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Trade Opportunities

Bullion and Gold Equity Divergence
Gold Equities Could Rally on Return of Risk Appetite

Alfred Lee, CFA, DMS
Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management

July 5, 2011

Recent Developments:
  • Since early April, gold related equities have sold-off despite gold bullion having enjoyed a steady rise in its price. This has led the gold bullion to gold stocks pair ratio as tracked by the Spot Gold/NYSE Arca Gold Bugs Index ("the Ratio") to aggressively diverge from its 52-week moving average (MA). With the weakness in economic data and macro-economic concerns in April and May, gold stocks were driven more by broad market equity market beta than gold beta. (Chart A)
  • Given the number of headline items, gold-related equities and gold bullion have recently moved to reflect the "risk-on" and "risk-off" trade respectively. Therefore, how long the Ratio can maintain its divergence to its 52-week MA is dependent on how long the equity market weakness will take to dissipate. The sharp bounce-back of gold related equities and particularly the small-cap gold companies on days of where investor risk appetite is high indicates that gold companies have been held down by equity market pressure. (Chart B).
  • Equity market sentiment has improved over the last several trading days, given further clarity in the Greek sovereign debt concerns. If confidence continues to trend up, gold related equities may outpace bullion over the short-term, leading the Ratio to converge with its 52-week MA, especially if recent economic data proves to be an anomaly caused by recent supply chain disruptions. Therefore, how to play gold over the short-term is a question of whether the weakness in recent economic data was a cause of one-off items such as the Japanese earthquake/tsunami leading to supply-chain disruptions or whether we are headed towards a period of long-sustained equity market weakness.

Potential Investment Opportunity:

  • In the context of portfolio construction, we believe gold bullion and/or gold futures are a better diversifier than gold related equities. In addition, gold tends to be less volatile than gold companies. The BMO Precious Metals Commodities Index ETF (ZCP) is an efficient way for investors to access gold prices and also silver to a lesser extent.
  • However, for investors looking for the risk appetite to return and thus the ratio to converge back with its 52-week MA, the BMO Junior Gold Index ETF (ZJG) is an ETF that provides investors with efficient access to a broad basket of small-capitalization North American gold companies. If equity market confidence does return, we believe ZJG could potentially re-enter its prior trading range (Chart C).
  • The risk of the junior gold trade however, is if the equity market rally over the last several days proves to be a head fake, the recent strength in gold equities could again dissipate. As investor confidence remains shaky, as evidenced by the trading pattern of the CBOE Volatility Index (VIX Index), investors may want to consider using a stop-limit order of no more than 10% below its entry price.

Chart A: Gold Bullion Overbought Relative to Gold Equities

Gold Bullion Overbought Relative to Gold Equities
Source:, BMO Asset Management Inc.

Chart B: Lack of Risk Appetite Have Held Junior Gold Companies Down

SLack of Risk Appetite Have Held Junior Gold Companies Down
Source:, BMO Asset Management Inc. (Daily Chart)

Chart C: Junior Golds Could Re-enter Prior Trading Range if Risk Appetite Returns

Junior Golds Could Re-enter Prior Trading Range if Risk Appetite Returns
Source:, BMO Asset Management Inc. (Weekly Chart)

*All prices as of market close July 1, 2011 unless otherwise indicated.

Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

BMO ETFs are managed and administered by BMO Asset Management Inc, a portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds. Please read the prospectus before investing. The funds are not guaranteed, their value changes frequently and past performance may not be repeated.


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