GDR i
Gold & Historical Norm
Eric Hommelberg
April 11, 2005
Gold & Historical Norm is Chapter I of the Gold Drivers Report
and analyses Gold against its own historical norm. This is important
since many people argue that Gold is at an historic high these
days and therefore bound to fall. Jeff Christian of the CPM group
said on ROB TV late March:
"Gold prices are at an
historic high and will likely come down."
OK fair enough, but an historic
high compared to what? To Gold itself? To Oil? The CRB index?
The Dow Jones? Please take peek at the following charts and see
if you share Mr. Christian's view or not!
- DOW/GOLD ratio
- Gold vs its own long term
average
- Gold/Oil Ratio
- Gold vs CRB
- Gold vs Inflation rate
DOW/GOLD ratio
When I first wrote about the
DOW/GOLD ratio two years ago I started off by saying:
"Looking for a tool to
predict future POG movements? A tool which is extremely easy
to use? A tool which has proven to be extremely useful in the
past? A tool well respected by many veteran market analysts?"
Of course when I say 'easy
to predict future POG movements' I'm not talking about one year
projections, not even two year projections. No, by saying predicting
future movements I mean average up or down for at least a decade.
Indeed, the DOW/GOLD ratio has proven to be an accurate tool
when it comes to identify major turnarounds in stocks/gold. Please
take peek at the chart below and see yourself:
Again, the DOW/GOLD chart is
a powerful tool in order to determine major turnarounds. It's
simple, when the DOW/GOLD chart tops you buy gold, when the DOW/GOLD
chart bottoms you buy equities. Once you've established your
position you can ride the wave up or down for at least a decade.
The DOW/GOLD chart flashed a 'buy' for Gold again in the year
2000 and indeed 5 years later Gold is already 66% off its lows
since then. The DOW/GOLD chart tells you to hold on to your Gold
until a new bottom has arrived in the 1 - 5 area. Well, if it
were all that simple why don't we hear that much about it?
Well, as said before the DOW/GOLD
chart isn't useful at all in order to predict yearly price movements.
It could very well be that next year will show a higher reading
than this year instead of an expected lower reading thereby losing
confidence as being a reliable indicator. Unfortunately that's
the same analogy as denying that higher temperatures will arrive
in summer based on a single day temperature drop in spring. The
problem is that the DOW/GOLD cycle has a wave length that's so
big that we humans have a hard time to figure out where to position
ourselves into this cycle.
Nevertheless many veteran analysts
such as Richard Russel and John Hattaway do refer to this cycle.
Richard Russel often said that he wouldn't be surprised to see
Gold crossing the Dow at 3000 thereby suggesting a new bottom
for the DOW/GOLD ratio at one. Indeed history does suggest that
the DOW/GOLD ratio bottoms periodically in the 1 - 5 range. The
Dow/Gold ratio topped in 2000 far above 40 and is heading down
now (currently at 23.5). If the DOW/GOLD ratio can live up to
its expectations than we can expect a new DOW/GOLD bottom within
this decade or shortly thereafter.
The bottom line is that the
current reading of 23.5 is nowhere near an historic high for
Gold. To trade at an historic high today Gold should be trading
above $2.000 at least (assumed DOW/GOLD bottom of 5)
Gold vs its own long term average
When an expert claims that
Gold is trading at an historic high these days at $425 you would
probably think that gold never traded above $500. Well, for the
first 70 years of last century Gold was dull indeed and never
traded above 40$/ounce. But as we know, that was all about a
fixed Gold price by government decree. When Nixon closed the
gold window in 1971 gold could finally crawl back to its natural
equilibrium. Therefore I think it's fair enough to take 1970
as a reference point from where on we should calculate Gold's
long term average. In order to do so we should re-calculate the
gold prices with 2005 dollars (inflation adjusted) and check
out if Gold is at an historic high indeed or not.
See chart below and judge yourself:
As you can see Gold is trading
nowhere near an historic high according to its own long term
average. In order to do so, Gold should be trading at least above
$1500.
Gold/Oil Ratio
The Gold Oil ratio is at an
extreme 35 year low these days. Such extremes won't stay there
for a long period of time. So what gives? Lower Oil prices or
Gold catching up? Since higher Oil prices are permanent it seems
to me the latter.
The Gold/Oil chart says it
all.
The fact that higher Oil prices
are permanent is all about PEAK-OIL. We're facing flattening
production curves while demand is on the rise. PEAK-OIL could
very well arrive this year according to Prof. Kenneth Deffeyes,
author of 'Beyond Oil - the View From Hubberts Peak.' PEAK-OIL
will be described in detail in upcoming chapter VIII 'Gold &
Oil'. So if Oil prices won't come down and Gold has to catch
up to its historical gold/oil average it should be trading at
$ 866 these days. So a current reading of the Gold/Oil ratio
at 7.3 doesn't reflect an historic high for Gold in any way!
To trade at an historic average
Gold should be trading at $866 these days and to trade near historic
highs Gold should be trading above $1500.
Gold vs CRB
We're witnessing the most powerful
bull move in commodities these days since the seventies. According
to the legendary Jimmy Rogers (co-founder of the Quantum Fund)
this marks only the beginning. Jimmy Rogers says:
"The next bull market
is here. It's not in stocks. It's not in bonds. It's in commodities
- and some smart investors will be riding that bull to record
returns in the next decade."
Of course you can bet against
Jimmy Rogers but please remember that Jimmy Rogers retired himself
at the age of 37 and that was certainly not due to lack of success.
He puts his money where his mouth is and started his own commodities
index fund (with more than $200 million invested) and guess what?
It's the single-best performing index fund in the world in any
asset class.
If future history proves Jimmy
Rogers to be right, what could that mean for Gold coming years?
How do commodities interact with Gold?
History suggests a very strong
correlation between rising commodities prices and rising
gold prices. The chart below says it all:
Again, when you wonder if Gold
is trading at an historic high these days you certainly won't
get confirmation from the GOLD-CRB chart. To trade at an historic
high Gold should be trading above $700.
Gold vs Inflation Rate
Many people argue that rising
interest rates are the death for Gold since rising rates would
make the dollar more attractive so it will rise. Gold will therefore
go down since there is a strong inverse correlation between Gold
and the US$. Although there is a strong inverse correlation between
the dollar and Gold indeed the thing is that current rising inflation
rates are a result of a dropping dollar. Rising interest rates
won't cure the Inflation pain as long as the FED stays behind
the Inflation curve (see chapter III 'Gold & Inflation').
So what does history suggests about rising Inflation rates and
Gold? See graph below:
As you can see higher inflation
rates are extremely Gold friendly.
OK you'll say, a strong correlation
between Gold and Inflation, but according to our government there
is no inflation so forget about higher Gold prices. Right! The
government says there is no inflation. The thing is that inflation
is picking up steam but the government just doesn't report it,
see chapter III 'Gold & Inflation'. Just to give you an idea
what future Inflation figures could be see chart below:
Higher Oil prices always led
to higher inflation rates in the past.
Stephen Leeb (president of
Leeb Capital Management and author of 'The
Oil Factor - Protect Yourself (AND PROFIT) from the coming
Energy Crisis,' said during an interview with Jim Puplava
of Financial Sense Newshour:
"Sharply rising energy
prices, similar the the 70's, will lead to double digit inflation
figures over the next 10 years. It's going to turn the economy
on its head."
Ok you'll say, higher Oil prices
are a worry indeed but didn't Greenspan came out lately assuring
us that higher Oil prices are just temporary? Sure he did, but
let me ask you this: Whose words carry more credibility when
it comes to future Oil prices, Oil expert Alan Greenspan or Oil
experts such as Matthew Simmons, Colin Campbell and Kenneth Deffeyes?
Simmons, Campbell and Deffeyes are very very resolute in their
statements and they aren't projecting a pretty picture. The end
of cheap Oil has arrived! Chapter VIII 'Gold & Oil' will
discuss the details.
So Oil prices which won't come
down most probably lead to higher Inflation rates and therefore
higher Gold prices.
Summary
Gold is trading nowhere near
an historic high as some experts do suggest.
Historical averages do suggest
the following prices for Gold as being historic highs in today's
environment:
Projected Historic Highs
for Gold according to:
DOW/GOLD
ratio:
Gold Long term average:
Gold/Oil ratio:
Gold/CRB: |
+$2000
+$1500
+$1500
+$700 |
April 8, 2005
Eric Hommelberg
email: ehommelberg@golddrivers.com
website: www.golddrivers.com
NOTE: Readers interested in future GDR updates can drop
a mail here.
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