A guide to using the gold miners-to-gold ratio
The gold miners-to-gold ratios are indicators that show how many gold ounces are required to purchase one share of an index. Technically, the numbers are the value of the index divided by the price of gold. They show a relative value of miners to the price of bullion, thus indicating whether gold stocks or gold are overvalued or undervalued relative to each other. When the ratios are low, miners are cheap compared to gold, and when the numbers are high, gold stocks look expensive relative to bullion.
Let’s examine some charts, starting with the graph presenting the XAU-to-gold ratio. As one can see, until the 2008 financial crisis the ratio was usually traded within the range 0.22-0.28, with the average of 0.25. We can say that any time the ratio jumped above 0.32, gold stocks were overvalued relative to gold and due for a pullback, and any time the indicator fell below 0.20, gold stocks were undervalued in relation bullion and it was a good time to buy them.
Chart 1: The price of gold (yellow line, left axis, London P.M. Fix, in U.S. dollars), the XAU Index (red line, left axis) and the XAU-to-Gold Ratio (blue line, right axis) from 1984 to 2016.
In 2016, rally in gold prices pushed the mining stocks higher. Now, the ratio stands at 0.7, which is still extremely low by historical standards. Therefore, if somebody believes in mean reversion, the current level of XAU-to-gold ratio offers an important opportunity to reap beautiful profits by purchasing stocks. However, the notion that everything has to revert to some historical average is nonsense in the world of continuous changes and paradigm shifts. The XAU-to-gold ratio peaked in 1996 and has fallen since then until 2016. It means that precious metals equities have been gradually discarded for two decades, even by diehard gold bugs. Investors turned away from them after the 2008 crash, when the ratio plunged to its historical low and then continued its downward trend.