The Big Picture: Is Gold Going to $4500?

Gold bugs are an interesting bunch. Traditionally known for extremely conservative political views as well as a passion for guns and canned goods, talking to a true gold bug can be a lot of fun if you have an open mind. However, these days, the gold-is-always-good crowd just might have a point or two worth considering.

To the average investor, something that has already moved up ~25% this year and has almost doubled over the past two-plus years may not be considered to be a great value. The average technician might even call such an investment “overbought.” But to the gold bugs who have studied history, it looks like gold is still a good buy as there might be some room to run yet – maybe even a LOT of room.

To be clear, we are not looking at the movement of the yellow metal over the next week, month, or even year. No, forget about the wiggles and giggles you might see on a daily chart; we’re talking about the big-picture here.

Before we ever consider looking forward in the investment game, we have learned that it is often helpful to look at the past. And while anyone owning gold over the last year (or ten) has been loving life, this has not always been the case with yellow metal investing.

I began my investment career in the spring of 1980. Thus, from the time the Hunt brothers got caught trying to game the system until just recently (again, from a big-picture perspective) gold has been a wasting asset. Sure, there were rallies here and there, but for the most part, gold fell steadily for the first 20 years of my career.

Which brings us to point number one of this missive. Although the data series is limited, it is fairly safe to say that from a secular perspective, gold bullion has tended to move inversely to the stock market.

Gold – The Anti-Stock Investment

If you are not familiar with the term, a “secular” market cycle involves a length of time something on the order of at least a decade. For those that know their stock market history, you will recall that the DJIA experienced a secular bear market period from 1966 to 1982, then a spectacular secular bull market through 2000 (during which time the mutual fund industry as well as the buy-and-hold mantra came into their own), and now the stock market finds itself more than a decade into the current secular bear cycle.

Given that the cycles we’re talking about here last an average of fifteen years, most investors don’t have enough experience to be able to identify a change in the cycle or to know what to do when the cycle morphs from bull to bear (and vice versa). However, in studying the data of the last forty-plus years, it becomes very clear that gold is an “anti-stock” investment vehicle.

For example, from April 1968 through August 1982, the stock market was stuck in a secular bear cycle and lost ground at a rate of -6.5% per year. However, during the same period, real spot gold prices sported an average annual rate of return of 9.4% (and it would have been a lot higher if the clock had been stopped a couple of years earlier when gold was above $800 an ounce.)

Although gold prices and stocks headed the same direction for a brief period in 1982-83, from there, gold once again became the anti-stock asset class. And from August 1982 to the beginning of 2000, gold produced an average annualized return of -5.1% per year while the Dow gained +11.8%.

To finish off the discussion of gold’s performance during secular market cycles in the stock market, we should take a look at the current cycle. While the DJIA has lost an average of -2.2% per year since the beginning of 2000, gold has grown at an annualized rate of +12.9%. Not bad, not bad at all.

What can we take away from this little analysis of history? Perhaps the most important point is that since 1906, secular bear market cycles in the U.S. have lasted an average of 14.6 years. Therefore, given the fact that the current secular bear is just 10.8 years old, the stock bears (as well as the gold bulls) may still have some time left on the clock.

Prior Super-Bulls in Gold

The next point a gold bull will want to make is that although the current move has been impressive, previous gold and commodity secular bulls were actually better. For example, over the last 110 years, there have been three massive commodity bull cycles. The shortest lasted 12 years (1968-1980) while the longest stretched closer to 19 years (1901-1920). So again, since this gold bull “just” 10 years old, it may still have some legs.

How far can gold go from here, you ask? The most recent bull run in bullion took place from early 1970 and lasted until late 1981. During this advance, the price of gold rose from $35 an ounce to $825, which in simple terms represents a 23-fold return from trough-to-peak. And since the current gain for gold is about 4.7 times, one could see how there could certainly be some additional upside.

If we expand our look at super-bull cycles to include other markets, we can also argue that gold could keep on keepin’ on for a while longer yet. For example, the super-bull seen in the Nikkei during 1968-1990 saw a trough-to-peak gain of 30.7 times. The oil bull from 1974–1980 rose 9.2 times and the current oil move (1999 to present) sports a gain of 6.7 times. Here in the U.S., the NASDAQ bull of 1990-2000 saw a surge of 15.5x while the Dow from 1921-1929 went up six-fold and the 1982-2000 run advanced 15.1x.

Thus, if we take an average of the ten “super-bulls” seen in gold, commodities, oil, and stocks since 1900, the average trough-to-peak multiple has been north of 17.7x. While this is admittedly a VERY rudimentary analysis, applying a multiple of 17.7 to the trough price of gold for this cycle would put the peak of gold during the current super-bull somewhere around $4,525. So, yes Virginia, if you look hard enough there are indeed reasons to be bullish about the potential upside left in this cycle.

What’s The Driver?

I know what you’re thinking… What could drive gold prices ever high? The mantra that gold bulls have at the present time is “deflation now, inflation later.” And it just might be this concept that carries gold higher for several years to come.

The fear of deflation now is real – just ask Ben Bernanke. We’re of the mind that it is the fear of a Japan-style deflationary cycle that was the primary motivation behind the Fed’s launching of QE2.