Like many things in this environment, there has been some pretty extreme measures ... One to add to the mix is the ratio of gold bullion to the price of gold equities (using the price level of the Philadelphia Stock Exchange Gold & Silver Index or XAU for gold equities because it has the longest history)

The long-term average ratio since 1983 has been 4.2x. The Dec 31 reading of 7x is a historic level and was even higher in late October when it hit 10.0x (see attached chart showing historical ratio of gold/gold equities). The higher the ratio, the lower the price of gold equities is in relation to the price of gold bullion.

The ratio spiked in October as global deleveraging forced investors to sell liquid positions, including gold equities, to fund shortfalls elsewhere. In addition, gold and/or gold equities are included in many commodity/resource baskets which were popular investment vehicles during the commodity boom. Gold has been sold as investors exit these broad commodity/resource positions. The result has been a disproportional drop in gold equities vs gold bullion from January 1 to Oct 22: gold bullion declined 8% (in USD) and gold equities declined 59% (represented by the XAU index). Keep in mind that the XAU index is +80% exposed to senior gold producers (+50% in Barrick, Newmont and Goldcorp) and that many junior and gold explorers were down significantly more during this period. Precious metals funds were down more than the gold index, anywhere from -60% to -70% over the same period as all have some degree of diversification among senior, intermediate, junior and explorers (see slide highlighting allocation comparison of precious metal funds by type of company)

Since Oct 22, there has been a reversal of fortune for gold equities and precious metal mutual funds vs gold bullion. The XAU index advanced 73% to Dec 31 while gold bullion advanced 15%. In comparison, precious metal funds returned anywhere from +36% to +83% (UPMF returned +51% and UWPMF returned +53%) see attached graphs showing 2008 performance of gold, gold equities and the trade weighted USD. The strong performance of gold equities has reduced the gold / gold equity ratio from the peak reading on Oct 22 of 10x to the Dec 31 reading of 7x. Historically, when the ratio exceeded the long-term average by a significant amount (ie, +1 standard deviation), gold equities significantly outperformed gold as well as broad equities the subsequent year. While we have already seen a significant move in gold equities, if you believe in reversion to the mean from the current level, then gold equities would need to continue to significantly outperform gold bullion with the possibly of the greatest returns in the smaller junior or explorers who as a group have not gained as much as their senior counterparts.

Fred and Benoit and team are optimistic for the prospects for gold and gold equities for the following reasons: