Gold Bugs, Don't Panic (Yet): A Historical Perspective

Includes: GLD
by: Matthew Salter, CFA

For those readers who have become accustomed to my few contributions to SA, you will be aware that I like to look through short term trends and identify the bigger picture. This is partly because short term trends are so difficult to identify at the time. And secondly, because (unsuccessful) investors tend to react instinctively to short term price action, whilst ignoring longer term trends. This is often understandable from a behavioral psychology point of view, often encouraged by dramatic headlines, but will lead to the retail investors selling low and buying high.

So, with gold tumbling 5% or more over Friday and another 7% or so today (Monday 15th April) at the time of writing, this is a classic moment to stand back and look briefly at some longer term trends, whilst ignoring Friday's headlines ("prices dive" , "gold plunges") which will have denied skittish investors the pleasure of a worry-free weekend.

Let's start by looking at gold since 1979, when daily data is available from the World Gold Council.

In that period of just over 33 years, gold has had a daily fall (dive, plunge …) of more than 5% on 33 occasions, or an average of once a year. With the last daily fall in gold of over 5% having taken place in September 2011, perhaps we were due another similar daily move. In fact, way back (!) in 2008, gold fell almost 8% in October followed by another fall of over 5% three days later. Which is remarkably similar to the fall over the last couple of days. And yet that drop in 2008 is but a distant memory. Though even that pales in comparison if we go all the way back to 1980 when gold fell by over 13% in a one day move.

If we look at the long term graph, the longer term trend does indeed look a bit like a popping bubble:

(Click to enlarge)

But I prefer to look at gold on a logarithmic scale because it offers a much clearer perspective on the volatility and returns of the asset. (For those unfamiliar with the concept, a $10 price move when gold is worth $100 is far more significant than a $10 move when gold is worth $1,000. A logarithmic scale corrects for this and shows proportional changes as being equal, as opposed to a regular graph which shows absolute changes as being equal).

The long term logarithmic graph for gold is shown here:

(Click to enlarge)

Suddenly, the bursting bubble doesn't look quite so scary. Yes, this is a strong bull market which appears to have stalled recently. But no "plunging" gold price quite so evident here.

The following graph shows the same logarithmic scale, but zoomed in to just the last decade or so since the current bull market of 12 positive annual returns began.

(Click to enlarge)

Again, evidence of a stalling bull market but no fundamental reason to panic. Indeed, within this bull market there have been three significant drawdown periods. These are shown in the table below:

Beginning of drawdown

Drawdown Loss

Length of drawdown

February 2003


7 months

May 2006


17 months

March 2008


18 months

Current drawdown

Sept 2011


19 months

We can see that the present drawdown, even though it is the longest so far of the current bull market, is still similar in magnitude to two other 20%+ drawdowns that have occurred over the last 7 years.

This article is not arguing about whether or not gold is fairly valued or not. Indeed, I don't have any view on that for good reasons, as I set out in my previous article on the precious metals. I believe gold is almost impossible to assign a fundamental value - there are no earnings, no cash flows, no coupons, etc.

But all the reasons that (other) people have been arguing are the fundamental drivers of gold over the last ten years still seem to be in place. QE is alive and well and shows little sign of finishing abruptly. On the contrary, Japan has just embarked on a historically unparalleled new path of massive money printing. Another important argument that is made is that gold serves as a hedge or insurance ticket against inflation. Well, inflation has been low for many years and it doesn't seem to me that there is any reason just now to abandon this insurance ticket.

So, if you believed in the fundamentals for buying gold before this weekend, it appears that nothing significant has changed to alter those fundamentals. Of course, a 10% loss over a few days generates worrying headlines. But if you're a gold investor, it's worth stepping back and putting the current situation into a historical perspective to see that there have been previous periods where gold suffered (even greater) nerve-wracking losses before continuing its relentless march upwards.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.