Gold's performance over the past month has truly been epic.
Since late October, it has soared 18.2% higher. Over a 21-trading-day span,
no fewer than 16 days achieved closes at new nominal all-time-record highs!
Even the perpetual gold disdain from Wall Street and the financial media is
fading.
With gold surging so rapidly and relentlessly, growing numbers
of investors and speculators are wondering if we are now entering the
long-awaited Stage Three gold bull. Over 5 years ago, when gold was trading
at $400, I wrote an essay describing the evolution of
a secular gold bull through 3 distinct stages.
Stage One stealthily emerges out of a secular-bear low when
everyone loathes gold. In response to a devaluation in the dominant currency,
this metal starts quietly creeping higher. Stage One in today's bull began in
April 2001 and ran for over 4 years. It was marked by modest yet consistent
gains in gold.
Once global investors figure out that gold is moving up on its
own supply-and-demand-driven fundamental
merits, Stage Two dawns. More and more
investors "discover" gold and deploy increasing amounts of capital
in it. Today's bull transitioned into
Stage Two shortly after euro gold broke decisively above
€350 in June 2005.
A gold breakout in a secondary currency may not sound like much,
but it was a game-changing event that finally convinced global investors that
the young gold bull was the real deal. Before that to everyone but Americans
(who see gold through a dollar-centric lens), gold's strength was perceived
as nothing more than the other side of the dollar-bear coin. They thought
gold was only rising because the dollar was falling.
Stage Two can run for many years, it is the longest phase of a
gold bull's lifespan by far. It persists for so long due to the way bull
markets affect investor psychology. Early on in a bull, few investors believe
it is real so little capital chases it. But as a price powers higher, more
and more investors start to believe which gradually yet relentlessly
increases capital inflows. This drives prices even higher, forming a virtuous
circle that attracts in even more investors. All this takes a long time.
Some bulls end at Stage Two, but the truly great ones ultimately
transition into Stage Three. Lasting less than a year, this is the terminal
phase of a secular bull. After professional investors are already fully
deployed in gold, the general public soon grows enamored with it and wants in
at any price. The resulting massive influx of capital drives a popular
speculative mania and its resulting parabolic blowoff.
Think of the NASDAQ tech-stock mania in early 2000. Tech stocks
were all over the mainstream news, and everyone wanted in no matter
how little capital they had. People were mortgaging their houses to buy
speculative tech stocks trading at hundreds of times earnings. Conversations
everywhere in all walks of life eagerly discussed the tech-stock boom. There
is nothing else like a Stage Three speculative mania, they are impossible to
miss.
So much capital flooding in so fast drives vertical price gains,
a parabolic ascent. The last Stage Three gold parabola unfolded over several
months climaxing in January 1980 at $850 (just under $2400 in today's
dollars). That event was blisteringly fast, gone
in the blink of an eye. Over the final 10 trading days leading to the end of
its bull, gold soared 34.1%. Over the final 20 trading days, it was up 80.3%.
And over the final 30, just 6 short weeks, it nearly doubled with a 95.9%
gain!
Now despite November 2009 being exciting, it was nothing
remotely like a Stage Three blowoff top. At best over the past month, gold's
gains over any 10-trading-day, 20d, or 30d span ran 8.8%, 15.7%, and 15.1%.
These are obviously a far cry from the last Stage Three climax's 34%, 80%,
and 96%. So there is no doubt at all that we have not witnessed
anything Stage-Three-like in the recent exceptional gold strength.
But even though gold clearly hasn't entered Stage Three, could
it be on the cusp of rocketing parabolic as many analysts assert today? The
only honest answer is sure, of course it could. Anything can happen in the
markets, and none of us mere mortals can see the future. It is even the right
time of the year, a seasonally-strong
period for gold that also happens to coincide with the last Stage Three
climax from November 1979 through January 1980.
Nevertheless, for a variety of reasons I am almost certain our
current gold bull is nowhere close to Stage Three yet. Gold isn't
going parabolic anytime soon, so if you are planning on retiring in early
2010 from the next few months' gold gains I suspect you'll be sorely
disappointed. As any student of the markets who has studied history and
psychology can tell you, today's conditions are all wrong for Stage Three
dawning.
Think of bull markets as popularity contests. The higher prices
go, the more popular those assets get. And the more popular the bull gets,
the more investors deploy more capital to chase the gains. Stage Two
chronicles this journey from relative obscurity among investors to widespread
adoration. This long stage lasts until professional investors are fully
invested. Has this happened yet with gold? No way.
There are many ways to illustrate this truth. In the new
December issue of our Zeal Intelligence monthly newsletter, I outlined a
couple key ones. Despite the GLD gold
ETF's huge success in enticing stock-market
capital into gold, stock investors are still incredibly underinvested. At the
end of November, the market capitalization of GLD only ran about 0.4% of the
combined market cap of the elite S&P 500 stocks.
Are stock investors fully invested in gold yet at an allocation
of under a half percent? At today's levels they have barely even started
deploying in gold! I don't know if "fully invested" in this bull
will ultimately cap out at 5%, 10%, or even 20%, but it is certainly not
going to be 0.4%. Central banks are also big gold
investors, and the growing Eastern CBs are woefully underinvested in gold.
The top 5 Asian CBs in terms of gold holdings now have an average of just
3.5% of their foreign-exchange reserves in gold.
Is this fully-invested? Certainly not. For comparison the top 5
Western CBs have an average of 64.8% of their forex reserves in gold bullion
today! Given the Eastern CBs' undiversified heavy exposure to the ailing US
dollar, which has been in a brutal secular
bear since July 2001, it is impossible to
imagine them not wanting to sell more dollars and buy more gold. Like
American stock investors, Asia has barely even started investing in gold.
How can Stage Two transition into Stage Three when the only
investors with heavy gold exposure today remain a relatively small fraction
of contrarians? It can't. Stage Two will not reach maturity until large
professional investors all over the world have great-enough allocations in
gold to consider themselves fully invested. I suspect it will be many years
yet before professionals reach this milestone.
And simply having professionals fully invested in gold is not
enough to spark Stage Three on its own. Even more important is popular
psychology. For a Stage Three parabola to ignite, ordinary folks who aren't
even serious investors have to utterly fall in love with gold. We need to
see a popular gold rush flare up across the vast majority of the
populace that doesn't even follow the financial markets on a regular basis.
As the NASDAQ bubble proved, the seeds for a popular speculative
mania are not sown overnight (or even in a few months). It really takes years
to prepare the soil of popular psychology for a mania. While gold's favorable
exposure in the financial media has grown considerably over this past month,
all this coverage is just a drop in the bucket compared to what is necessary
to enthrall the people.
Leading up to the early-2000 NASDAQ bubble, tech stocks had at
least 18 months of all-the-time everywhere coverage in both the financial and
mainstream media. Over this long span, CNBC talked about tech stocks all
day everyday. Nearly every cover of every financial magazine, and many
non-financial ones, featured the tech boom and profiled the vast riches to be
made. Mainstream newspapers, news shows, and even afternoon talk shows spent
endless time exciting people about tech stocks.
Back in early 2000, if you had picked random people and asked
them what they thought of tech stocks, nearly all would have been eagerly
trying to invest. The popular enthusiasm was pervasive and overwhelming,
impossible to escape. Contrast that with gold today. If you ask the average
person you see anywhere whether they are excited about gold investing, the
vast majority will give you a dumb stare.
While today's hardcore investors and speculators who religiously
follow the markets and financial media may feel like gold is becoming
popular, our perceptions are skewed. Sure, gold is more popular in this
specialized realm than ever before in this bull. But to an average casual
investor who doesn't follow these things, at best all they've seen is some
sporadic gold-coin and scrap-gold commercials on mainstream TV. Popular
psychology among normal folks has barely even started considering gold, let
alone getting excited about it.
And without people who've never been gold investors rushing in
to become new gold investors solely to plow their lives' savings into gold,
we won't see a Stage Three parabolic blowoff. They are called popular
speculative manias for a reason, because they extend far beyond contrarians,
professional investors, and even mainstream investors to a general populace
that isn't yet in the gold market in any meaningful way.
Professionals are not fully invested in gold and mainstream
casual investors still largely aren't paying attention to it. So neither the
capital foundation nor sentiment foundation necessary to undergird a Stage
Three superspike have been laid yet. This is all well and good, but it still
doesn't address gold's awesome gains in this past month. After seeing such
"unprecedented" gold activity, doesn't it still behoove us to
accept that "this time is different, gold really could be going
parabolic".
I mentioned that at best in the past month, gold's 10d, 20d, and
30d gains ran 8.8%, 15.7%, and 15.1% respectively. This may seem impressive
if you haven't been actively trading this gold bull very long, but it really
isn't exceptional in context. And despite perceptions in the financial media
which is full of reporters and analysts only "discovering" gold
now, there is nothing unprecedented at all about gold's recent gains.
This chart documents the entire secular gold bull to date.
Underneath the gold price in blue, I rendered gold's 10-trading-day (yellow),
20d (orange), and 30d (red) returns over every such span in this bull. When
you study this history, it quickly becomes apparent that gold's behavior over
the past month is not exceptional. In fact, gold's recent returns don't even
jump out as particularly impressive relative to this bull.
Let's start by establishing some context here. Stage One ran
from April 2001 to June 2005 when euro gold broke out above €350. Note
that gold's progress was relatively muted when it was primarily just
mirroring the dollar's decline. When global investors started chasing gold
and transitioning it into Stage Two, the magnitude of its uplegs multiplied
considerably. There have been 3 large Stage Three uplegs that are all labeled
above. And both previous ones conveniently ended without a Stage Three
parabolic blowoff.
Check out the first Stage Two upleg that ended in May 2006. On
the day that gold upleg climaxed at $720, its 10d, 20d, and 30d returns ran
13.6%, 20.6%, and 25.6%. This translates into 1.6x, 1.3x, and 1.7x gold's
best gains over this past month. And this was a perfectly normal Stage Two upleg,
gold wasn't emerging out of a stock panic like it was in early 2009. Yet
Stage Three didn't ignite.
If you were trading gold and gold stocks back in May 2006
though, you remember that the
hype then was very comparable to
recent weeks'. Like today, gold was getting increasing face time on CNBC.
Like today, predictions for imminent parabolic-type price surges abounded.
Like today, momentum-seeking traders believed gold was on the verge of a
superspike and chose to buy most aggressively right when gold was topping.
Sadly the markets always work this way. Most investors are not
willing to put in the time and effort to train themselves to be emotionally
neutral, nor to study market history to recognize what it looks like when
greed or fear start to get out of hand. Thus most buy in near tops and get
killed in the subsequent sharp corrections, and then they sell in disgust at
the resulting interim lows. It's the recipe for financial ruin.
Since Stage Three bull-ending parabolas are such exceedingly
rare events, once every third
of a century or so on average, the
probabilities wildly favor any sharp move higher merely representing a
short-term overbought condition within a bull instead of the precursor
to the end of that bull. And when you consider that Stage Two hasn't matured
yet and the groundwork for a popular mania hasn't been laid yet, it is almost
certain that gold's big gains today also merely represent overboughtness.
A key peculiar tendency in overbought times is the widespread
attempts to justify further technical gains with fundamental
arguments. You've heard them, gold will continue higher because the dollar is
weak, or central banks are buying, or mining it is getting harder, etc. All
these things are certainly true, and bullish. But realize gold's fundamentals
were just as bullish in past overbought times yet the metal still
corrected hard. Long-term fundamentals never override necessary
rebalancings of extreme short-term sentiment!
At Zeal we've been actively trading this gold bull since I first
recommended physical gold coins for investment at $264 in May 2001. We've
earned our subscribers fortunes in the major uplegs while shepherding them
through the inevitable periodic corrections. Instead of succumbing to hype,
be it greed or fear, we continually study the gold markets' sentiment,
technicals, and fundamentals to give our subscribers the greatest odds for
success in their own investing and speculating.
The hot-off-the-presses December issue of our acclaimed Zeal
Intelligence monthly newsletter analyzes
the recent gold surge in depth from a variety of perspectives. In it I
examine the psychology that drove this move, gold's latest supply-and-demand
fundamentals, what happened immediately after similar fast-gain episodes in
the past, and how other markets could heavily influence gold's upcoming price
action.
Subscribe today and become an informed investor! At just $10 a month for 8
pages of world-class research, why would you not? It's a steal. In addition,
first-time e-mail-PDF-edition subscribers get this hot new December issue for
free. Your paid subscription will start with the January issue. You can
harness our endless research and formidable market wisdom at Zeal for your
own advantage.
The bottom line is gold is not going parabolic despite all the
hype today. Only a popular speculative mania can drive a bull-ending vertical
superspike, and we are still years away from one. Not only are professional
investors barely starting to buy into this gold bull now, but it remains
largely unknown among casual mainstream investors. While the recent gold
surge was exciting, it isn't exceptional for this bull.
Gold has indeed rallied far and fast, but rather than a
bull-ending omen it merely looks like a mature upleg in need of a breather.
Both the recent surge and its likely consequences are typical when short-term
greed leads to prices becoming overbought. So be wary of all the gold hype
today. Remember that the financial media always gets the most excited at
exactly the wrong times, just before highs yield to pullbacks.
Adam Hamilton,
CPA
Zealllc.com
November 6, 2009
Also
by Adam Hamilton
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