Holy cow! How about that gold price this
week? With the Ancient Metal of
Kings powering to awesome new bull-to-date highs, gold traders are
rejoicing. The Bernanke Fed’s reckless decision on Tuesday to
shove the ailing US dollar off a cliff has really
ignited a fire under international gold investment demand.
$725+ gold is indeed
remarkable to behold. It is a
great blessing for us battle-hardened contrarians who were buying gold back in 2001 in the sub-$300
range when even mentioning “gold” in public triggered endless
ridicule. Vindication, especially
since it has been accompanied by legendary profits and rapidly multiplying
wealth, has never been sweeter.
Forging over $725, gold has
truly entered a lofty rarified-air realm where it
has seldom tread. In fact, prior to this week, gold only
closed above $725 Federal Reserve Notes per troy ounce one other time in all of
history! From January 16th to
January 22nd in 1980, gold managed to close above $725 for five consecutive
trading days. The fourth day of
this span, January 21st, witnessed gold’s all-time closing high of
$850. Until this week, over 27
years later, gold never again closed over $725.
So with this metal now at
its sixth-highest closing level ever
in US-dollar terms, the mainstream financial media is weighing in. The same pundits, analysts, networks,
and publications that swore sub-$300 gold was a terrible investment six years
ago are convinced gold’s latest highs are unsustainably extreme. They argue that it is foolish to buy
anything at 27-year highs and even that “a gold bubble” is due to
pop.
But just as they were
mistaken about gold under $300, odds are they are as equally wrong
today. Wall Street has never
liked gold because it thrives when
general stocks languish in secular bears, competing for
investment capital. Governments
have never liked gold because it
exposes their endless fiat-paper inflation schemes. So it is no surprise that the same
establishment that was hyper-bearish on gold every step of the way from April
2001’s $256 to today still loathes this metal.
While gold’s bull
still looks young today in fundamental terms due to global
demand growth far outpacing global mined-supply growth, now I want to focus
on a technical argument. Although
there is no doubt that gold now sojourns at lofty levels in nominal terms, due to the Fed’s
perpetual inflation there is just no real
comparison between January 1980 and September 2007.
Back in early 1980 at the
end of the last secular gold bull, the US dollar was worth a lot more. If you were old enough to buy anything
back then, you know exactly what I mean.
New houses averaged $76k.
The median US
household income was under
$18k. The average new car price
was less than $6k. A candy bar
cost just a quarter. It was a
radically different world in price terms compared to what we face today in autumn 2007.
Prices rise over time
simply because the Federal Reserve
creates too much money out of thin air.
If the money supply rises faster than the actual pool of goods and
services on which to spend it, prices rise. Relatively more dollars compete for
relatively fewer goods and services, bidding up prices. This is the true definition of inflation, which is
exclusively a monetary phenomenon.
Between January 1980 and
today, the US MZM money supply ballooned by 9.1x! Of course the US
economy grew too, but nowhere close to as fast as the Fed ramped
the money supply. So prices had
no choice but to climb much higher
over the last few decades. Even
the US Consumer Price Index has climbed 2.7x higher
since gold last traded above $725.
So comparing 1980 to 2007
in nominal, or non-inflation-adjusted, terms is
irrational and illogical.
Thus the financial
media’s hysteria surrounding this week’s 27-year gold highs,
although technically true in nominal terms, is incredibly misleading. 27 years ago $725 went a whole heck of
a lot farther in terms of purchasing power than it would today. Straight nominal price comparisons
across such vast gulfs of time are an apples-to-oranges kind of thing,
totally useless. They make as
much sense as you trying to live on your 1980 salary in today’s
world. Odds are you’d be
living in a cardboard box and eating cold ramen!
While nominal comparisons
across decades are meaningless, real (inflation-adjusted) ones paint a far
more accurate picture. This
week’s gold highs need to be considered in real terms, adjusted for the tremendous inflation the Fed has
unleashed upon Americans since 1980.
When you look at gold in real terms, a radically different picture
emerges.
To adjust the daily gold
price for inflation in this essay, I used the CPI. Yes, I hate the CPI. Yes, it seriously understates true monetary inflation since the government has huge
incentives to lowball it. Higher
CPI numbers mean higher government welfare payments and hence less funds for politicians’ pet projects. Higher CPI numbers mean more nervous
stock markets and upset voters. Higher
CPI numbers mean the US Treasury will have to pay higher interest rates to
borrow. And higher CPI numbers
shine unwelcome light on the devastating stealth tax of inflation insidiously
and relentlessly eroding our savings.
But despite the CPI being a
total joke, it remains the
most-widely-accepted inflation gauge
among mainstream investors. If I
used true monetary inflation in these charts, the gold prices shown would be much higher. But by using the CPI these gold prices
are very conservative and these arguments will be much more palatable for
mainstream minds. Even the hedonized CPI reveals incredible truths about prevailing
real gold prices today.
In all these charts this
week, the real CPI-adjusted daily gold price is rendered in blue and complimented
by key moving averages. Meanwhile
the usual nominal gold price is rendered in red in the background for
comparison. Of course the farther
back in the past we delve, the greater the gulf between real and nominal
gold. Also, as usual the data cutoff for this essay was Wednesday’s close. So while I am marveling
at $735 gold as I pen this on Thursday, these charts reflect Wednesday data.
We’ll start with just
our current gold bull, and telescope out from there to encompass longer
periods of history. As of
Wednesday, gold’s high in constant 2007 dollars was still below the real May 2006 high of $739. This is very amusing to me, as earlier
this week when the media was trumpeting 27-year gold highs in real terms gold
was merely at a 16-month high! Talk about misleading.
Since April 2001 this gold
bull has powered 182% higher in nominal terms or 146% higher in real
terms. Such returns are awesome
in an absolute sense, but even more amazing in a relative sense. Gold’s gains since the early
2000s utterly dwarf those of the general US
stock markets, which have largely ground sideways. And most of gold’s gains, until
late 2005, came in conservative fashion via a moderate uptrend. Such persistently higher prices in the
face of such mainstream hostility reflect overwhelmingly bullish underlying
supply-and-demand fundamentals for this yellow metal.
My flippant 16-month
real-high scenario aside, in reality gold is pushing 19-year real highs as this next chart reveals. Gold last traded for sustained periods
above $725 in today’s dollars between 1986 and 1988. Now multi-decade real highs are
certainly nothing to scoff at, but they are a far cry from the nearly
all-time nominal-high scenario the financial media is promoting to scare
investors away from this gold breakout.
Back in late 1987, gold
challenged $900 in today’s dollars. Granted, the final months of that
particular upleg were driven by the fear generated
from the 1987 stock-market crash, but it still shows that gold can go higher
than today’s levels without the world ending. Interestingly in all of 1987 before October, gold averaged $805 in
today’s dollars. First
heading over $725 real in August 1986, the metal remained above these levels
until September 1988.
And other than the October
1987 stock-market crash, a weird one-day mid-bull anomaly caused by the first widespread use of computer
trading on a panic day, August 1986 to September 1988 was not all that
remarkable. Yet real gold traded
above today’s levels for this entire span of time because these were the clearing prices where supply
and demand met. With gold trading
above today’s levels for two solid years so recently, it really makes
today’s highs seem a lot less intimidating than the financial media
claims.
But real gold gets the most
interesting when we look at the really
big picture, since 1970. Once
properly adjusted for inflation to make a legitimate apples-to-apples
comparison, today’s gold levels look positively low compared to the
strong gold prices of the early 1980s.
This real blue line, as opposed to the red nominal one, is the only
rational way to view the gold price over such a long multi-decade span of
time.
Note that gold in constant
2007 dollars spent the better part of five
years over $750 in the early 1980s!
In order to get anywhere close to hitting an all-time real high today,
gold would have to rocket to nearly $2300 per ounce! This, more than anything, puts
today’s gold levels in proper perspective. Gold may be high in nominal terms
today, but it remains quite low relative to where its last secular bull gave
up the ghost.
It is also interesting to
consider today’s gold levels relative to the major secular gold highs
of the past four decades. There
have been seven of these highs, all of which are numbered above. For every secular high, the
inflation-adjusted gold price is labeled in blue
and the nominal one in red. While
the gold price is certainly significant today, it is still only higher than
one of these six secular real highs so far.
Although this chart is
pretty self-explanatory, that gold is not all that high today compared to a
secular bull top, there are some interesting observations to consider. For example, note that it was near
$750 real in 1979 when gold went parabolic and tripled in about 8 months.
It is provocative that we are once again nearing the same real levels
at which the last gold superspike started. On the other hand though, gold’s
biggest slump of the 1970s also started near $750 real in late 1974. I’ll discuss this further after
the next chart.
Before that though, I do
realize $2300 gold seems impossibly high today. But we shouldn’t underestimate
the power of secular bull markets.
Believe me, six years ago this month when gold was trading under $295,
$725 seemed impossibly high too. Yet
here we are. Long-term bull
markets are governed by supply and demand. And since it can take a decade for gold miners to respond to
high price signals by bringing new mines online, the gold price can go much
higher and stay for much longer than most imagine.
And incredibly, in some
ways the all-time $2300 real high shown above is conservative. Of
course the CPI is lowballed for political reasons,
being reported as far below monetary inflation. As mentioned above, US MZM money has
grown by 9.1x since early 1980. In order to witness such a gain over
27 years, an annual compound growth rate of about 8.5% is required. This should be much closer to true
inflation than the 3.7% compound CPI growth required over 27 years to see it
multiply by 2.7x.
But the gold market is
global, and around the world the broad money supplies for first-world nations
generally average growth rates around 7% a year. This leads to a conservative estimate
of 6.2x more paper money sloshing around the world today than in January
1980. Of course non-first-world
countries often have much higher money-supply growth rates, which is one
reason this 7% estimate is conservative.
Meanwhile, all the mining
in the world only manages to grow the global gold supply by about 1% a
year. Provocatively this average
has held for centuries due to the extreme difficulty of wresting gold from
the bowels of the earth. This
slow natural growth in global gold is why it has been the ultimate form of
money throughout all of history. Since
it cannot grow fast due to natural limitations, excessive inflation is
impossible. At 1% growth annually
over 27 years, today’s gold supply should be 1.3x as big as
1980’s.
So we have a 27-year
estimate in first-world fiat-currency-supply growth of 6.2x compared to 1.3x
in global gold-supply growth. Dividing
these numbers shows paper-money growth outpacing gold by 4.8x. So based on these assumptions there is
4.8x as much paper money floating around today per ounce of gold as there was
in 1980. If you multiply the
nominal $850 gold high of January 1980 by 4.8x, it yields $4000 per
ounce! Yes, the climax high of
today’s secular bull could briefly drive gold to such staggering
levels.
But even this may be
conservative! In early 1980, Asia was
slumbering. Today it is
awakening. Several billion people
are industrializing and seeking to raise the standards of living for their
families. This is fueling global commodities demand the likes of which the
world has never seen. As these
Asians grow more affluent, they are going to invest in gold. Unlike the West, Asia
has a deep cultural affinity for gold (and distrust of paper money) that will
never fade. And if a modest
fraction of 3b Asians get excited and buy even small amounts of gold each,
the potential mania highs in this gold bull are just unimaginable.
So truly the $2300
CPI-adjusted gold price of January 1980 is conservative in many ways. And today’s $725ish gold is so
far below the stellar levels that ought to be seen at the next secular top
that this bull can only be considered young. So don’t let the financial media
convince you that gold over $700 is an extreme event that is
unsustainable. Nothing could be
farther from the truth based on history.
This final chart shows the
famous 1970s secular gold bull in today’s dollars. I believe it is useful as a general pattern, to illustrate the
major stages that secular gold bulls go through. While our current bull isn’t
going to follow this technical pattern precisely, it should go through the
same three major stages.
Early on, gold is primarily
bid higher because the predominant
currency is being devalued. Only
contrarians buy in Stage One as gold remains way out of popular favor. After
some years in Stage One, Stage Two arrives. Investors start to notice gold rising
and soon buy it for its own intrinsic fundamental merits. The sharp gold upleg
in late 2005 likely marked the arrival of Stage Two in our current bull. Thus I suspect we are early on in
Stage Two at this point, kind of like 1977ish in this chart.
Eventually so many
investors will buy gold that the general public becomes aware of its
bull. Since there is no rush like
a gold rush, the public will flood in to the market late in the bull’s
life. This popular speculative
mania is what drives Stage Three.
Gold shoots parabolic and ultimately climaxes in a vertical blowoff top. In
the 1970s, this mania stage started in mid-to-late 1979 between
$750 to $1000 real. Obviously
the biggest gains of the entire gold bull by far happen during this brief
mania stage.
The key lesson here is that
when gold is really ready to hit a secular top in our current bull, everyone will be enthralled by
it. Housewives will be trading
gold futures. Shoeshine boys will
be offering tips on junior gold stocks.
CNBC will report on nothing but gold all the time. At every social gathering, talk of
gold stocks will be as popular as talk of tech stocks in early 2000. Obviously we are nowhere close to such
a popular mania yet. I bet 19 out
of 20 people on the street still have no idea that gold is over $700 again.
Although gold ought to once
again follow the general three-stage pattern in this chart, I don’t
think it is precisely transferable to our current bull. Sometimes people ask me if a slump
like 1975 and 1976 is imminent or if we are on the verge of a blisteringly
fast tripling in gold like in late 1979.
I suspect neither is the case.
Today’s gold bull has a life of its own and is not a carbon copy
of its 1970s ancestor.
On the slump, our wonderful
government had actually banned
Americans from owning gold bullion between April 5th, 1933 and December 31st,
1974! But as usual when Washington
operates outside the Constitution, most Americans ignored the confiscation
order. In 1933 the only gold
bullion Washington
could seize was the gold kept in bank “safety deposit”
boxes. Americans who held their
gold bullion outside of banks almost universally ignored Franklin
Roosevelt’s appalling theft of private wealth.
So when 1975 rolled around,
a lot of this “underground” gold bullion hit the market. Families had held their gold bullion
for four decades and suddenly they could legally sell it in early 1975 just
after gold had rocketed 419% higher in the early 1970s. There is no similar pent-up selling
pressure today. And it
wasn’t easy for American investors to buy gold bullion in 1975
either. After 41 years of bullion
being considered an Enemy of the State, coin shops were generally not selling
low-premium bullion coins. Today
buying gold is as easy as buying groceries, and the gold ETFs
can even be purchased in a stock trading account.
And central banks in the
mid-1970s controlled a vastly
larger proportion of above-ground gold than they do today. So their perpetual sales had a far
greater effect in 1975 and 1976 than will ever be possible again. The nearly tripling of gold since 2001
despite the best that the central banks could throw at it decisively
demonstrates that they are impotent.
They are just collectively too small relative to the 80%+ of
above-ground gold held by investors.
The Information Age also
argues against another mid-bull multi-year gold slump. Thanks to the Internet, the spread of
financial-market knowledge is exponentially faster than it was in the
1970s. And if there is one thing
that gets investors and speculators excited about deploying capital, it is rising prices.
So higher gold prices should get more people interested in gold
investment today a lot faster which greatly lessens the probability of a
slump. And don’t forget the
arrival of hundreds of millions of new gold investors out of Asia today who had no
capital in the 1970s!
On the popular mania and
vertical blowoff, I think there is a high probability
our gold bull will eventually enter Stage Three. But I believe it is some years off
yet. Our current gold bull
started in April 2001, only about six years ago. The 1970s one ran for nearly a decade
before the public grew enamored with gold. Also, broader secular commodities
bulls tend to run for 17 years or so in history. While today’s various
commodities’ bulls started at different times, at best we are now only
one-third of the way into our current 17-year commodities-bull cycle. It is hard for me to imagine gold
hitting a secular top many years before
commodities in general.
Only time will tell of
course, but today’s gold bull still looks relatively young. Real gold prices remain quite low
compared to historical highs and gold is still largely ignored by mainstream
investors. Most of the general
public still doesn’t even seem to know it exists. While gold will correct from time to
time, a multi-year slump like the mid-1970s seems unlikely. And while gold will eventually go
parabolic, it should be some years later in this gold bull after Stage Two
fully runs its course.
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The bottom line is gold
remains nowhere close to its last secular bull’s real highs of early
1980. Despite what the financial
media claims, it is just plain silly to compare nominal prices across
decades. Once you adjust the gold
price by the most lowballed and conservative
estimate of inflation, $725 gold is just one
third of the way to the $2300 Stage-Three mania highs witnessed in
January 1980.
And gold generally traded
above today’s real levels for the vast majority of the entire
1980s. Yet the world as we know
it didn’t implode. The fiat
US
dollar didn’t hyperinflate, the US
stock markets remained in a young secular bull, and the bond markets
thrived. $725+ gold is really not
that big of deal historically and there is no doubt that it is quite sustainable.
Adam Hamilton, CPA
Zealllc.com
September
21, 2007
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