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FRED GOODMAN'S KEY INDICATORS FOR
INVESTMENT SUCCESS
The new XAU Oscillator uses the XAU Gold and Silver Index. XAU, shown on the chart below as the pink line, is a capitalization weighted index of the stocks of gold producers, including those who hedge their production. The chart also shows the S&P 500 as the black line -- and the the ratio of the XAU to the S&P 500 (that is, XAU divided by the S&P 500) as the blue line. It is certainly apparent that the ratio declined from early 1996 until the top of the stock market in late 2000. During the subsequent decline in the market, the ratio moved higher. However, it rose much less during the market's decline than it had declined during the market's rise. Recently it has become much more volatile.
To develop an indicator from the ratio, I have constructed an oscillator by subtracting the daily value of the ratio from its 50-day moving average. The oscillator is plotted in the next chart. Here we have charted the XAU Oscillator against the S&P 500 Index. When the oscillator is between .5 and -.5 it is neutral. However, when it exceeds .5, we get a buy signal and when it drops below -.5 we get a sell. Notice that it is about to move from below -.5 to neutral. Like every indicator I have studied, this one is not perfect. However, I have found it useful to further define the major signals given by the Summary Index. This chart displays the XAU Oscillator, with its buy and sell shown in green and red diamonds on the chart of the S&P. There have been some very short term signals, but there have also been some that lasted for close to a full year. The following charts cover two-year periods in detail, so you can study the individual buy and sell signals.
Each colored diamond is a buy or sell signal, but the signal only persists as long at the oscillator remains above .5, for buy signals, or below -.5 for sell signals. For example, the buy signal that started in May of 1996 lasted without a sell signal until March of 1997, but in the interim, there were three periods when the indicator went neutral. When these periods are upon us we need corroboration from other indicators. If there are many sell signals among other indicators, we might close all long positions. However, if there are other indicators that are positive it is more likely that we will maintain our positions or just modestly decrease the allocation. The point to keep in mind here and always is that indicators do not work in isolation, they belong to a group from which we derive a consensus.
The period from may of 1997 through April of 1999 saw several big upward thrusts during strong markets, but it also saw two big missteps that kept us out of the market during a rally and in the market during a decline. However, when combined with other indicators, much better results were produced.
Most of the period between May of 1999 and April of 2000 was spent in the neutral zone. There were a few sell signals and a couple of buys, but most of the time it was neutral.
The most recent period was handled extremely well. We stayed out of the market from January of 2002 until just after the July rally got started, and we missed most of the summer decline. Notably, the indicator has not liked the market since November of 2002. I can't emphasize strongly enough that this indicator is not meant to stand alone. It is instead to be used in combination with others.
Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. 
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