Stepping Forward to $1,254 Gold
Ned W. Schmidt, CFA, CEBS
Schmidt Management Company
For North American investors, and those others with significant investment exposure to North America, the beginning of 2002 was an important time. The Gold market added further confirmation to the notion that the era of financial assets had ended. That confirmation also suggested that a new era for Gold was coming. The time of a depreciating U.S. dollar was soon to be at hand.
The first graph holds some important lessons for investors. Plotted in this graph is the ratio of the U.S. dollar price of Gold to the S&P 500. When that ratio is rising, Gold is performing better than stocks. When that ratio is falling, stocks are the better performers.
In this graph we can observe three distinct cycles since the end of World War II. After the end of WWII the world generally moved into a more peaceful period. Investors turned back to stocks, and other financial assets, after having avoided them for about 20 years. Gold began to under perform as indicated by the ratio declining for a number of years.
In the early 1970's another cycle started. In about 1972 the ratio rose up through the moving average as a new bull market in Gold began. Gold investors would go on to experience a dramatic rise in price. But like all market environments, bull or bear, that rise came to an end.
In the early 1980's the ratio fell down through the moving average, indicating the end of the reign of Gold and a new period of dominance by of financial assets. Stocks went on to experience the Great Greenspan Financial Bubble. That bubble popped as have all before it.
At the end of 2001 the ratio again rose up through the moving average suggesting a new era for Gold. Investors in Gold have been waiting for 30 yeas for this development. The ratio of Gold to the S&P 500 gave a signal last seen in the early 1970's, before the last great Gold market.
Before we go on to explore the Gold bull market let us remember something about the nature of markets. Markets, be they for stocks, real estate, gold, bonds or whatever, rarely repeat past performance characteristics. What that means is that while each can experience a new bull market, the driver for each market move will be different. The asset class may repeat, but the driving force will be different. In simple terms, this means that technology stocks will again have a day in the Sun but not those you are holding from the last cycle. Gold will again shine, but the driving force will be different.
The driver for Gold is always government policies, usually manifest in the policies of the central bank. Gold is a reflection of the value of every currency for Gold is priced in every currency. That also means that every currency is priced in terms of Gold. Only Gold is the universal evaluator of the value of a nation's policies and currency.
Good government, or central bank, policies cause a currency to maintain value, or appreciate against weak policy currencies. If however the central bank prints excessive amounts of a currency, the Gold value of that currency will decline. In terms of Gold and the world, that currency is being devalued.
Investors, particularly those in North American, need to reorient their currency thinking. The Gold value of the U.S. dollar is the true measure of the currency's worth. For example, Gold at $322 equates to 0.003106 ounces of Gold per dollar. When the dollar value of Gold is rising, the Gold value of the dollar is falling. This relationship is the same as with any other currency, and Gold is simply another currency.
Consider the nearby graph of the annualized rate of change of depreciation of the U.S. dollar. Much talk has recently focused on the value of the dollar, and whether the recent slide a measured by some popular indices is real. Of course it is real. Look at the graph. In terms of Gold, the U.S. dollar has been depreciating at a fairly rapid rate.
We do note some recovery in the dollar's rate of depreciation occurred after 9/11, but that was rather short lived. Recently the U.S. dollar has been depreciating at about a 20% annual rate. The U.S. dollar has so many fundamental problems that even the Canadian dollar has rallied somewhat against it. Only now is the popular media discovering what many of us have known for some time. Fundamentally the U.S. dollar is not a sound currency. Add to that problem a Chairman of the Federal Reserve determined to create more dollars than the rest of the world desires, and one has a near "perfect storm" for Gold.
At the outset we compared the recent events with those of the early 1970's. What is common between the two eras is the mistakes of monetary policy. The Federal Reserve in the former period monetized the oil price shock and other tribulations of the day. Today again the Federal Reserve is monetizing the expenditures on the Pan Eurasian Islamic Ware, the deficit at the Federal level and the current account deficit. Rather than let the U.S. economy cleanse itself, the Federal Reserve is monetizing the repercussions of the stock market bubble.
All of these subjects are worthy of further study. However, at this point we want to begin our series of articles with a review the basic situation in the Gold market. North American investors need to fully understand the sound base that has been built in the Gold market. Many are still focusing on US$300 when attention should be on the coming assault on the $350-400 area.
SEVEN INDICATORS VALIDATE GOLD
Seven indicators can be identified as validating the case for including Gold in the portfolio of North American investors:
| 1 |
Gold
is undervalued in U.S. dollars. Fair value is about US$499, and an
ultimate target in excess of US$1,254 can be calculated. Valuation
cannot make a market go up or down, though it is usually an
essential ingredient for a viable new cycle. |
| 2 |
A
major bottom was created in July of 1999. That bottom has persevered
the test of time for three years. Whenever an asset has gone that
long without a new bottom investors should put on their bullish hat. |
| 3 |
Gold
has demonstrated clear relative strength. Relative strength always
precedes absolute performance. Relative performance was validated at
the beginning of the year when the ratio of Gold to the S&P 500
rose through the moving average as discussed earlier. |
| 4 |
Gold
has demonstrated clear upward momentum. Our measure of long-term
momentum turned positive in March of 2001. By the way, that
indicator is whole lot better forecaster than this writer. We should
listen to it rather than our thinking. |
| 5 |
Gold
has shown absolute performance. Gold has broke out in a positive
manner from a long lateral pattern. That development is one of the
most powerful market patterns that can develop. Back in the days
when investors did real technical analysis they would spend a good
part of their life looking for stocks with patterns as Gold has
developed in the past few year. |
| 6 |
Gold's
fundamentals are sound. Fundamentals in this case are the
fundamentals of the U.S. dollar. The current account deficit and
accumulated debt to foreign investors are negative fundamentals for
the U.S. dollar but are positive fundamentals for Gold. |
| 7 |
Gold
again has a "driver." As we talked earlier, the Federal
Reserve is going to monetize the current situation. Chairman
Greenspan is doing every thing he can for Gold investors. |
The case for Gold in the portfolios of North American investors is so compelling we would even expect CNBC to acknowledge the situation. But, we notice a tendency among even knowledgeable investors that should be tempered. Owning a housing stock is not the same as owning a home. Owning a Gold stocks is not the same as owning Gold. Investors should be, one, including Gold bullion and coins in their portfolio. Go to the heart of the returns. Gold stocks derive their value from Gold. Again, go to the source of the returns.
Investors should be, two, having some frank discussions with their investment advisors. If your advisor does not have Gold in your portfolio, your course of action is obvious. Look them in the eye and say, "You have 24 hours to get Gold in my portfolio or I get a new advisor." Why keep paying them to lose money in those mutual funds? Why have your portfolio miss out on the Super Cycle in Gold to $1,254?
The compelling case for Gold in portfolios is built on the developing new Super Cycle in Gold. Remember the Dow Jones Industrial Average went from a thousand to 11,000. A similar move in Gold implies a target of $2,700+. If Gold simply went back to the average relationship with the S&P 500 it would trade in the neighborhood of $1,300. Quite simply, the investment table is set and those that select Gold will have a most satisfying experience. Those that persist with yesterday's paper assets can expect investment indigestion.
Ned W. Schmidt, CFA, CEBS
nwschmidt@earthlink.net
Originally posted at www.financialsense.com
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