GOLD IS FOLLOWING ITS TRADITIONS!
Sy Harding
September 27, 2005
Gold has a centuries-old history of providing protection for asset values in times of rising inflation. What does that mean?
An old-time observation put it this way; that through many centuries the price of an ounce of gold remained roughly equal to the average price of a man's suit. That is, long ago when a man's suit cost $20, gold was $20 an ounce. By the time inflation had the average price of a man's suit up to $200, the value of an ounce of gold was $200, and so on. As inflation constantly eroded the value of paper money, requiring more dollars, or yen, or whatever, to buy a suit (or a loaf of bread), the value of one ounce of gold kept pace with inflation, one ounce of gold always able to buy a man's suit.
Gold's tendency to rise in value when inflation is eroding the buying power of paper money has never been more clear than over the last 30 years.
In the 1970s inflation soared out of control. As measured by the Consumer Price Index, inflation was growing at only a 5% annual rate in 1970, only somewhat above a normal pace. Prices then began to rise out of control, and by 1980 inflation was growing at a horrible 13.5% a year. The catalyst had been the Arab Oil Embargo in 1973, which started energy costs rising sharply, followed by corporations passing their rising energy costs along to consumers.
Gold, with its history of holding its value in times of rising inflation, also soared. Gold was $70 an ounce in 1972, and by 1980 had soared to an all time record high of $850 an ounce.
Then the aggressive rate hikes by the Federal Reserve in the late 1970s (which had the Fed Funds rate as high as 17.6% by 1980), finally began to work to bring inflation under control.
As the rate of inflation then began to decline, the price of gold also began to drop. Inflation entered a long-term downtrend, as did the price of gold. Twenty years later, in 2000, the rate of inflation was down to 2.0%, and the price of gold was down to $250 an ounce.
However, in the year 2000 major shifts again took place. The stock market, which had been the main beneficiary of declining inflation and declining interest rates (which are good for the economy and good for corporate earnings), had been in a long secular bull market since 1982. By 2000 it had become overvalued, and topped out into the severe 2000-2002 bear market. (It was pushed toward topping out by the Federal Reserve, which had begun to raise interest rates again in 1999 to slow down the over-heated economy).
Inflation, particularly as measured the CRB Index of Commodity Inflation, also changed direction in 2000, beginning to rise. And yes, gold's 20-year long bear market ended and gold prices began to rise.
It was a couple of years before it was clear that the rise in the price of gold was not just another of its frequent bear market rallies, but was indeed a major trend reversal into a new gold bull market.
Since 2000, the stock market suffered through the 2000-2002 bear market, and then enjoyed the new bull market that began from the low in 2002.
However, inflation has continued to rise, and sure enough the price of gold has also continued to rise. This year, from its level of $411 an ounce in February, gold had risen to $433 an ounce by the end of August. Then the Katrina disaster hit and gold spiked up dramatically, and continued to do so this week as hurricane Rita entered the picture. Gold bullion reached an 18-year high on Wednesday of $475 an ounce, before pulling back to end the week at $463.
Gold, that long-time predictor of inflationary trends, is telling us that inflationary pressures have been underway since 2001, and that Katrina and Rita will add to those pressures by raising energy, food, building materials, and transportation costs even higher.
I just wish the current situation didn't so closely resemble the 1970's, the last time that multi-year trends of rising inflation, rising interest rates, rising energy costs, and rising gold prices, were in place. The result then was the severe 1973-74 recession and the worst stock market decline since the 1929-32 bear market.
The problems in the 1970s began in 1973 with the Arab Oil Embargo, and the resulting higher oil and energy costs. The Fed then, as now, was also raising interest rates to try to ward off inflation. And as now, it continued to do so even after economic problems worsened, more concerned with inflation than the threat that high energy costs, inflation, and rising interest rates, would cause an economic slowdown. There was even a similarity in the political picture, as the U.S. president's support in the polls plummeted (in 1973 it was as a result of the growing Watergate scandal).
Let's hope the bulls will be right, that this time is different.
Meanwhile, as in the 1970s, a portion of portfolios in gold is not a bad idea.
Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at www.StreetSmartReport.com and author of 1999's Riding The Bear - How To Prosper In the Coming Bear Market!
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