A Long-Term Outlook of the Gold Market

We turn our attention now to an examination of the long-term outlook for gold prices. This is a subject of great importance since it concerns not only many of our favored investments, but more importantly, the state of health of the world economy itself. In undertaking such a broad overview of gold prices, we must take license to examine several factors which influence the price of gold—factors which may seem initially to be totally unrelated to our subject at hand, but will nevertheless be seen to be of equal concern, since these factors are all inter-related.

The intermediate-term outlook for gold is actually quite positive (and for our present purposes, we define "intermediate-term" to mean the next 12 months or so). The long-term picture, however, isn't quite so sparkling, but still carries hope. In outlining our forecast and analysis for gold we will attempt at explaining our predictions from both a technical perspective as well as from a "socionomic" (a term coined by Bob Prechter of the Elliott Wave Theorist) point of view.

While we do not deny the purely monetary nature of gold (as the yellow metal is first and foremost the quintessential standard of money), neither can we ignore the fact that gold in recent years is viewed primarily as a commodity. As such, we must first analyze gold within this context in order to arrive at a truly balanced understanding of where its price may be headed.

It is well known that commodities have been in the proverbial "dumps" since 1997. In fact, the long-term bear market for commodities began in 1981, punctuated by gold's blow-off price peak at over $800/oz. prior to crashing to its present low levels. This magnificent price crash of the early 1980s was nothing more than the physical manifestation of the peak in the latest Kondratief Wave cycle. We have been in the downward part of the K-Wave cycle ever since, and while the trough is surely near, there remains a final washout stage before the downward part of the cycle can be said to be complete.

As 1980-81 marked the beginning of long-term deflation under the K-Wave sequence, the year 1997 represented the start of the most severe part of the deflationary cycle, which K-Wave theorists style "runaway deflation." This phase of the cycle was seen in the stock market mini-crash of October 1997. Since then price deflation has become much more noticeable than in previous years, and while there has been a recent uptick in price inflation in recent months, this should be seen as nothing more than a counter-trend "correction" in a much larger downward trend. We still fully expect to see a deflationary collapse in prices of equities, commodities, real estate, and interest rates in the years ahead, and this dynamic phase of the deflationary cycle will likely commence later this year.

One of the hallmarks of deflation is efficiency, which is both a symptom as well as a contributing factor of deflation. Simply put, efficiency expedites deflation. And efficiency has become the mantra of our era, as everything from retail sales to information services and from banking to grocery shopping can now be done at the touch of a button though the magic of the Internet. But the Internet represents much more than just a technology for improving the quality of our lives and making things easier. It is nothing less than a monstrous catalyst for deflation.

But the obsession for efficiency in the business sector is in more places than just e-commerce—it permeates every fiber of the global corporate community. It can be seen in the replacement of human employees with computers and machinery, in the outsourcing of manufacturing to low-cost overseas countries, and in new methods which allow businesses to execute with pinpoint precision tasks which previously required tremendous outlays of time and capital. In short, business has become hyper-efficient, and this is but an evident proof that the deflationary cycle is alive and well and building momentum with each passing month.

What this deflation ultimately portends for gold is lower prices. Gold, as the ultimate barometer of inflation/deflation, is most sensitive to these monetary forces, and it only follows that as the physical world economy contracts and, by extension, the value of the dollar increases, gold's dollar price will decline. However, its value will remain stable and, relative to the value of the dollar itself, can be expected to actually increase. In fact, we foresee a great demand for gold coins throughout the duration of the coming worldwide debt deflation, and gold investors can take heart at this.

The incomparable P.Q. Wall writes concerning the gold outlook, "It is true we are in a long term deflation since the Kondratieff peak in '80/'81, and that we now verge on Phase Four, runaway deflation, in which commodity prices and indeed all prices will collapse. But we have a final flare-up of business activity to get through…in which gold should rise nicely once the B wave rally in bonds runs its course." Wall continues, "Gold should resist deflation better than most commodities in a deflationary crash because third world currencies will collapse and gold will be sought out."

Before we analyze the gold market itself, we must examine the U.S. dollar. As we noted above, a deflationary collapse of prices entails a shrinkage in the money supply as the available money supply is largely destroyed in the black hole of runaway deflation. This process will begin later this year when the U.S. equities market—the beneficiary of a tremendous part of the money supply—collapses during the onset of K-Wave Winter. (A confluence of short-term, intermediate-term and long-term cycles are due to simultaneously peak in late summer/early fall of this year, which should have the effect of touching off the end of the secular bull market in equities. This period also marks the onset of the most dynamic portion of the K-Wave downward leg). From a technical perspective, the long-term chart of the U.S. dollar is tracing out a series of concentric parabolic, or "bowl," formations which reflect the fact that the dollar is in the midst of a long-term upward cycle and has numerous supports. What all of this means is that the dollar can be expected to appreciate in value in the years immediately ahead as the deflationary collapse deepens.

Since the dollar is expected to strengthen in value, gold can be expected to weaken in price (though not in value). Gold has already been in a bear market for nearly 21 years, and it is surely nearing the end of this phase. But the decline is not quite over, and even after the bottom is seen it could take years for its dollar price to build a sufficient base to begin a new long-term bull market. We do not subscribe to the theory which states that a collapse in stocks automatically translates into a soaring price for bullion, for this argument displays an ignorance of the forces which govern the cycle.

Since gold is a cyclical commodity it must be viewed within the context of cycles. At any given time, there are a variety of cycles interwoven with one another impacting gold's price. This can be seen most remarkably in the chart for gold. Take a look at the line charts we have analyzed. Marked clearly are the alternating cycles which exert an influence over gold's price at all times (in this case, the cycles are manifest in the chart showing the XAU index). While there are many upward and downward cycles in force at different times, there can still be seen a much larger, dominant cycle in the long-term chart for gold. Over the next year or so, the cycle presently afoot is an upward cycle which should initially bring a rise in gold's dollar price in the early stages of the stock market collapse (especially since the currencies of the world—with the exception of the U.S. dollar—will be largely worthless during this time). So again, there is room for optimism among gold investors in the short-to-intermediate-term.

The long-term outlook, as we mentioned previously, is less optimistic (though by no means completely pessimistic). While the intermediate-term chart of the XAU shows a bullish bowl formation (in which the "sides" of the "bowl" act to shepherd prices to higher levels), the longer-term XAU chart shows a bearish dome formation, which likely will act to shepherd prices to lower levels. Note the contracting triangle pattern in the XAU, which means prices are gather strength for a sudden upthrust, the amplitude of which normally equals the height of the triangle, in this case nearly 100 XAU points. Since triangles are normally continuation patterns, we can reasonably assume the breakout will be to the downside. (Please note, however, that in the event this dome becomes punctured by a sudden upward movement in prices, the bearish outlook will be completely annulled as it means a new, powerful upward cycle has taken force. So there may still be some hope for the inveterate gold bugs).

How long is the deflationary period ahead expected to last? P.Q. Wall, a noted cycle expert, estimates it will continue until the year 2013. Gold will likely have bottomed and will probably be in the early phases of its next bull market well before then, but there will probably be continued price weakness at least for the next two or three years. Still, the long-term picture for gold is a strong one, and the next one to two years alone will be exciting times for all.

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