit to be made at that particular dig.

Pring writes, "the general rule is that the prevailing trend is assumed to be intact unless a new high or low in either the stocks or bullion is not jointly confirmed. This represents a disagreement and warns that the prevailing trend is likely to reverse. Usually bullion lags behind the shares, but occasionally it is the shares that are slow to turn. In either case a trend reversal should be expected". This rule is can be said to be set in stone; virtually all technical analysts recognize this to be true and follow it to the letter.

Below you can see the mirror image of the three charts selected to demonstrate the relationship between the CBOE Gold Index, the AMEX Gold Bugs Index, and the mining company Anglogold Ltd. Ads. Investors looking to invest in this arena will do well to run their analysis over the index charts at the same time they are breaking down Newmont Mining, Anglogold and Barrick Gold.

Figure 1: CBOE Gold IndexSource: Tradestation
Figure 2: AMEX Gold Bugs IndexChart Created with Tradestation
Figure 3: Anglogold Ltd.Source: Tradestation

The Bottom Line

The quest for this shiny commodity has made millionaires of paupers and, on the flip side, has been the ruin of many wealthy families. No matter how you choose to invest in the gold market, keep an eye on the prevailing trends in the market and in gold bullion.

It's your money, invest it wisely – learn, understand and execute.

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