first majestic silver

Gold & Historical Norm

July 19, 2006

When gold (and most commodities) came crashing down recently from a high of $730 to $540 in just a few weeks time many experts declared the end of the precious metals (and commodity) bull run. But based on what? What's the sense of declaring the end of a 4 year bull run which followed a 20+ year bear run. Believe it or not but commodities are dirt cheap these days no matter what the 'experts' want you to believe. Believe it or not but gold is nowhere near historic highs these days, no matter what the 'experts' want you to believe. In order to trade in record high territories based in 2006 dollars we should see gold trading above $1500,- these days and the CRB index at 1000!

Mind boggling numbers? Well, take a peek at the charts below and judge yourself:

  • DOW/GOLD ratio
  • Gold vs its own long term average
  • Gold vs Oil
  • Gold/Oil ratio
  • Oil vs Inflation
  • Inflation vs Gold
  • Gold vs CRB

DOW/GOLD ratio

When I first wrote about the DOW/GOLD ratio three years ago I started off by saying:

Looking for a tool to predict future POG movements ? A tool which is extremely easy to use ? A tool which has proven to be extremely useful in the past ? A tool well respected by many veteran market analysts ?

Of course when I talk about 'easy to predict future POG movements' I'm not talking about one or two year projections. No, by saying predicting future movements I mean average up or down for at least a decade. Indeed, the DOW/GOLD ratio has proven to be an accurate tool when it comes to identify major turnarounds in stocks/gold. Please take peek at the chart below and see yourself:

Again, the DOW/GOLD chart is a powerful tool in order to determine major turnarounds. It's simple, when the DOW/GOLD chart tops you buy gold, when the DOW/GOLD chart bottoms you buy equities. Once you've established your position you can ride the wave up or down for at least a decade. The DOW/GOLD chart flashed a 'buy' for Gold again in the year 2000 and indeed 5 years later Gold is already 66% off its lows since then. The DOW/GOLD chart tells you to hold on to your Gold until a new bottom has arrived in the 1 - 5 area. Well, if it were all that simple why don't we hear that much about it ?

Well, as said before the DOW/GOLD chart isn't useful at all in order to predict yearly price movements. It could very well be that next year will show a higher reading than this year instead of an expected lower reading thereby losing confidence as being a reliable indicator. Unfortunately that's the same analogy as denying that higher temperatures will arrive in summer based on a single day temperature drop in spring. The problem is that the DOW/GOLD cycle has a wave length that's so big that we humans have a hard time to figure out where to position ourselves into this cycle.

Nevertheless many veteran analysts such as Richard Russell and John Hathaway do refer to this cycle. Richard Russell often said that he wouldn't be surprised to see Gold crossing the Dow at 3000 thereby suggesting a new bottom for the DOW/GOLD ratio at one. Indeed history does suggest that the DOW/GOLD ratio bottoms periodically in the 1 - 5 range. The Dow/Gold ratio topped in 2000 far above 40 and is heading down now (currently at 19.5). If the DOW/GOLD ratio can live up to its expectations than we can expect a new DOW/GOLD bottom within this decade or shortly thereafter.

Another industry insider who's favoring the DOW/GOLD chart is Newmont's president Pierre Lassonde.

Lassonde certainly raised some eyebrows last year when he predicted a gold price exceeding $1000 referring to the DOW/GOLD chart in order to justify his claims. In an Australian TV interview he said:

Gold will have three zeros after its price - it is just a matter of what figure precedes the zero's. END.

The host was floored by this comment and couldn't get her mind around many more than a 1 and thereafter kept referring to gold at $1000 an ounce until Lassonde said (roughly) a rule of thumb historically has been one for one with the DOW. In 1930 gold was $35 and the DOW was 37. In 1980 gold was $800 and the DOW was 800. The host jumped in and said "Now gold is trading at $495 (Nov 05) and the DOW is 10,500 and Lassonde replied:

Yes, is out of kilter by a factor of 20 times and I can assure you the DOW is not going to 1000. END.

The bottom line is that the current reading of 19.5 is nowhere near an historic high for Gold. To trade at an historic high today Gold should be trading above $2.000 at least (assumed DOW/GOLD bottom of 5)

Gold vs its own long term average

When an expert claims Gold to be trading at record high territories these days you would probably think that gold never traded above $600. Well, for the first 70 years of last century Gold was dull indeed and never traded above 40$ / ounce. But as we know, that was all about a fixed Gold price by government decree. When Nixon closed the gold window in 1971 gold could finally crawl back to its natural equilibrium. Therefore I think it's fair enough to take 1970 as a reference point from where on we should calculate Gold's long term average. In order to do so we should re-calculate the gold prices with 2005 dollars (inflation adjusted) and check out if Gold is at an historic high indeed or not.

As you can see Gold is trading nowhere near an historic high according to its own long term average. In order to do so, Gold should be trading at least above $1800.

Gold vs OIL

There has been a huge debate lately whether or not a correlation exists between gold and oil. The naysayers argue that gold is a product only to be accumulated over time while oil on the other hand is a commodity being consumed towards zero over time so therefore making it impossible to compare. What they fail to recognize however is the simple fact that rising oil prices are causing higher inflation rates and gold has proven to be the ultimate hedge against inflation. The charts below speak for themselves:

The Gold vs OIL chart proves beyond any doubt that there's a very strong correlation between gold and oil indeed:

Gold/OIL ratio

OK, so we've seen that there's a strong correlation between gold and oil indeed but how to determine a projected gold price based on today's oil prices? Well, in order to do so one should calculate the historic average of the gold/oil ratio which equals about 16. This ratio in turn projects a 'normal' gold price of $1200+ and historic highs of $2600+

Oil vs Inflation rates

As stated above rising oil prices do cause higher inflation rates. We've seen enough headlines lately which do confirm statements like these.

Fed chief fuels inflation fears
AP June 06, 2006

Just when investors hoped the Federal Reserve was nearing the end of its two-year rate-raising campaign, the specter of still higher rates stuns investors.

"So far this year, inflation at the consumer level has been elevated in large part by rising energy prices, Bernanke said. As measured by the Consumer Price Index, "core" inflation rose at an annual rate of 3.2 percent over the last three months and 2.8 percent over the past six months. "These are unwelcome developments," he said. END.

So there it is: rising energy prices translate themselves into higher inflation rates. (It's estimated that for every 10% rise in oil prices inflation rates will increase by about 1%)

The chart below speaks for itself

Gold vs Inflation rates

So we saw higher oil prices leading to higher inflation rates. What does that mean for gold? Since gold is seen as the ultimate hedge against inflation gold should do well on rising inflation rates. The chart below speaks for itself:

Gold vs CRB

Many 'experts' are calling for the end of the commodity bull run which lasted for only four years. They argue the commodities being in bubble territory which is simply not sustainable and therefore bound to collapse. But are commodities really that 'expensive' these days? In absolute terms maybe yes but in 'real' terms (inflation adjusted) certainly not. If the CRB index would catch up to its 'real' (inflation adjusted) high then it sure still has a long way to go since the inflation adjusted 'high' for the CRB exceeds the 1000 points mark! Would it make sense for the CRB index to drop from a 1974 high of 1000 points to a low of 200 points in 2002, then climb towards 400 points in 2006 just to be declared dead? Well, not according to the legendary Jim Rogers who simply points out there has never been a commodity bull cycle in history which lasted less than 14 years. The chart below doesn't contradict Roger's view, there' still plenty of upside potential left for the commodities.

This chart clearly demonstrates a high correlation between gold and commodities. The only big anomaly we see is during the early seventies where gold seems to be lagging the commodities. But since gold was being pegged at $35 till 1971 it simply had some catching up to do for the next few years.


Gold is nowhere trading historic highs; and in order to do so it should be trading at least above $1500 these days!

The CRB index is nowhere making historic highs either. In order to do so it should beat the 1000 mark level first, an event which will take at least a couple of years more in order to achieve!

Eric Hommelberg


The Gold Drivers Report
The Gold Discovery Letter

Email: [email protected]

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