Gold Bubble! -- What Bubble?

TECHNICAL SCOOP FOR APRIL 25, 2008

Charts and technical commentary by David Chapman

Union Securities Ltd, 33 Yonge Street, Suite 901, Toronto, Ontario, M5E 1G4 fax (416) 604-0533, (416) 604-0557, phone (toll free) 1-888-298-7405

david@davidchapman.com
www.davidchapman.com

GOLD BUBBLE! WHAT BUBBLE?

We keep hearing that gold has been in a bubble and the bubble may have burst. A quick Google punch with “gold” and “bubble” revealed a number of articles dating back to 2005 that talked about Gold in a bubble. We saw and read numerous blogs and an article telling us that the bubble is bursting for gold and oil is about to follow and “everyone will lose their shirts”. We have been reading dire forecasts for gold (and by extension, silver and platinum) for several months. Since then gold has gone up at least $200.

A well-known popular market guru also very noisily announced recently that he is abandoning his long-held bullish outlook on gold. Seems that the fact that gold appears recently to have abandoned its link with both the US dollar and oil prices has spooked some people. And of course the big $28 down day seen last Friday April 18 worried a lot of people. The comment was that gold doesn’t do that in a bull market. In the very short term he is looking very smart. But then only a few days have passed.

As to big down days I guess he forgot the nasty $59 down day seen last March 19. Or the $28 down day November 12, 2007; or the $21 on March 2, 2007 when gold was still in the $600s; or $20 on January 5, 2007; or how about the $44 drop on June 13, 2006 that pushed gold back under $600? To the best of our recollection he didn’t scream that Gold bull was over at those times. But we could go on, citing numerous nasty falls seen quite regularly since we began the bull market way back in 2001. (Some count the bull market from the 1999 low and that may be the source of their problem. But we will get to that later.)

We have seen many bubbles over the past number of years. The most recent stock market bubble was the internet/tech bubble seen at the end of the 1990s. From a low in September 1998 at 1,556 the NASDAQ soared to a peak close of 5,048 in March 2000. That was an incredible gain of 222 per cent in just 18 months. Gold was in a bubble in the late 1970s and from late November 1978 at a price of $192, it soared to a high close of $825 in just 14 months for a gain of 329 per cent.

The NASDAQ bull began quietly from a low in October 1990, and in the ensuing decade it soared 1,443 per cent or 4,721 points. But it took eight years to gain 1,239 points or 378 per cent. Gold was fixed at $35 an ounce in the early 1970s and it took eight years to gain $157 or 448 per cent. The final gain for the decade – 2257 per cent.

For gold this time around we have been in a bull market for roughly seven years (low in February 2001 was at $255) and have gained roughly $660 or 258 per cent. What -- is that all? In the 1970s after eight years gold had already gained 448 per cent, and the NASDAQ after eight years had gained 378%.

But let’s check. After seven years, the NASDAQ was up only 269 per cent and gold in the 1970’s was up 322 per cent. So by that measurement we are right in the mix but gold today still looks like a piker. We have not as yet hit the incredible run-ups that pushed both the NASDAQ and gold into their bubble markets. No, we haven’t seen a bubble in gold yet. By this measurement we are still basing.

Another famous bubble had its low in August 1921 at around 64. Of course we are referring to the stock market bubble of the 1920s. Seven years later, in February 1928, it was up 200 per cent. But the last good low was really in June 1928, when it was only five per cent higher. Then it rose 88 per cent in 18 months. Seems paltry. The total gain from the 1921 lows was only 494 per cent; a pittance compared to the NASDAQ bubble of the late 1990s and the gold bubble of the 1970s.

Bubbles have a long history. They were famously written up in Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, first published in 1841. Mackay brilliantly told us about famous bubbles including tulip mania in the early 17th century, the South Sea Bubble of 1711-1720 and the Mississippi Company bubble of 1719-1720. We are showing the South Sea Bubble below.

What is amazing is the similarity in the pictures of the bubbles. Four other bubbles follow. First the 1920s bubble, gold in the 1970’s, the NASDAQ bubble of the 1990s and the poster boy for the 1990s bubble, Nortel Networks. For consistency we are keeping with the log scale used in the South Sea Bubble below. All charts are monthly, using monthly closes.

The South Sea Bubble picture shows only a three-year period although the bubble got under way in 1711. We are showing the entire picture from 1920, 1970 and 1990. Note the gentler uptrend seen through the first eight years of the decade. Gold was an exception as it had a sharp run up in the first few years, but remember that in 1970 gold had been fixed for years fixed at $35, so it had some catching-up to do.

Just like the South Sea Bubble, the big up move was seen in the last year or two, although none of them was as spectacular as the South Sea Bubble itself, which rose from just over $100 to almost $1,000 in barely half a year. This emphasizes that the best part of the bubble occurs near the end and the first several years may just be a slow but steady rise.

Our final chart is gold over the current decade. While it looks good, with sharp up moves seen in 2005 and again in 2007-08, the correction thus far is not yet particularly significant. Indeed the up move has been punctuated by numerous corrections over the years and is instead making a classic stair step pattern that is a characteristic of a strong bull market. The past three has seen a steeper rise but we also went through a significant correction throughout 2006. At no time over the past several years have we taken out a prior year’s low another good sign of a strong bull market. The 2007 low is near $640 and we are long way from that level.

But if one goes back and looks at the other charts of the NASDAQ, the DJI and even Nortel and gold itself, we see similar moves. Irregular up moves, with sudden sharp corrections but overall relentlessly upward throughout the decade. We note on each of the above charts that the major launch point is seen in the eighth year up. All were seen in the last six months of the eighth year of the up trend. From the beginning of the decade (not the lows) the DJI 1920-28 was up 75 per cent at its key launch date in October 1928; gold 1970-78 was up 451 per cent until November 1978, but again, it had to catch up after being fixed for years; the NASDAQ 1990-98 was up 261 per cent into August 1998; and finally Nortel 1990-98 was up 248 per cent into September 1998.

So far this decade gold is up 223 per cent, well above the movement in the DJI 1920-28, but well behind gold 1970-78, but right in the mix with the NASDAQ and Nortel 1990-98. AS we noted these key launch points occurred in the latter part of the year, from August until November, so it is possible that gold could wash around for the next few months with a number of ups and downs. It is even possible that we could at some point test the major uptrend line (currently near $800 but rising) before this current correction is over. We note as well the 40-week moving average is near $820 and the 200-day moving average is near $810. The 1980 highs of the close of $825 and the high near $850 are also points that would provide significant support.

Finally we note our long-term cycles. Ray Merriman of MMA Cycles Report notes an 8.5-year cycle low in gold and a longer 25-year cycle in gold. Now data is thin because gold has been free-trading only since the early 1970s. But we note major lows in August 1976, February 1985, January 1993, and the double bottom of July 1999 and March 2001. Merriman, in the case of double bottoms, says we should always count from the second bottom.

His ideal next 8.5-year cycle low is due in August 2009 +/- 17 months. So really the entire period from roughly March 2008 to December 2010 could see the trough of this cycle. It is possible that we could be seeing the drop into this major cycle low now but we doubt it very much. To help us further, we look at sub-cycles. Merriman also notes an 18.5-month cycle with a range of 15 to 22 months but which has occasionally shortened to 13 months or been as long as 23 months. Since our lows in March 2001 we note lows or launch points in November 2002 (20 months), July 2004 (20 months) but then the next good low wasn’t until at least September 2006 over 24 months away. So we looked at the cycle in a different fashion by doubling the term to 37 months. That could have a range of at least 30 to 44 months.

From our March 2001 lows we note a significant low in July 2004 (40 months) then our next good low in June 2007 (35 months). The June 2007 low was a higher low but it was the final low before the recent take off to $1000 and fit well with the cycle. If the 37 month cycle is the dominant one our next one is not due to at least July 2010 with a range from January 2010 to February 2011. We are then right in the mix for our next 8.5 year cycle low.

As well we note that the 37 month cycle can break down into three’s meaning roughly every year we have a cycle low. This one has worked pretty well and therefore we could be looking for this years low to occur anywhere from May 2008 to August 2008. If that is the case we could be looking for our low as early as the next week or two.

Our conclusion is clear. While we are going through a correction with a real risk of a fall towards the $800-$825 level it is just that – a correction within the context of bull market. That correction should end over the next few months. We should then embark on another up leg that could prove to be the most spectacular part of this bull market in Gold that got underway back in March 2001. So to answer our question “What Bubble?” it is simple – we are not in nor have we been in a Gold bubble. In fact the best may be yet to come. Investors should use this opportunity to re-balance their gold positions and also ensure that they are long bullion as well because past history has shown that bullion in these cases usually outperforms the stocks.

David Chapman is a director of Bullion Management Services the manager of the BMG BullionFund (formerly Millennium BullionFund) www.bmsinc.ca