 Gold Bulls' Three
Stages
Adam Hamilton
Archives
Sep 3, 2004
As the unofficial end of summer
storms in over this long weekend in the States, I find myself
pondering the changing demand profiles over the lifespan of a
typical secular bull market in gold.
The word secular, which has
a dictionary definition of "going on from age to age,"
is used to describe any major market trend that runs for a long
period of time. For a general mental yardstick, I think that
a bull or bear market running for a decade or so lands right
smack in the middle of the annals of seculardom.
The Great Gold Bull of the
1970s, for example, ran from 1970 to early 1980, exactly one
decade. While gold did not rise in every single year, when you
look at a long-term chart (see below) this secular bull market
is utterly unmistakable. Secular bulls in general stocks tend
to last even longer, usually two
decades each, like the Great Stock Bull of the 1980s and
1990s.
Since the average investor
really only has four decades in which to build his or her fortune,
from the ages of 25 to 65, any trend that runs for a decade or
more sure does feel like it is going on from age to age!
A secular bull or bear can easily run from a quarter to a half
of an entire average investing lifespan. Thus it is unbelievably
important to run with these primary trends since getting
even one wrong could cost an investor half their investing life.
The price for fighting these secular trends is staggeringly high.
On the short end of the measuring
stick, I think the absolute minimum amount of time necessary
for a trend to attain secular status is three years. If any trend
runs for less than three years, then it should be considered
cyclical instead of secular. Thus it is pointless to even
think in secular terms until a trend has been fire-tested and
battle-proven for at least three years. Which brings us to our
current gold bull.
On April 2nd, 2001, gold was
battered down to a devastating 22-year
secular low just under $257. This formed a massive double-bottom
with similar gold lows on central-bank
gold sales in late summer 1999. Prior to 1999, even in nominal
terms gold had not witnessed such dismal prices since 1979, ages
and ages ago. At the time in 2001 gold sentiment was understandably
horrendous, with high-profile predictions of sub-$200 gold abounding.
Yet, as markets are wont to do, gold's secular trend stealthily
changed during its darkest hour.
As I hammer out this essay
exactly 41 months to the day later, gold's glorious new bull
market is finally readily apparent to all. From April 2001 to
April 2004, the requisite three-year minimum necessary to catapult
gold's current bull market into the elite ranks of seculardom,
gold has soared over 66% higher. Since we are already three-and-a-half
years into gold's present bull, we have to start thinking in
secular terms. Only then can we begin to understand what
wonders might lay ahead for gold investors.
Now naturally the tools used
to analyze a strategic secular bull are far different from those
used to speculate on short-term tactical trends oscillating within
the primary secular trends. While various
technicals tools are crucial for short-term tactical speculation,
long-term analysis is exclusively dependent on fundamentals.
The most foundational of all
the fundamentals is supply and demand. As long as demand exceeds
supply, prices will be forced to rise over the long term.
This elegant mechanism is the ultimate way that free markets
allocate scarce supplies to those most willing to pay for them.
Eventually some new equilibrium price is found where supply equals
demand and the gold market perfectly clears, with no long-term
surplus or deficit.
As the invisible hand of the
free markets, really the collective buying and selling decisions
of every gold player on the planet, guides prices, signals are
sent to gold producers, consumers, and investors. The higher
the gold price goes, the more gold producers want to sell. Higher
gold prices lead to higher supplies of gold as miners around
the world rush to capitalize on the increased profit margins
on their product.
Of course mining more gold
is nowhere near as easy as producing an additional copy of Microsoft
Windows! Finding new gold deposits that are large enough to mine
is exceedingly difficult, and even once they are discovered it
takes years to dig shafts and spin a new mine up to operational
speed. For this reason, historically the total global gold supply
only grows by an average of a couple percent or so each year.
Faster growth is impossible at almost any gold price due to the
extreme difficulty and huge capital costs necessary to bring
new gold deposits to market.
Thus, on the gold production
end supplies are very inelastic to price. Regardless of how high
the gold price goes there will not be a flood of newly mined
gold as ramping up global gold production fast is simply not
viable. But there is another potential supply of gold beyond
mining, which comes from investors choosing to sell gold that
they have previously purchased.
Since gold is rarely destroyed,
virtually all the gold ever mined still exists in various forms
today, from bars sitting in secure vaults to jewelry adorning
beautiful women around the world. Investors who own this gold
can generally be divided into two distinct groups with vastly
different motivations, official central banks and private investors.
As these investors choose to sell their gold, it can cause additional
supply to come onto the markets at various times.
Central banks rightfully see
gold, the ultimate money over six millennia of human history,
as a threat to their fragile fiat-paper currencies, so they tend
to act irrationally. Rather than buying low and selling high
like a private investor, central banks buy and sell at the wrong
times. Central banks tend to exacerbate secular trends.
At the end of long gold bears central banks wrongly assume that
gold is finally becoming worthless so they sell and drive the
bear lower. At the end of long gold bulls they worry that
their particular fiat paper does not have enough gold backing
so they buy and force the bull higher. If the goofy bureaucrats
who ran central banks had to trade for a living, they would soon
go broke by selling low and buying high!
While private gold investors
tend to fear central banks due to their ominous urban-legend
status, I don t believe central banks have any hope of controlling
gold action over longer periods of time. It is believed that
about 150,000 metric tonnes of gold have been painstakingly chiseled
out of the bowels of the Earth during all of world history, and
only about 20%, or 30,000 tonnes, is controlled by various central
banks today. While 20% is certainly not trivial, it is the private
investors that control the other 80% that really hold gold's
destiny in their hands.
Since newly mined gold can
only grow total world supplies by a couple percent a year at
best, and central banks only control 20% of the above-ground
gold and tend to buy and sell at exactly the wrong times lengthening
secular trends, the real force to be reckoned with in
the gold world is private investors. It is to these private investors,
people around the world like you and I, that we must look to
understand secular gold bulls.
The key to a secular gold bull
is the demand or supply that private investors generate
worldwide as they buy or sell gold. It isn t mining supplies,
it's not central banks, but it is the collective gold transactions
of hundreds of millions or even billions of individual investors
worldwide buying and selling gold that ultimately sets its price
and determines its fortunes.
I believe that the collective
demand trends of private gold investors worldwide effectively
divide secular gold bulls into three distinct demand-driven stages.
In order to understand these stages and their implications, we
first have to understand the peculiar nature of gold investment
demand.
Normally in economics, the
lower the price of something the higher the general demand for
it. This is evident everywhere in society today, but perhaps
especially so in technology. Twenty years ago when a computer
cost $3000+, there weren t a lot of families with computers.
Prices were high and demand was low. Yet as prices gradually
fell over the years demand increased far beyond the small enthusiast
market.
Today with a decent computer
for surfing the Web, e-mailing friends, and doing office work
only running $600 or so, computers are ubiquitous. While the
statistics say they are out there, I have yet to meet a family
without at least one computer in their home today. Whether we
are talking about computers, pizza, cars, whatever, the lower
the price the higher the demand grows for a particular product.
This is a normal downward-sloping demand curve.
But with gold, and indeed most
other investments, the demand curve is far from normal.
As all contrarians know, in the investment world the higher the
price of an investment climbs the greater demand becomes!
It is all backwards. While virtually no one wanted anything to
do with gold near $250 a few years ago, once gold soars to $2500
everyone will want a piece of it. In the financial world
higher prices don t retard demand, instead they actually breed
demand!
The higher the price of gold
climbs, the more potential investors will become aware of its
impressive returns. As they buy in over time, their marginal
investment demand will drive gold even higher, putting it on
the radar of even more investors worldwide. This investor demand
creates a wonderful virtuous circle, with higher gold prices
leading to more interest and higher demand which in turn leads
back to higher gold prices and feeds the cycle. There is no better
advertisement for a particular investment than rising prices,
as most investors are not contrarians so they will only chase
existing well-established trends.
And remember that private investors
collectively control 80% of the world's gold, so if demand is
growing in this realm it is almost irrelevant what the mines
can pull or what nefarious machinations the central banks happen
to be up to! The whole secular gold game unfolds in terms of
private investor demand for gold, as we are collectively the
dominating force in the gold market.
Thus it is not only important
to realize that it is not mines or central banks that ultimately
drive gold prices, but private investor demand, it is also crucial
to understand that global gold investment demand only grows
with higher gold prices. Using this high-level model of gold
supply-and-demand fundamentals, we can divide secular gold bulls
into three distinct stages based on pure global investment demand.
Our lone chart this week compares
the Great Gold Bull of the 1970s with today's young secular gold
bull. It is divided into the three distinct stages of a secular
gold bull, each of which is driven by evolving demand profiles
among private gold investors around the world. And, lighting
up my own long weekend, I am thrilled that we were able to incorporate
our old bull image which has been largely missing in action in
recent years. In my book any graph capable of sporting a cartoon
bull is a darned good one!
The first important thing to
note on this secular gold bull graph is the typical parabolic
shape of a secular gold bull. All secular bulls that ultimately
culminate in bubbles exhibit this distinctive pattern of price
increases continuously accelerating over time. As this yellow
parabola shows, this acceleration is almost imperceptible in
the early years, picks up dramatically in the middle years, and
is breathtaking in the final years. This pattern was also witnessed
in both the NASDAQ
and S&P 500 as well during their own recent secular bulls.
The left axis of this graph
corresponds to the blue line of the Great Gold Bull of the 1970s.
Interestingly, since we used monthly data, this 1970s gold bull
is even a bit understated. While the all-time monthly high close
for gold is under $700 as this graph shows, gold actually soared
to $850 per ounce briefly in January 1980 at the top of its last
mania!
The right axis defines the
red line, which is our current gold bull to date from January
2001 to today in monthly terms. As you can see, the early slopes
of this gold bull and the early years of the 1970s Great Gold
Bull match remarkably well. Today, just as gold did from 1970
to 1973, it is once again stealthily climbing the initial modest
upslope of the yellow parabola. If our current specimen continues
to hold the course plotted before it in the 1970s, gold will
ultimately trade over thousands of dollars per ounce before this
decade ends!
I believe the key to understanding
this parabolic shape that all secular bulls ending in bubbles
assume is to understand the changing investment demand profiles
throughout a secular bull. The constantly accelerating parabolic
profile is driven by shifting investment demand over the life
of a secular bull. The higher an investment price gets, the higher
demand grows and a positive feedback loop is created.
Stages One, Two, and Three
of a secular gold bull are defined by the two major slope changes
in this standard secular-bull parabolic ascent. Each stage, considered
in turn, makes perfect sense when described in terms of global
investor demand.
Gold is ultimately money, and
during Stage One bulls it trades like another currency. One of
the primary reasons why the Stage One upslope is so moderate
is that the main reason gold rises initially is due to a devaluation
of the dominant currency in which it is priced, obviously the
US dollar today. As the US
dollar bear has festered in recent years, and as the dollar
eroded in the early 1970s, gold is a direct beneficiary of the
dollar's losses. As the dollar grinds lower, the gold/dollar
exchange rate rises.
Since Stage One is currency-devaluation
driven, the young gold bull is most noticeable in terms of the
dominant eroding currency. Since April 2001 gold's gains have
been greatest in the US since it is the US dollar that is devaluing.
But from foreign-currency perspectives, such as the
Europeans, gold has traded largely sideways in recent years.
Stage One gold bulls witness gains that are roughly one-to-one
with currency losses, so they are most evident in local-currency
terms.
Now since these early Stage
One bulls are only apparent to contrarian investors in
the country with the dominant devaluing currency, overall investment
demand is low. Not only is gold coming off a multi-decade secular
bear so not many folks believe in it, but it has no established
momentum so only hardcore contrarians will even consider it.
Even in the States the total capital the contrarians command
is very small relative to the markets as a whole, so initial
gold buying on the local-currency devaluation is rather anemic
and makes for a tepid initial upslope.
Now after three or four years
of Stage One, Stage Two arrives. Stage Two marks a momentous
event when gold decouples from the local-currency devaluation.
In the case of our gold bull today, Stage Two will be here when
gold starts consistently rising faster than the dollar is able
to fall. This key decoupling works on multiple fronts to really
kindle investment demand around the world and marks the first
significant steepening of the parabola's upslope.
Locally, the gold and dollar
decoupling in Stage Two leads to accelerating US dollar gold
prices. This draws in more American investors, who see the 66%
gold gains in the past few years compared to stock-market losses
over the same period of time. You can already see the great gold
marketing machine spinning up, with even CNBC and Fox News having
advertisements today heralding the new bull market in gold. The
slowly rising prices of Stage One that drew in the contrarians
start accelerating and gradually gold becomes known and sought
after outside of the small contrarian community.
Even more importantly in Stage
Two though, since gold's gains start outpacing the dollar's losses
gold starts rising in virtually all currencies worldwide!
Rather than appearing flatlined, a mere product of the dollar's
misfortune, gold starts showing up on foreign investors radars
as it consistently carves new local-currency gold highs around
the world. And not surprisingly foreign investors, who generally
know how fragile governments and fiat currencies truly are, are
far more receptive to gold investing and don t need convincing
like Americans.
Gradually these foreign investors
out of Asia and Europe start buying gold and global investment
demand accelerates. The more global capital that is poured into
gold, the faster its price rises tracking the accelerating parabolic
upslope. And of course the faster gold's price rises the more
new capital it attracts. This virtuous circle on a global scale
is what fuels the strong gains of Stage Two, which provocatively
utterly dwarf Stage One. While gold went from $257 to $427, or
66% higher in Stage One so far, it should trade considerably
above $1000 before Stage Two ends, or another 134% higher from
here!
After five or so years of Stage
Two gains, gold has a chance at going ballistic in Stage
Three. Stage Three is only ignited if the general public around
the world starts growing enamored with gold investing. If you
thought the dot-com mania was crazy, wait until you see a global
gold rush. All of us humans have an innate lust for gold burning
somewhere in our hearts and there is no rush like a gold rush!
Gold rushes define speculative manias!
When the gold bull spreads
beyond the usual investment class to the general public, so much
capital deluges into gold so rapidly that it is blasted parabolic.
Naturally a vertical upslope is totally unsustainable and cannot
last for much longer than a year at best. Stage Three is a captivating
time for the early contrarians who rode the entire gold bull
from its early Stage One days to its mania days. Vast gains rapidly
multiply, yet a sustained vertical ascent on a long-term chart
is a dire warning sign that the party will soon be ending. Contrarians
are torn between riding gold "just a little longer"
and immediately selling it all.
Not surprisingly the greatest
gains of all are found in Stage Three. Extrapolating today's
bull-market data on a 1970s-style gold parabola, gold could easily
shoot from $1000 to over $3500 if the public enters and
ignites a popular speculative mania. This massive 250% gain in
Stage Three alone is roughly twice as great as Stage Two's 134%
and four times as great as Stage One's 66%! As the parabola model
suggests, secular bull gains multiply exponentially until the
bubble pops and the mania comes crashing down.
It is crucial to realize that
this unfolding secular parabola is totally dependent on only
one force, global investment demand for gold. Mines just
can t wrest enough gold free from Earth fast enough to stop this
parabola once it is in motion and central banks relatively small
20% control of global gold supplies isn t enough to stop the
other 80% when goldlust spreads from contrarians to mainstream
investors to ultimately the general public.
And, unlike normal demand profiles,
gold investment demand only increases as gold prices march
higher in currencies around the world. The higher the gold price
goes, the more demand it spawns, at least until the public jumps
in, foments a bubble, and all the capital available to chase
gold is already in leading to the bubble bursting and the end
of the secular bull market.
If you note the transition
in the graph above from Stage One to Stage Two, it looks like
our current gold bull is almost there. For a variety of reasons
I agree and believe that Stage Two is probably right around
the corner today. I am even finding increasing empirical
evidence in my research suggesting that gold is now preparing
to lift into Stage Two leading to a vast surge in global investment
demand in the coming years.
If you are interested in this
key Stage One to Stage Two transition, please consider subscribing
to our acclaimed monthly Zeal
Intelligence newsletter.
In the hot-off-the-presses
September issue just published this week, I detailed the actual
evidence suggesting that Stage Two is near. In addition I discussed
the key market development, which you can watch for yourself,
that I believe has the highest probability of signaling that
Stage Two is upon us. And, as always, our letter is full of actual
stock and options trading recommendations to help you ride this
secular gold bull to legendary gains. If today's bull proves
true to the parabolic historical form, then the vast majority
of profits still lie ahead!
The bottom line is that today's
gold bull, over three years old now, is definitely a secular
specimen. Past secular gold bulls unfold in a massive parabolic
shape over a decade or so, driven by accelerating global investment
demand. This investment demand growth can be divided into three
distinct stages driven first by contrarians, then global investors,
and ultimately the general public.
So far our current gold bull
is tracking this model perfectly. Even better, increasing empirical
evidence suggests Stage Two is near so the upslope of this secular
gold bull is due to accelerate significantly in the years ahead.
Is your capital positioned and ready to ride this accelerating
secular gold bull?
September 3, 2004
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
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