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The Adjusted Gold/XAU Ratio as an Indicator of Forward Returns for Gold Stocks

May, 08 2012
In an October 2011 an article explained how the ratio of gold prices to the price of XAU, a capitalization-weighted index consisting of 16 precious-metal mining companies, provides useful information that investors can use to anticipate the price of gold stocks.
The gold/XAU ratio has had an upward trend since 1968, which reduces the value of gold stocks relative to the price of gold bullion. Because of this trend, in order to make the current ratio directly comparable to the historic ratios, one has to increase the ratio’s historic values to compensate. This adjustment enables us to predict the returns for XAU based on the historic returns that followed trend-adjusted gold/XAU ratios of equal magnitude.
My analysis shows that XAU is considerably undervalued, as the relationship between the price of gold and the shares of companies who mine it is now significantly above the long-term trend line.