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Gold & Historical Norm

April 8, 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. END,

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 and 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. 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 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 ?

The chart below shows a strong correlation between rising commodities prices and rising gold prices.

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. END.

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 :