Gold Market Update

It seems that market watchers and economic forecasters are unevenly divided into two camps with widely divergent views. The first and most populous are those who see the current economy in terms that relate to benchmarks or events that have occurred in the recent past. These folks have a time horizon that goes back five or ten years and tend to believe that the coming decade will be as prosperous as the last. The second camp are those who take a more historical perspective, measured in decades or centuries. These folks tend to believe that the coming decade will not be as prosperous for most people as the last. After spending half of my career measuring the world in geologic time, where 10 million years seems like yesterday, I naturally have a preference for the longer view. I also believe that, despite advances in education, technology, and living standards, human psychology has not changed much since the days when painting pictures on the walls of caves was popular. Markets have been around for much of human history, and since most market participants are, in fact, human, it stands to reason that human behavior will impact modern markets in a similar fashion to markets of the past. We believe that the magnitude of the tech collapse and the scope of the corporate accounting crisis are on a scale that ranks the excesses of the nineties on par with other great financial bubbles of history. Because of this, we find the chart below to be extremely compelling. It plots the before and after patterns of three stock market bubbles; the Dow from 1920 to 1941, the Nikkei from 1979 to 2000, and the Nasdaq from 1992 to present. The peaks of each market are aligned and each scale is set to a common starting point eight years prior to the respective peaks.

The chart patterns are so remarkably similar that they suggest that the Nasdaq could continue to follow a path not unlike the post-bubble Dow in the thirties or the Nikkei in the nineties. (Note: We first referred to this chart in our January 16th, 2001 Gold Market Update. The similarity between this chart and the chart that appears in the C-section of today's Wall Street Journal is purely coincidental). This type of research leads economic historians to warn investors of heightened financial or economic risk, however, the recent recession has thus far been short and mild. Past recessions have served to cleanse the market of excesses that had built during the boom years - years in which human behavior, such as greed and speculation, dominated the markets. Yet, unlike past recessions, consumption has remained strong, the U.S. trade deficit continues higher, and home values have increased. How is this possible? CREDIT! The record levels of debt amongst businesses and households continues to climb. The speculative mood is still alive. Modern Fed policy says that any time the economy is threatened in any way, offer them credit, and they will spend it. The Fed found the Asian currency crisis an appropriate time to ease in 1998. Then the Long-term Capital crisis - ease some more. Then Y2K - ease again. Then the recession - let's ease one more time. The accommodative policies of the past several years have kept one crucial element of human investment psychology from affecting this business cycle - fear. A general lack of fear and an abundance of confidence in the abilities of government to provide prosperity have thus far subdued the impact of the recession. Meanwhile, the debt overhang that has been allowed to fester could potentially cause the post-bubble Nasdaq to continue to follow the pattern of other post-bubble markets, as a leveraged economy could become hypersensitive to increases in interest rates.

How did gold and gold shares act in the post-bubble environments covered above?

• The gold price was fixed in the 1930's, as the U.S. dollar was partially convertible to gold. The government raised the gold price from $20.67 to $35.00 in February of 1934, an increase of 69%. Between 1930 and 1935, the stock of Homestake Mining Company rose approximately five-fold.
• The Yen price of gold started a long decline after the Nikkei peaked in 1990. Yen-gold bottomed in August of 1999 and has since risen by nearly 50%, but is still well below its 1990 level. We know of no Japanese-domiciled gold shares for comparison.
• Since the Nasdaq peak in early 2000, gold traded lower until April of 2001. It has since gained approximately 22% and is now $12 shy of its February 2000 peak of $315. The XAU Gold and Silver Index followed a similar pattern to gold, but bottomed several months earlier in November of 2000. The XAU has since risen about 65%.

Depression-era investors were richly rewarded for holding gold or gold shares. Japanese investors have been disappointed by gold's performance, although banking problems persist that could cause gold to continue its recent rise in Yen terms. Gold closed Friday at $302.10 amid news not unlike that of our last update - reports of producer buying through hedge reductions, talk of Bundesbank sales, and fighting in Israel. Like the 1930's, the current post-bubble market has thus far been good for those who invested in gold and gold shares.