The Most Important Gold Chart

Most global gold indexes, as well as the bullion price, peaked in late May. At that point of time the Dow was trading at 9900 and has since fallen 23% in just eight weeks. All the major currencies appreciated as the dollar took a beating. Yet what did gold and its related stocks do? ZILCH! NOTHING! NIX!

Many will argue the manipulation war cry but even this theory has a lot to explain in the face of such huge market and currency degradation that would normally have pushed gold through the roof. Investors forget that many leading gold stocks appreciated over 600% during the past 18 months with the leveraged mines such as Durban Deep up over 1000%. They are currently experiencing a long overdue correction from hugely over valued levels. When this necessary correction has run its course a major buying opportunity will occur.

But gold stock charts fade into total insignificance compared to the gold price chart in Swiss Francs and its long term implications.

Why is this chart more important than the gold price in dollars or any gold share index?

Very simply it is a comparison between an investment hard asset and an investment currency. The chart is one massive base formation, a reverse head and shoulders bottom pattern. It heralds a major potential upside move on the chart. This would imply that the gold price is ultimately going to dramatically out perform the Swiss Franc. Why is that so important?

Firstly, gold is regarded as a wasting asset as it carries no income. Second, it has been totally out of favour in the investment community for over 20 years and an bull run in this chart would signal a re-emergence of gold as a major international investment vehicle. Finally, it is slated to out perform the world's traditional last-ditch investment currency.

The Swiss Franc has always been the ultimate hide-away for nervous currency investors. Thus for gold to outgun the Swiss Franc implies some form of major re-assessment of investment attitudes. It indicates a complete about face in global investment strategy. It dictates a move away from equities and currencies, a move out of bonds and a move into a non-interest bearing asset.

Investment is a remarkably uncomplicated matter. It is simply a function of two well-thumbed characteristics, value and confidence. Markets that exhibit value without confidence go nowhere, but represent outstanding long term buying opportunities. Conversely markets that have confidence without value are skating on thin ice and usually collapse. Global markets have been overvalued for some time but had, until the September 11^th calamity, an abundance of resilience bordering on over-confidence. This was a recipe for disaster. For the past year poor company earnings, growth performance and forward forecasts have eroded confidence levels. Economic recovery in the US is now realised to be on the back burner. Superimposed on this increasing negativity is the current plethora of assurance sapping accounting malpractices.

Three years ago I detailed the huge sideways top patterns on the global markets and discussed the potential of a major worldwide bear market emerging from these patterns. This has finally commenced in earnest.

We are in the process of a once in a lifetime massive global change of investment attitudes that will force investors to look for protection and safety rather than growth or earnings. This is a frightening prospect as it proposes that stock and bond markets as well as economies will fail to attract investment. Bond markets are ending their 25-year bull run and I believe that as a result US interest rates are likely to rise rather than fall, especially with Bush's deficit spending programme.

Respected Elliott Wave analyst Robert Prechter has proposed deflation as a likely economic scenario and this he believes will lead to a fall in the gold price. The above chart indicates exactly the opposite. I also find it incongruous to anticipate a bear market in the gold price when the gold shares have improved on average by 700% over the past two years. A contracting economy leading to deflation could be a candidate for consideration, but this usually is accompanied by lower interest rates that help to ease the investment pain. I believe that Prechter is correct that there is no real incentive to run into gold from the deflation scenario. But a contracting economy with static or rising interest rates in a stagflation type of environment would be a definite possibility for the driving force behind investors flooding into gold.

Unlike inflation that erodes purchasing power, stagflation contracts earnings and incomes whilst increasing prices so that the end buying power of nest egg investments simply collapses. The main losers in this mêlée are the play it by the rules white-collar middle-income earners. This sociological class who studiously saved for their golden years by investing in endowment, retirement and life policies will find that when these reach term there will not be anywhere near enough buying power for retirement.

There is a correlation between the gold and economic cycles in which gold acts about one third of a cycle behind the economic moves. This is illustrated in the graph.

As economic markets bottom out growth occurs and spending starts up. Once the growth cycle is established the inflation cycle kicks in and about one third of the way up the economic cycle the gold market becomes attractive as a hedge against inflation. This has led to the mistaken belief that gold must have inflation to move into a bull market. At the end of the economic up cycle gold has only completed part of its cycle. As markets turn over we move into a period in which there is a flight from paper. This is exactly the current market position, a flight from equity paper. The final nail in the coffin will be when investors realise that bonds offer no real return. At this juncture gold takes off into its final spectacular bull market finale.

I find the first chart of gold in Swiss Francs chart and its implications to be horrendous as the effects will be global and not confined to any one market. I have for the past two years warned of a massive global downturn in equities. I have constantly bombarded clients with data showing that gold shares will out perform global equities. But we are entering a stage in which global economies are about to be dramatically affected by all this negativity.

Make no mistake this chart data indicates a complete change in economic and investment attitudes that are diametrically opposed to current thinking. It implies an extremely serious incident or series of events. Whatever causes the move into the gold arena will reverberate around the world. Our lives will be dramatically changed and our investment attitudes turned upside down.

Dr. Clive Roffey

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25 July 2002