The 'Death of Gold' Revisited

A couple of weeks back I put out an article (The Death of Gold?) saying that “The Shoeshine Boy” principle may have flagged a major top in the gold market.

The Times' cover trumpeting gold was published one trading day before gold’s $1030 top.

Not surprisingly this generated a number of emails from gold bulls which with one exception disagreed to the point of employing four letter words you would not even use against alleged members of a gold cartel. Let me clarify one point, the use of the phrase “Death of Gold” was a play on the phrase “Death of Equities” though some readers thought this meant gold going back to $300 for the next 20 years.

Gold is still in a bull market but now it is time to explain one aspect of gold bull markets that gold investors probably ignore and that is sizeable corrections big enough to be called bear markets. Now when gold investors think of reaping in precious metal profits they think of the gold bull of 1970 to 1980 as a benchmark. The graph for that familiar event is shown below (click to enlarge both graphs).

Many will recount gold at $850 in January 1980 and will tell you that this is somewhere near $2500 in inflation adjusted terms. But not many talk about the big dip in the middle of that bull market. Let’s zoom in on that period between 1974 and 1978 to get a lesson on how bull markets can give the impression they have died never to come back again.

Just like our current bull market, gold got off to a flyer rising by a factor of 5.6 times in five years. Compare that to this current bull which has run for seven years and has risen by a factor of 4.1 in that time. We have here two comparable performances both reflecting the mood of the time.

When gold topped in December 1974 at $195 we were seeing comparable fears to what we have today.

Inflation in the USA had risen from 2.7% in June 1972 to 12% in December 1974 spurred on by a quadrupling of oil prices.

The US Dollar index had dropped from 120 in January 1971 to 98 by December 1974.

The real rate of interest had plummeted from about 3.5% to -4.7% by December 1974 as Fed interest rates failed to keep up with inflation.

Everything looked in place for the gold bull to continue and I bet there were plenty of cheerleaders egging on gold investors at that time!

Then gold corrected and viciously as it lost more than half of its gains and the $195 high of December 1974 was not exceeded again for over three and a half years! How many gold investors were expecting that to happen? Not many I think.

So why did gold correct so much? Inflation dropped down to 5%, the US Dollar Index rallied to 107 and the real rate of interest got back into positive territory at 2.6%.

If such a correction prevailed today, gold would drop below $500 and would not take out $1000 again until the end of 2011. Of course I am not saying that gold must drop to $500 but gold (and silver) investors need to realize that things do not keep going up and up. They need to balance future hopes with past realities. If the 1970s gold bull market teaches us anything it is not to be presumptuous about how high an asset value can go.

But as they say, one man’s disaster is another man’s opportunity. Nail the bottom of this current correction and you will realize even greater profits as gold and silver take off again into the stratosphere in the years to come.

Inflation, the US Dollar and real interest rates all went belly up again as gold hit the bottom in August 1976. Those who got in then at $103 would see gold increase another 8 fold. What is an eight fold increase from a bottom like 1976? Something worth waiting for, that’s what it is.

Comments

[MNSL]

I rate this article as an excellent article. He has given very good detail analysis about gold including past history. Really this article will help intelligent investors to get better decisions.

[John Angstrom]

Roland, this is very useful to know, thanks. I just hope we don't see a 58% decline this time, even if it is followed by an 8-fold increase.

[B. Ray]

Roland,

You mentioned US dollar index, inflation rate, and interest rate in your article. Can you show them all in the graph?

[Paul Airasian]

Roland, good vision and wisdom. During my thirty years following Gold and silver mining shares, I find Buy and Hold (since 2001) has been the best strategy for me, with a small portion of my portfolio for trading.

History, and you relevant posting, shows the shakeouts in Gold are PARTICULARLY violent, weeding out only the strongest hands.

We are in a Strong Secular Bull Market in Gold, with significant historical precedence.

"Put 10% of your assets into Gold, and hope it doesn't work!"

Regards

[EE]

Well, it is possibile for gold to break under 800 as the summer doldrums approach, but reading Ted Butler (found at ) investmentrarities.com , both gold & silver are in manipulated markets to an extreme degree with concentrated shorts trying to activate sellers and begin to cover at least some of their huge,huge, huge, back against the wall position. Since gold has limited industrial use, it operates on percieved values and habits. Silver is industrially important and in very short supply and in a much smaller market. When less than 1% of the gold investors see silver out perform gold, understand the small market shortage, the ungodly short position, and switch gold for physical in fist silver, the climb past $100/oz silver will begin and gold could stagnate. You want to be early in the play this year, probably this month! Junior silver miners planning to dig before 2011 are under valued now along with silver maple leafs, eagles, rounds, and bars. Just read Butler and Jason Hommels silverstockreport.com A lifetime opportunity is on a silver plate. The illegal short position waiting to be destroyed will be a history lesson in the near future. Live it profitably. One last item.. the manipulators can take down gold easily as no real industrial demand is present and thus hope silver will follow as usual. The silver shortage will soon break that strategy. The sooner more take delivery on silver and reduce paper plays the sooner the explosion. Just need one multi-millionaire or large fund to do it and COMEX will be scared stiff unable to get the bars. Its the concentrated shorts using fear that have always started the steep corrections, it will work in gold for a long time, not so with silver.

[EE]

And one more thing ...Butler says he hears that the far east auto makers are looking at replacing platinum with silver in catalitic converters to reduce costs.

[mongoose]

I like the neutral bias of this article. A very open minded look at the possibilities on both sides. Thanks

[petersl]

The major flaw in the reasoning of this writer is to largely ignore the role of the vast dollar decline, not just against other currencies, but against the things that people around the globe use every day. This list includes, not necessarily in order of importance, oil, food, metals, building materials and all sorts of tangible goods, that people require for their standard of living. As the peoples of the undeveloped but rapidly developing world seek a better life, these things will command a premium. To the contrary, financial assets like shares of Citigroup, Countrywide Financial, the whole array of derivative investment paper, is not as appetizing to consume. This whole trend is absent from the writer's analysis. I agree that gold and other precious metals are in a temporary decline, but if you examine the charts from the mid 1970's until the present, you can readily see that the dollar index has convincingly broken through the 80 level to the downside, and the better view is that this is not a temporary phenomenon, as much as general consensus would have you believe otherwise. For those who are interested in learning more about the role of secular bull markets in commodities, one could profit handsomely from a thorough reading of Jm Rogers' "Hot Commodities," which though an unfortunate choice of words for a title, has demonsrated over the past two years, Rogers' prescience.

[paultaut]

Charts are used to deliniate what has occurred in the past...when one compares gold activities to what happened in the 70's, please also look at what happened to the S&P during the same time frame...

The same multi-year double top that occurred then is also in place...does this mean that a revisit will also occur?...

Based on the two charts, I'll stick with oil.

[bill sanders]

Valid, valuable perspective. Most of us know about it, want to forget it, and shouldn't. Something similar may or may not happen -- but we shouldn't be blind-sided if it does. Thanks.

A tangent, Roland, for another post: do the double-long / double-short ETNs play a role?

bill

[dieuwer]

Let's put this in a different perspective:

From 1970 until 1978, gold rose about 4x, from $35 to $140.
From 2000 unti 2008, gold rose about 4x, from $250 to $1000.

Both span 8 years, both increase by 4x.

Conclusion: I am not so sure we experienced the 1973-1975 yet, or will experiece it at all. I just think that the current bull is much less volatile that the one during the '70s AND that we already passed the "1977 point".

[bettyb]

The one difference between December 1974, when gold went down from $195 to $103, and now, is that now, inflation is rising very fast, and there is no reason to believe it will moderate.

[rcwill]

Let us not forget in 1980 Paul Volker had the option to raise interest rates to 2% higher than inflation which was roaring at 15%. And, with a government debt of a mere 1 trillion in a 4 trillion dollar economy he could do that. Subsequently the money came out of gold and into CD's/Treasuries and the dollar went through the roof while gold went into the dump for 20 years.

Now our GDP (app. 13 trillion) to debt (9.4 trillion) ratio is closer to 4-3 rather than 4-1 as it was in 1980 and to do a Paul Volker would cripple the economy, drive up the cost of servicing a growing deficit and put many of our exporters out of business as the dollar would mimic the 1981 climb. Not to mention that the trade deficit would soar.

Inflation may be our only option though not a solution as time will tell.

[BBrown]

Good reminder on what to expect if history has taught us anything at all. When I look at all of the causes that caused the rise in Gold's price to $850 in 1980, and compare what is causing the price to rise now, I do see some similarities, but the price of gold rising to be inflation adjusted from 1980 to now and a price of $2,350 to $2,800 plus the cost of our current causes for Gold's rise in price, war-dollar weakness-real estate devaluation-sub prime loan problems-Derivative problems-unemployment problems-national security problems-immigration problems-foreign trade problems and Oil problems, we're destined to go far beyond just inflation adjusted gold at the levels mentioned above. People live to close to their computers these days. A slight drop in the price of gold and they sell off. In the 70's we didn't have computers to buy and sell at the touch of our fingers. Things are different in a big way and this bull market in gold has a long way to go.

[poet1]

BBrown- very good point on tech's effect on the trading world!

[ACA]

Thanks for the info. The question is, where does one go from here? Does one take profit and run (if you are in the green; if you are in the red, does one cut his or her losses and run). Would appreciate any suggestions.

ACA

[Nawar Alsaadi]

Don't forget ETFs, it is much easier today to buy gold then it was in the 70s, I am seeing gold ETFs launched worldwide, the latest being in Dubai last week, being able to purchase gold through ETFs has opened gold speculation to the masses, the 70s high was driven by pros, today gold bull is being driven by pros + the general public, and since the quantity of gold has not increased massively since the 70s, while wealth and paper money has multiplied multiple folds, the Gold high this time will be much much higher.

The fact that gold crossed $1000 an ounce in March has broken an important psychological barrier, where the sky is the limit, much like oil when it crossed $100, Gold has found strong support at its hold high of $850, and there is not telling how high it will go this time, but it will be much higher in my opinion.


Regards,
Nawar

[enviro111]

This is an excellent article. It is a warning to the unabased bulls who think there is only one way - UP! To the bears it should also be a grave warning that the gold market is really just getting started. There is money to be made on the short side, but you better be smart and quick on the trigger.

If history is any guide, we should ultimately see gold at $8,000/oz. This sounds like a big number but it is not too much different than a move from $35/oz to $800+/oz in the 1970's. The current and future move might even be bigger in real terms. The US economy is much weaker today and primary commodities like oil are declining in supply (forever). Even the primary gold and silver supplies are declining.

Eventually, a major government (China, Russia, Islamic, even the USA) might even make gold it's national currency again. This would send its real purchasing power to the moon. This a long time from now, though.

[CaptBob]

Good basic philosophy: But be proactive not reactive.
Sell a falling dollar and take payment in gold.
And vice versa.

[REBEL]

Am always surprised and bemused that those who delight in slamming Gold ignore the fact that one US Dollar printed today is worth 4 CENTS of a 1916 dollar; however every ounce of Gold - the Midas metal - is still buying the same amount - or more - of "stuff", (food,etc.) as it did in 1916. And Gold will still have value as it did 50 centuries ago while countless fiat currencies have come and gone
in that time.