Precious Metals In A Bull Market Cycle

 |  Includes: CEF, GDX, GDXJ, GLD, SLV, SLW
by: Robert Hallberg

History has shown us that different asset classes are more or less favorable during different time periods. The bigger returns are made from being in the right market at the right time.

An understanding of economic cycles gives you a road map for where the market is headed and by studying monetary history and economic history you will quickly realize that the same patterns keep repeating over and over again. Looking for big trends and then finding opportunities that match those trends, whether they are commodities, equities or perhaps real estate, has been a time tested investment approach.

Economic cycles are not new to human history;. They have been around before ancient Greece and Rome and they still reoccur in today’s modern society. In fact, recognition of cycles is a way humans recognize patterns and plan for the future.

Discovery Of Cycles

French economist Clement Juglar was the first economist to clearly identify economic cycles. He is best known for identifying the 7-11 year fixed investment cycle which also bears his name. He described the basic format of an economic cycle as an expansion that leads to a crisis, followed by a recession, and finally preceded with a recovery, which leads back to an expansion. He concluded that the timing of basic economic cycles can be predicted with some regularity.

The stock cycle, for example, is a regularly reoccurring phenomenon. For a time, stocks and real estate outperform gold, silver and commodities. Then the cycle reverses, and gold, silver and commodities outperform stocks and real estate.

The chart below shows an example of the stock and gold cycle over the last 80 years. It measures the Dow Jones in gold rather than dollars and it shows how stocks and gold have been fluctuating with regular internals against each other. Gold has historically peaked out around a gold-to-Dow ratio of 1:1 or 2:1. At these points in time, gold has reached its peak in terms of purchasing power relative to stocks and other financial assets. During these periods, investors have lost confidence in paper products and favor gold and other tangible goods. Once gold trades at a 1:1 or 2:1 ratio it is prudent to sell gold and buy stocks or real estate.

It currently takes 8 ounces of gold to purchase the Dow, but not too long ago at the height of the technology bubble you needed 44 ounces of gold to buy the Dow. The Dow has fallen 80% in value measured in gold, and before this cycle is over we may see this ratio at 1:1 again.

Gold / Dow Ratio

The next charts measure the real estate cycle. It shows gold’s purchasing power in terms of real estate. In 2001, it took almost 800 ounces of gold to purchase a new home. Today, you can buy it for only 155 ounces.

Dow / Gold Ratio

How To Profit From Economic Cycles

The economic cycle principle is a way for an observant investor to use economic cycles to forecast market direction and choose investments based on these forecasts. By recognizing what stage of a cycle the market is in, you can invest heavily before it reaches its peak and sell once it becomes overvalued. It is important to keep an eye on market fundamentals and price fluctuations. You must be alert to what's happening in other sectors, watch for changing conditions, and always have an eye on the next big thing.

The chart below shows how an investor could have grown a $35 investment to over $400,000 by simply riding four big trends over the past four decades. This chart is a modified version of a chart Bud Conrad at Casey Research originally developed and it illustrates how investors can make huge returns by recognizing and understanding economic cycles.

Bull Market CyclesClick to enlarge

  • Between 1970 and 1980 gold went up 24 times from top to bottom.
  • From 1980 to 1990 the Nikkei made a 5.69 fold gain.
  • The Nasdaq went up 13.5 fold between 1990 and 2000.
  • Gold has made a 6 fold return since year 2000.

Investment Implications

We are currently in the middle of a precious metals cycle. But as a result of decades of fiscal mismanagement, record debts and market manipulations, our current economic situation offer far more distress as well as investment opportunities than what a mere economic cycle would ordinarily entail.

Physical gold and silver is the most obvious investment strategy, and with perhaps a small speculative position in different gold and silver derivatives.

iShares Silver Trust (NYSEARCA:SLV) is one of the most popular silver ETFs. The trust holds physical silver in a custodian bank, and is designed to reflect the price of silver on the market less expenses and liabilities. Although you are subject to the risk of relying on a custodian to hold your silver, this ETF is a very cost efficient instrument and an excellent trading vehicle.

SPDR Gold Trust (NYSEARCA:GLD) is one of the most popular gold ETFs. The trust holds physical gold in a custodian bank, and is designed to reflect the price of gold on the market less expenses and liabilities. Although you are subject to the risk of relying on a custodian to actually hold your gold, this ETF is a very cost efficient instrument and an excellent trading vehicle.

Market Vectors ETF Trust (NYSEARCA:GDX) attempts to replicate the NYSE Arca Gold Miners Index. GDX represents a mix of 30 small, mid tier and large capitalization gold mining companies. GDX’s holdings include some of the biggest and best producers in the industry and they are far better positioned to withstand a downturn than many other gold mining companies.

Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) is made up of 72 junior gold miners. The index provides exposure to a wide range of small to medium capitalization gold mining companies globally that generate at least 50% of their revenues from gold and silver mining. Because of its holdings, GDXJ is more volatile than most other ETFs invested in precious metals. This ETF is suited for investors who wish to speculate on price movements in gold, but refrain from holding individual junior minors.

The Central Fund of Canada (NYSEMKT:CEF) is heavily invested physical gold and silver bullion. The fund currently holds over 95% of its assets in gold and silver, which makes the fund highly affected by the price movement of these two metals. This is a relatively safe and cost efficient way to invest in gold and silver.

Silver Wheaton Corp. (NYSE:SLW) is the largest metals streaming company in the world. It generates its revenue primarily from the sale of silver. It buys streams at low fixed prices and sells the metal at market prices. The streaming strategy allows the company to significantly reduce its operating costs and keep its capital expenditures at a minimum, while still having access to a large amount of silver.

The company at present has 14 silver purchase agreements and two precious metals agreements where, in exchange for an upfront payment, it has the right to buy all or a part of the silver production, at a low fixed cost, from high-quality mines located in various geographical regions. In 2010, the company generated sales of $423 million, and with an impressive 69% margin, SLW made $290 million in net income.

Disclosure: I am long GLD, SLV, GDX.