Gold's Price Correction Evokes 1979-1980

Includes: GLD, GTU, IAU, PHYS
by: Mark Thomas

It is the question on every gold investor's mind right now: Was the recent surge in the gold market a parabolic end to a bubble, or just a severe correction in an ongoing bull market? We have been nervous as you have, as the market price has fallen 15% in such a rapid fashion. It caused us to go back and reexamine the fundamental reasons behind the bull market in gold, and if they had changed. Nothing fundamentally has changed except there was probably some disappointment that Quantitative Easing 3 in the US was not announced at the recent meeting of the US Federal Reserve. The only other major issue is as confidence in Europe declined again the US dollar has strengthened. So we decided that we needed to go back and study the market technically, and not just from a fundamental standpoint. So we went back again and looked at the 1974-1980 bull market in gold again, especially the 1979-1980 period when gold made its biggest gains and the bull market ended.

We pride ourselves at not overstaying our welcome in trades during our career. You just have to develop a sense over the years that when everyone else has finally come around to your original thesis, you have to start selling, because the gig is up and the party is over. When gold peaked twice above $1,900 and made a double top recently, we made a mistake and didn’t cut our position at least in half. Ever since then we have been struggling with what our game plan will be going forward. Is our original thesis that gold could still go parabolic from current levels correct? Have we overstayed our welcome, and are we just in denial?

We have had a pretty good instinct and track record on knowing when to sell over the years. However, that was with stocks, where you have some fundamentals to base valuation decisions on to define where you should sell numerically. With gold it is more difficult because technical analysis and momentum will take over near the end of large moves, just as it did recently.

As the market continues to test us, and gold just isn’t acting like it was for so many weeks, it is really scary. We had gone back over some evidence technically before about how things set up in 1979-1980 and thru the longer period of 1974-1980. A few weeks ago our nerves were raw when gold broke below $1,600, and it forced us to reevaluate again. We have come to our conclusion now and will stick with it no matter what, even if they try one final shake-out of us gold longs. The bull market in gold is not only still intact; in fact it is about to enter its third and final phase of the bull market. The third phase is when the largest and most rapid price gains occur. That is a very bold statement, but we found evidence from the past that backs our hypothesis.

Notice on the following chart that in Oct./Nov. 1979 gold went on a parabolic run from $310 to $460. It then had a sharp correction of 17%, which is very similar to our current 15% correction. It then consolidated and traded between $385-460 for 9-10 weeks, then broke out again, and that is when it really went parabolic. Gold peaked on September 8, five weeks ago, so we are probably halfway through its consolidation phase. It is setting up a bull flag, and when it breaks out it really going to accelerate. The next parabolic move was its final move, and it was very wild with five large gap ups in price and went from $470 to $875 in just 30 days. This is what we could be on the verge of again, and while others have turned cautious, we’re more bullish than ever. Now when this happened silver also went parabolic, the Soviets invaded Afghanistan, and there was maximum uncertainty in the world.

Now, of course, history never repeats itself, but it does rhyme. There are many different scenarios that could bring about events similar to this. We think this might be about to happen is some country somewhere is going to wake up and find its currency has been replaced overnight (devalued). This could create a crisis of confidence in all currencies and a rush to convert cash to gold to save what is left of one’s savings. It could become clear that Europe will finally recognize the losses in its banks, inject a minimum 1 trillion euros recapitalization into them by borrowing. Then in the end this money will have to be raised, so it will be printed or created from new debt. The US Federal Reserve will do a QE3, using Europe and persistent unemployment as excuses. The bottom line is more debt racked up, more financial institutions in trouble, more money printed to ease the pain short-term. All of that equals a rising value of gold denominated in the world’s depreciating currencies and profits for owners of gold and silver. We’re not sure if this happens in the next few months or next few years, but the similarities are eerie.

Disclosure: I am long GLD, IAU, PHYS, GTU.