The Bottom has been Seen for Gold

April 16, 2000

A news brief appearing on the front page of the April 13 Wall Street Journal reported the recent findings of an experiment to discover that elusive quality that gives the jellybean its distinctive flavor. The experiment found that the secret to the jellybean's texture and flavor was the gradual migration of moisture from the shell back to the core. Concluded the study: "So, attempts to speed up the process through artificial drying inhibit the jelly bean from finding its equilibrium." This reminds us that in the marketplace, attempts at expediting the natural processes of supply and demand through artificial intervention, and attempts at speeding it up through fiat credit, only keep prices from finding their natural equilibrium—the very process for which the free market exists. Governments and bankers could learn a lot about the markets from that old Easter staple, the jellybean.

In the 1970s, gold led commodities in a magnificent inflationary bull market to new all-time highs before posting a top at over $800/oz. in 1980. Just as gold led the broad commodity sector higher, it also led on the way down, being the first major commodity to top out (most commodities peaked the following year in 1981). Thus, gold established its role as a leader in the inflation markets.

More than that, the 1980 blow-off top in gold was a manifest token of the top in the 56-year Kondratieff Wave Cycle, which divides roughly into 25-30 years of inflation (increasing money supply accompanied by rising prices) followed by 25-30 years of deflation (decreasing money supply accompanied by falling prices). Since the peak was reached in 1980, we can expect the trough sometime later this decade. But inflation-sensitive commodities such as gold tend to peak out and bottom ahead of most other assets in the K-Wave cycle, so it is reasonable to expect an early K-Wave bottom in gold prices. And if our latest analysis is correct, we have already seen that bottom.

Based on our exhaustive cyclical analysis, we have concluded that the high-volume spike in gold prices in late September of last year was indeed the long-wave cyclic bottom in gold. We will outline our reasons for this conclusion in the paragraphs and corresponding charts that follow.

Since the underlying basis for all prices is the time and price cycle (which vary in degrees), in order to analyze gold we must first and foremost isolate the major cycles that control its movements. This is done by obtaining charts with the longest possible timeframes and looking for peaks and troughs in prices, which always indicate the topping and bottoming of cycles. We are further aided in this endeavor by noting the trading volume and open interest patterns which correspond with these peaks and troughs. Typically, volume will surge at tops and dry up at bottoms, though the opposite can occur in either case. By combining price, time and volume, we begin to see the "big picture" coming into focus and can make accurate forecasts and investment decisions based on this understanding.

Since the price and volume surge on the days of September 27-30 in Comex gold futures is quite conspicuous on the charts, we therefore conclude that this represented a major bottom in gold's price. But was this in fact the ultimate bottom in gold's price? To answer that we must perform what we like to call "parabolic analysis." (Incidentally, this form of analysis—initially discovered by P.Q. Wall—is detailed in our latest book, "How to Trade Cattle Futures: If Hillary Can Do It, So Can You!" As far as we know, this is the only book to have ever explained parabolic analysis in detail. See our website at www.tapetellsall.com for details).

Parabolic analysis is based on the Spenglerian notion of the conflict of opposites, namely, that at any given time there are forces conflicting with counter forces. Another way of putting this would be to say that every action evokes its own equal and opposite counter-reaction. In price charts, this principal can be seen in the way that parabolas in the form of bowls and domes constantly interact with each other. Looking at a long-term chart of gold prices, note how prices gently conform to the edge of the bowl pattern we have drawn. One of the distinguishing properties of the parabola is that either side of the parabola is equidistant from the midpoint. In performing cycle analysis, the "midpoint" corresponds to either the peak or trough of the cycle you happen to be analyzing.

If we assume that the explosive price movement in gold futures last fall was the midpoint of the cycle (a high probability), then this will serve as the midpoint of our parabola, or bowl. By measuring the distance from the midpoint to the extreme left edges of the bowl and projecting that same distance and curve onto the right side of the chart—the side which represents the future—we have a guideline for how gold prices can be expected to perform in the coming months for the next four or five years. While there will almost certainly be some dragging along the bottom of the bowl, at some point the gently upward curving sides of the bowl will begin shepherding prices to higher levels until our upside target of approximately $400-$450 is met. From there, prices will probably correct and consolidate before rising again into the early inflationary leg of the next K-Wave cycle.

As for a near-term analysis of gold, it is reasonable to expect a fairly considerable price rally from current levels ($282 as of this writing), since volatility, volume and open interest have been rapidly diminishing in climactic fashion. This extreme diminishing of volume and volatility typically harbingers a significant movement in one direction or the other, and in this case the direction would most likely be to the upside. Another technical phenomenon worth noting is the fact that gold's open interest line on the COMEX—which perfectly represents the gold price cycle—has traced out a bullish head and shoulder bottom pattern.

Now, here is where our analysis takes an interesting turn. We have been forecasting a bull market for the U.S. dollar, which has already technically begun, over the next few years and even throughout the worst part of the deflationary collapse. Yet we also propose that gold will maintain its value throughout this collapse and will behave quite bullishly for the most part. Isn't this a contradiction of terms? Not necessarily. While it is generally true that a strong dollar corresponds with weak gold prices, and vice versa, it isn't always true. What is important to remember is that in a deflation the prices for almost all assets are falling rapidly and relentlessly, erasing the value for most hard and soft assets. But all the while, the dollar is increasing in value by virtue of its relative scarcity. Money tends to be hoarded during such deflationary periods, and this diminishes its supply while increasing its demand. Credit, which was plentiful and profuse throughout the better part of the previous inflationary bull market, is now hard to come by, so cash becomes precious. Of course, gold, too, will be in demand, especially when considering that the insolvency of so many individuals, institutions and governments will create a greater demand for strength in financial investments, and no financial asset has greater strength than gold.

Gold is the only asset which requires no backing, but is backed by its own inherent value. The dollar, however, does require such backing. In prosperous times, the dollar is backed by the faith and credit of the solvent U.S. government. In a depression, such faith, credit and solvency does not exist. Yet gold as a financial standard does exist. Therefore, it is only logical to conclude that the dollar will once again be backed, in some measure at least, by the gold standard. Thus, gold and cash will be the most sought-after assets during the final leg of runaway deflation in the present K-wave over the next few years.

We do not say that gold will begin a powerful bull market anytime soon; only that the worst is over for gold and its ultimate bottom has most likely been seen. Things certainly cannot get any worse from here, only better, but that does not mean there won't be a prolonged consolidation at these low levels for a while before things really get moving. By our estimation, gold should begin moving in a sustained upward fashion sometime next year. There should still be plenty of time to accumulate gold at these present low levels, but we wouldn't hold off purchases for too long, for who knows what the coming equities collapse will do in the way of engendering a panic-driven gold rally. A slow, steady accumulation of gold from this point onward would seem to be the wisest course.

We are not yet out of the tunnel yet, fellow gold advocates, but for the first time in 20 years we can actually see the light at the end of the tunnel. And this time, it isn't the light of an oncoming train!

Note to readers: Our Web site can be viewed at www.tapetellsall.com

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.

The average human body contains 0.2 mg of gold with the bone containing .016 ppm and the liver .0004 ppm.

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