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Supply / Demand: The favoured series
of fundamental analysis has been jewelry consumption, which we do not
specifically cover. However, ostentatious consumption has been a feature
of every great inflation in financial assets and, in our example, jewelry
would likely be a part of the play, but this was expected to be
overwhelmed by a drop in price and demand typical of, now, all financial
bubbles.
Then once the mania was over, jewelry and
other ostentatious consumption has been likely to slump, but this would be
overwhelmed by increasing investment demand typical of a post-bubble
contraction.
We have long considered that the decline in
the deflated price would be a proxy for the slump in investment demand
with the boom and for its increase during the bust. (There is more to it
than this and it will be expanded in the "Philosophy" section below.)
Nearer Term: Once the low for the real
price (relative to commodities fit best) was accomplished in November,
2000, the first speculative high would likely be set around May, 2002.
Actually, that was rather a long-term call and the reliability of the
model was independently confirmed by ChartWorks technical analysis which,
on May 23, noted that both gold and gold shares had registered a rare
simultaneous "overbought" condition. With only 6 such occurrences since
1970, the last was in 1993. Senior golds were likely to decline by about
30% with more possible for speculative favourites (4).
The combination of two independent methods
provides a conservative "belt and suspenders" approach. Technically, most
of the shorter term swings have been called in a timely fashion. All
together, the combined approach has been successfully employed by
producers and fund managers for major policy decisions as well as a guide
for trading desks.
Philosophy: Over the past 300 years,
there have been only two periods when the senior currency was
inconvertible. That was from 1797 to 1819 and from 1971 to date. Each
enjoyed a rally as gold's nominal price advanced with the final stages of
an extraordinary inflation in tangible assets. In so many words, the
purchasing power of a fiat senior currency was marked down relative to
gold and commodities. Gold "rallied" from 1797 to 1816, which was the
natural high for that era of inflation. On the next example, gold's
nominal price rallied from 1970 to January, 1980.
Nine-year trends are frequently seen in
different time series and only the latest one (in the 1970s) for gold "as
a commodity" has been adopted as orthodoxy. Essentially, this convention
has looked at an enormous expansion of credit and has been disappointed
since, but so far not enough to review the big picture.
Ours was completed in 1980 when our
controversial observation was "no matter how much the Fed prints,
stocks will outperform commodities". More specifically, we also noted
that gold's deflated price typically declined during a new financial era
as real long interest rates also declined. As it turns out, this is
opposite to the academic work of Keynes, Gibson (of "The Paradox") and,
more recently, former Treasury Secretary Summers. Possibly, they
deliberately avoided gold's behaviour through new financial eras or were
ignorant of their power.
It is essential to have a conception on gold that works throughout the
main conditions of history.
Of course, during a gold standard, gold and money are synonymous and in 5
bubbles from 1720 to 1929 gold declined to a significant low. During our
regime of fiat money, gold went down until the new era blew out and, in
doing so and in spite of contrary establishment notions, it was acting
remarkably like money.
During the contraction consequent to all five bubbles prior to 1929, gold,
which was money, increased in purchasing power relative to most items most
of the time. Since our great financial boom ended so dramatically, gold's
purchasing power has been increasing relative to most items (particularly
against the Nasdaq) and is behaving remarkably like money does in a
post-bubble contraction.
Although New York did not have the stature of London in 1873, it was a
fairly sophisticated market. Well, except for suffering a government
monopoly on the currency, which provides another example of a financial
mania conducted with a fiat currency. Naturally, there was a market price
for gold in nominal as well as deflated terms and both declined to a
significant low in November, 1873 as the bubble concluded in September.
During that example, even the scorned "greenback" acted remarkably like
money on the way up the boom and during the consequent contraction.
Naturally, the establishment scorned gold and the usually admirable
President Lincoln ranted: "For my part, I wish every [gambler in gold]
had
his devilish head shot off.".
Yield Curve: Beyond the correlation with real long interest rates through
the conclusion of a financial mania, gold's turning point has occurred
with the reversal in the treasury curve.
During each example, the curve has inverted as gold's price declined and
then the curve reverses to steepening as gold goes up. More specifically,
at the end of the 1873 mania, the curve reversed to steepening in November
and that was the secular low for gold. This timing was replicated in 1929
and both became the model that expected gold and the curve to reverse in
November, 2000. Gold's price relative to commodities made the turn in
October (close enough) and the curve reversed to steepening in November,
2000.
In all previous examples, steepening was significant and mainly driven by
short-dated treasury rates declining precipitously. After March, this was
expected to resume with such rates being much lower by Fall as gold prices
are much higher. The 90-day bill rate dropped from 118 bp in March to 81
bp recently.
Wrap: In 300 years, there have been only two times when gold enjoyed a
huge rally with commodities. Each lasted for nine years and was part of
the ending phase of a long period of inflating prices for tangible assets.
At all other times, whether the senior currency was convertible or not,
gold was, or acted as, money. In this regard, it's a moot point whether
boom items soar in price or the purchasing power of the currency/gold is
marked down.
However, it is very clear that following every previous bubble, enormously
expanded, but normal, instruments of credit relentlessly contract in a
massive revulsion of debt. In all cases, Mother Nature filled the
liquidity vacuum by increasing the real price of gold to stimulate a
massive increase in production which, in turn, began to restore liquidity.
Outlook 2003: Using just the last three post-bubble examples, gold's price
as deflated by the CPI increased as follows:
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