Gold and gold stocks have a period of seasonal strength between July and December. What are the prospects for a seasonal trade in the sector this year?

Thackray’s 2011 Investor’s Guide notes that the optimal period to own gold bullion is from July 12 to Oct. 9 and the optimal time to own gold equities is from July 27 to Sept. 25. The average return per period for the gold equity sector during the past 25 years was 6.8%.

Gold and gold equities tend to take a break in October, their weakest month in the year. Thereafter, they have a second period of seasonal strength from the end of October to the end of December.

The traditional explanation why gold and gold stocks move higher from July to September is greater seasonal demand for gold by fabricators who manufacture jewellery for the Indian wedding season in November during Diwali and for the Christmas season.

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However, times are changing. Chinese fabricators buy additional gold in the fourth quarter each year to make into jewellery for the Chinese New Year at the end of January. Last year, Chinese buying for jewellery purposes exceeded Indian buying for the first time. Chinese buying late in the year could partially explain why the second period of seasonal strength from late October to December has become more prominent in recent years.

Gold has been advancing during the past decade for another important reason. Gold has become known as a haven to protect against deteriorating currency values. Developed nations recently have tried to re-inflate their economies by printing more money. Net result is a devaluation of assets priced in their currencies. Investors have chosen to own at least part of the valued asset in alternate investments, particularly gold. Gold has become the world’s substitute currency.

What about this year? Demand for jewellery purposes continues to grow despite gold approaching its all time high. Demand is particularly strong in India and China, two of the world’s fastest growing economies. One of the ways that people in India and China like to display their wealth is through the display of their jewellery.

Of greater importance, purchases of gold for investment purposes are accelerating in order to protect against currency risk, particularly against the U.S. dollar. Gold is being purchased by speculators as well as central banks such as India, China, Brazil and Russia.

Demand for gold to back investment products continues to grow. The prominent gold bullion SPDR Gold Trust ETF (GLD/NYSE), the largest ETF based on value in the world, continues to grow and more gold bullion ETFs have been proposed in developing nations such as China.

On the charts, gold has a positive technical profile. It currently is locked in a 10month trading range between US$1473.90 and its closing high at US$1563.20. The intermediate trend is up. Short-term momentum indicators are oversold and trending higher.

Gold is sensitive to changes in the U.S. dollar. Recently, gold struggled to move higher with strength in the U.S. dollar Index and weakness in the euro. However, the U.S. dollar is expected to start sliding again soon. An unending penchant by the U.S. government to spend more money than received, combined with an accommodative monetary policy inevitably will lead to a resumption of an intermediate downtrend. Short-term momentum indicators already are overbought and showing early signs of peaking.

In contrast, gold equities and equivalent ETFs have dropped about 20% since gold reached its record high at the end of April. However, gold equities and ETFs have shown technical signs of bottoming during the past week.

In addition, gold equities and ETFs have outperformed gold during the past week, a positive technical sign for both gold and gold equities. Improving technicals in gold equities imply that the period of seasonal strength is appearing earlier than usual this year.

Investors can participate in the current period of seasonal strength by buying a diversified basket of gold equities or by purchasing exchange-traded funds holding gold bullion or gold equities. A preference is given to higher quality equities and ETFs instead of junior exploratory stocks with a high risk profile.

Jon and Don Vialoux are authors of free daily reports on equity markets, sectors, commodities and exchangetraded funds. Reports are available at timingthemarket. ca and equityclock.com.

Source: National Post