Originally published in the February 21st 2009 edition of the Financial Post section of the National Post.

The seasonal trade in gold and gold equities has been exceptionally profitable this year. What should investors do now?

Seasonal influences

As noted in this column on November 15^th, gold, silver and precious metal equities have two periods of seasonal strength during the year: from the end of July to the end of September and from the middle of November to February. The focus in the November 15^th column was the period from mid November to February period. Gold gained in seven of the past 10 periods from mid November to February for an average gain per period of 9.8%. Silver advanced in eight of the past 10 periods for an average gain per period of 16.8%. The AMEX Gold Bug Index improved in seven of the past 10 periods for an average gain per period of 10.8%. Since November 15^th gold has gained 31.7%, silver has advanced 50.5%, the AMEX Gold Bug Index improved 73.8% and the TSX Gold Index has gained 79.3%.

Gold and gold stocks tend to record slightly negative performance from the end of February to the end of July. Gold has gained in five of the past 10 periods for an average loss per period of 0.4%, silver has gained in three periods for an average loss per period of 10.7% and the AMEX Gold Bug Index has improved in six periods for an average loss per period of 3.5%.  Following is a chart showing optimal technical exit points during the past six years near the end of February for the AMEX Gold Bug Index.

Chart courtesy of StockCharts.com                     www.stockcharts.com

Canadian gold equities have a history of moving higher in January and February prior to the annual Prospectors and Developers Association of Canada (PDAC) conference held in Toronto in the first week in March. Fresh corporate earnings and exploration news frequently is released just before or during the conference. However, the PDAC convention frequently marks the annual peak of good news from the sector. Canadian gold stocks have a history of moving lower during or just after the conference. The conference this year is held between March 1^st and March 4^th.

Technical influences

Upside potential during the next few months for the sector appears limited. Gold is approaching resistance levels at $989.60 and its all time high at $1,033.90 U.S. per ounce. Silver faces significant resistance at $16.06 U.S. per ounce. The AMEX Gold Bug Index is approaching resistance at 359.79. The TSX Global Gold Index is approaching resistance at 375.66. Short term momentum indicators (Moving Average Convergence Divergence, Relative Strength Index and Stochastics) are overbought.  

Fundamental influences

Earnings and cash flow reports will not help the sector during the nest few months. Fourth quarter earnings and cash flow reports by most major gold producers released this week recorded significant year-over-year declines.  Lower precious and base metal prices on a year over year basis had an impact. Moreover, earnings and cash flows in the first quarter will not look much better. Following are consensus first quarter earnings estimates for key companies in the sector:

What to do?

Several possibilities exist depending on investment objectives:

• Investors, who purchased gold and gold equities for a seasonal trade, can take profits on strength and move into another seasonal trade.
• Sophisticated investors can sell at or near the money calls against existing security positions. Preferred expiry for the calls is July or shorter. Implied volatilities on gold related call options currently are exceptionally high. The strategy either offers an extra return above current levels or provides at least some downside protection if price of the underlying gold equity declines.
• Longer term investors can continue to hold. The longer term fundamental and technical outlook for gold and gold stocks remains positive.

Don Vialoux, Chartered Market Technician is the author of a free daily report on equity markets, sectors, commodities, equities and Exchange Traded Funds. Reports are available at www.timingthemarket.ca . Mr. Vialoux currently owns iShares on the TSX Global Gold Index and has written calls against them.

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