According to Dow Theory, secular bull markets have three phases: The first phase is marked by slow appreciation of insiders and professionals; the second phase is characterized by more rapid appreciation, mainstream media coverage, and an increase in mass market investors; and the final phase is characterized by a parabolic mania. As the chart below illustrates, a case can be made that gold is about to enter phase three -- the mania phase.
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The fundamentals supporting a mania in gold (GLD) and gold stocks (GDX) remain intact, as the world is still awash in debt. Considerable weakness remains in the European and U.S. bond markets (long-dated Treasury bonds, as expressed by the iShares Barclays 20+ Year Treasury Bond ETF (TLT), are down nearly 7% year to date), likely the result of bond investors losing faith as $7.6 trillion in sovereign debt is maturing this year.
Based on these factors, I thought it would be a good time to revisit the bull market in gold from the 1970s in order to see how history may repeat, as well as differences investors should be aware of.
Ultimately, I think a strong case can be made that the current bull market in gold is far stronger than the one from the 1970s. The major observations I feel are worth noting that support such a thesis are as follows:
1. More Debt Now Than Before. Gold is a function of debt; its economic purpose is to balance debt when nothing else can, when politicians refuse to restructure out of their own will, and when the monetary system does nothing but create more debt. The chart below tells the story of U.S. public debt; it is clearly much larger now than it was during gold's bull market in the 1970s.
And that is, of course, just a snapshot of U.S. public debt; it does not include U.S. private debt, nor does it look at the situation around the world. As we are in a fiat monetary system in which all money is loaned into existence, the natural tendency of such a system is to create more and more debt. Gold's bull market in the 1970s was just a warning sign of the inherent instability in the design of the monetary system. However, with debt levels where they are now, it is clear the warning has been ignored and the system is insolvent. Because the debt problem is so much greater now, I think the current bull market in gold will far outperform the one of the 1970s.
2. The Current Crisis Is Global. Unlike during gold's bull run in the 1970s, the current crisis is global. Europe, Japan, Britain, and the U.S. are all mired in debt. In fact, a strong case could be made that the next big crisis could come from Japan, and could send an influx of capital into U.S. equity markets and gold. The infographic below, created by Glassman Wealth Services, tells the story.
In the 1970s, the crisis was just about the U.S. Because the current debt crisis is a global one, that means capital from all around the world will go rushing into gold. Therefore, the current bull market is going to be even more spectacular.
3. Bond Yields Are Currently Very Low. Perhaps the biggest difference between the current gold bull market and the one from the 1970s is that bond yields are currently very, very low. Contrast this with the 1970s, a time during which the yield on the 10-year Treasury bond consistently rose, as the chart below illustrates.
Low yields means that the bond market is increasingly incapable of competing with gold for capital. Given that these countries are still engaging in rampant deficit spending, raising rates would prove to be a dangerous strategy as it would increase the interest burden from governments, which would make them more insolvent and less capable of funding their programs. Low yields also make it more likely that capital-chasing income streams will find their way into high dividend stocks, and as the price of gold rises, many gold miners will be well-positioned to increase their dividends. Indeed, Newmont Mining (NEM) is the role model here, as the company has established a policy of pegging its dividend rate to the price of gold. As investors become increasingly disillusioned with bonds that have no real yield, gold stocks such as Newmont will be there to receive the capital.
For these reasons, I think the bull market in gold will go much, much further than it did in the 1970s. In those days, gold ran from $35 to $850 -- an increase of 24 times. If we identify the start of the current gold bull market as 2001 at a price of $250, a 24 times move would put the price of gold at $6,000. In light of how severe the debt problem currently is, a higher price is certainly feasible; the only question is when the parabolic move will truly start. Given the debt coupons that are due this year, and that much of the bullish sentiment in gold has subsided in the wake of the selloff after gold's run up past $1,900 this past September, I think the stage is being set for the mania to start soon -- perhaps by summertime.
There are two potential spoilers to my thesis here: debt cancellation and silver.
First, debt cancellation, such as the kind that Iceland has already conducted, could make the debt problem go away -- and thus make the need for gold go away. I find widespread debt cancellation to be extraordinarily unlikely, as there are no real signs that the monetary authorities of the world see debt as the problem; in fact, their prescription for the sluggish economy involves greater stimulus in the form of cheap credit and deficit spending. This only magnifies the debt problem, and thus is bullish for gold.
Second, silver could compete with gold for what the market will remonetize. Silver has served as a form of money through much of history; in fact, the U.S. was on a bimetallic standard for much of the early part of its history. However, as I previously noted, silver has had trouble serving as money when the government does not officially acknowledge it as such. For this reason, I think gold is a much better play and is more likely to be remonetized if governments do choose to return to some type of commodity standard. In the interest of being aware of potential spoilers, however, the price action in silver and government policy toward it is worth watching.
In light of all these factors, I think owning gold and gold stocks in anticipation of a parabolic mania is prudent. The challenge will be to preserve one's discipline and poise if a mania does in fact emerge.