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The Long Wave Gold Cycle

January 1, 2002

Most natural phenomena exhibit some sort of regular rhythms. From the change of seasons to the beat of a human heart, cycles dominate much of life. Study of repeating cycles extends to almost every scientific discipline. Cyclical behavior is fundamental in the life sciences. Biological organisms display many kinds of cyclical behavior. Organisms interacting with the environment form ecosystems that also display cycles. Humans, also being biological organisms, are subject to many of the same cycles. Human transactions have structures that are in many ways similar to natural ecosystems. We call these structures economies. Many people believe that economies are also subject to cycles or "waves" that can be detected and predicted.

Economic cycles were a hot topic of research in the early 20th century. Accurate economic statistics became widely available to construct models over significant periods of time for agricultural output, steel production, factory employment, etc. It is a natural human tendency to look for patterns in everything. The availability of voluminous economic statistics begged for cyclical analysis. Wesley C. Mitchell of the National Bureau of Economic Research performed some of the early work on economic patterns earning him the title as father of the business cycle. Austrian economist Joseph Schumpeter later identified many cyclical behaviors including a four-year business cycle and a longer ten-year wave. He also suggested that a very long-term cycle lasting many decades exists and speculated about its origin.

One of the most influential and enigmatic practitioners in the obscure art of economic cycle research was Nikolai Kondratieff (kon-DRAH-tee-ef), a Soviet economist who performed his research in the 1920's. Through laborious manual calculations and hand-drawn graphs, Kondratieff discovered an unmistakable cycle in the fortunes of capitalist economies. The data formed three long cycles over a period of study from about 1780-1924. Each of these cycles were 50-60 years in length. Economic activity appeared to rise in the beginning of a cycle, build to a crescendo, then decline for a period of time causing lengthy depressions. He summarized these findings saying that "During the period of a rising wave in the long cycles, the intermediate capitalist cycles are characterized by the brevity of depressions and the intensity of the upswings. During the period of a downward wave in the long cycles, the picture is the opposite." He found similar patterns in many different economic statistics and confirmed that this was a worldwide phenomenon. He called his discovery "The Long Wave Cycle" (now often called the k-wave) and wrote a short book of the same title to publish these findings. This periodic waxing and waning of economic activity puzzled the man and he struggled to compose a theory to explain it. Implicit in the theory of economic cycles is a process of evolution and self-correction. This was contrary to the official Soviet doctrine predicting an ultimate collapse of capitalism. Accordingly, Kondratieff's research inflamed the Soviet authorities and he was ultimately banished to Siberia where it is thought that he died in the 1930s. The timing of his disappearance was particularly ironic as the capitalist world descended into deep depression, arriving exactly on Kondratieff's long-wave timetable.

Many economic statistics show very prominent long-cycle behavior. Inflation and interest rates are glaring examples. The inflation rate cycle coincides almost perfectly within the Kondratieff long wave cycle. The inflation rate rises from the beginning of the long wave cycle to a peak then declines near the end. Kondratieff and others (most notably Schumpeter and Elliot) have performed detailed analyses on these long cycles using many different methodologies. Most researchers agree that there is some kind of long-cycle behavior in world economies but differ spectacularly on the details. The details are important. Cyclicality implies predictability. If long economic cycles are unavoidable, predicting them becomes a critically important task because of the profound implications on economic policy and investments.

Kondratieff speculated that long cycles primarily arise from the creation and replacement of capital stock. Capital stock is the sum total of productive capacity in the economy. This includes plant, equipment, cultivated land, and any other productive goods. In his words, "The replacement and expansion of the fund of these (capital) goods does not take place smoothly but in spurts, and the long waves in economic conditions are another expression of that." Railroads, automobiles, and the new global data communications network are all examples of capital investment spurts that followed similar patterns. Each of these developments were "enabling technologies" that gave rise to synchronized development in many other industries which caused an investment boom. The consequences of such massive capital investment spurts are periods of time in-between that have relatively low investment as the existing capital stock from the previous spurt is utilized and the debts incurred are paid off. The heavy debt burden resulting from the capital investment spurt suppresses new capital deployments for a period of time, delaying them until the next capital investment spurt. Overproduction of capital stock during the spurt creates excess capacity which reduces both production costs and profits. These conditions cause downward price pressure (deflation). As a result of reduced capital expenditure, demand for labor is lower which reduces consumption and increases savings. These are the ingredients of recession and depression. Kondratieff identified these in-between periods as the "downward wave" in the long cycle.

Low returns on capital investment make the stock market a poor place to save during the downward wave. Low inflation or deflation implies very low real interest rates which reduces returns in the bond market. These same conditions also make real estate and commodities poor investments because of downward price pressure. There are few attractive options for investment when the long economic cycle is in its declining stage.

Kondratieff suggests an investment strategy: "We know that commodity prices reach their lowest level at the end of the downward wave of the long cycle. This means that at such a time, gold attains its highest purchasing power and the production of gold becomes the most profitable. On the other hand, at the end of the rising wave of a long cycle, commodity prices reach a maximum. Consequently, the purchasing power of gold is at its lowest, and the profits to be gained from gold production are minimal." His advice during the downward wave is to invest in the production of gold, in other words gold mining stocks.

Kondratieff's advice raises several key questions about today's environment:

  • Is the long wave cycle an economic reality?
  • If so, then what stage are we in the progression of the cycle?
  • If we are at the beginning of a downward wave, are gold mining stocks still a valid investment strategy given the structure of today's markets?

In response to the first question, economists have fiercely debated the long wave cycle since it was first proposed. We now have the luxury of over 70 years of additional data, presumably another full long cycle to analyze. This means that there is reliable data to cover about four long cycles. Kondratieff's original pattern appears to still exist but economies are complex and do not evolve according to a script. Kondratieff explains that "…each new cycle takes place under new concrete-historical conditions, at a new level of development of productive forces and hence is by no means a simple repetition of the preceding cycle." Each cycle is unique and has its own flavor due to the conditions present at the time. To establish a true cyclical pattern, the internal economic dynamics of each complete cycle should correlate with the others. Kondratieff identified four "empirical patterns" that described the dynamical correlations between each cycle. These empirical patterns include such things as agricultural prices, technical developments, social upheavals, and the patterns of shorter, intermediate cycles. This level of analysis is complex and can be interpreted in contradictory ways. Although the evidence is limited, it is prudent to acknowledge that long economic cycles are at least a distinct possibility.

To answer the second question, we should be able to identify the current stage of the cycle by measuring the time elapsed since the last downward wave and by comparing the conditions prevailing at each time. There is general agreement that the last downward wave occurred during the Great Depression starting about 1930. Kondratieff's research showed that a full long wave cycle takes an average of about 56 years. If the world is just beginning a downward wave then this latest cycle would have taken an extra-long 70 years. But it is possible that the world has been experiencing a downward wave for some time. The 1987 stock market crash occurred exactly 58 years after the 1929 crash. Falling inflation and interest rates since that time are consistent with the typical conditions in a downward wave. Although the US economy boomed afterward, Japan has experienced depression-like conditions since 1989. Asia, Latin America, Russia and others have all had numerous crashes and depressions during the 1990s that seem to be increasing in frequency. Commodity prices have been declining for the better part of a decade. Kondratieff identified long-term declines in real agricultural prices as a marker for the downward wave. The downward wave may have been developing on a worldwide basis during the 1990s but was obscured by the investment bubble in the US. This implies that a synchronized world depression could occur near the end of this downward wave rather than at the beginning.

The last question posed above deserves the deepest analysis since the answer determines investment decisions. The objective is to compare the gold mining industry between today and the last downward wave to determine if the conditions are similar enough to make a reasonable correlation. During the last long cycle that ended in the 1930s, gold was primarily a monetary metal. The US dollar and most other major currencies were defined in terms of a fixed quantity of gold and officially convertible to it. A fixed gold price makes gold mining security analysis relatively easy. Profitability of a gold mine is determined solely by cost in a fixed gold-price environment. Kondratieff argued that during a downward wave depression, costs decline substantially for all firms because of deflationary forces. In most firms this also means a reduction in selling price which limits the profit gained from cost reduction. Gold mining firms enjoy an advantage with a fixed selling price in a deflationary environment and reap substantial profit growth. This profit growth is reflected in rising stock prices for gold mining companies that is further enhanced by the fact that there is little else to invest in during deflationary times. During the Great Depression gold mining stocks were outstanding performers in an otherwise devastated stock market.*

Today's gold environment is much more complex. Currencies are no longer fixed to gold. The gold price is now set by market forces and fluctuates daily which may remove the fixed-price advantage gold miners have in a deflationary environment. Although the gold price is set by auction, it is not necessarily free-floating. The Gold Antitrust Action Committee and others have established solid evidence that governments conspire to keep the gold price within a certain range. Federal Reserve Chairman Alan Greenspan has pretty much affirmed gold price manipulation in his oft-quoted "Central banks stand ready to lease gold in increasing quantities should the price rise" remark. The price of gold has remained in a fairly narrow range of $260-$300 US dollars since 1997. Governments seem to be committed to keeping the gold price within that range by selling or leasing gold from their huge stockpiles when the price drifts upward. There is good reason for this strategy. A stable gold price implies stable currencies. If the gold price rises substantially, government currencies may lose favor due to high inflation. If gold prices fall precipitously, this would imply a deflationary collapse which would be even worse. As such, it is probable that governments will attempt to maintain the gold price-fixing strategy for as long as possible. This makes the current gold pricing environment functionally the same as the fixed-price environment of earlier eras. Assuming this situation continues, Kondratieff's advice to invest in gold production during the deflationary period of the downward wave is still valid today.

If world economies are entering the final downward wave of the long economic cycle, then gold mining stocks should already be anticipating this and show an upward pricing bias. Indeed, gold mining stocks have performed very well since the beginning of 2001 with the Amex gold industry price index up about 62% for the year. This made gold mining the best performing group of the year. Gold stocks rose during that period while the price of gold barely moved. Investors were pricing either a future rise in gold prices or a decline in production costs or both. Kondratieff showed how gold mining stocks can rise during a downward wave even if the gold price remains relatively constant. This is consistent with the current global environment that is tilting towards deflation. Should gold prices rise from here, it would also be bullish for mining shares. Long wave cycle theory suggests that now is the best time to invest in gold mining stocks.

…or maybe not.

Long wave cycle theory is like an economic ink-blot test. Its interpretation tells more about the analyst that it does about the data. The theory can be adapted to support almost any point of view. It is possible that long wave cycles may be a valid analysis technique for historical data yet be unable to provide any meaningful insight into future events. The true pattern may not emerge until many years after the fact. Kondratieff's discovery has mesmerized and bewitched economists for generations. Economic cycles taunt people with the possibility of seeing into the future and making untold fortunes investing on that knowledge. Many have gone out on a limb to make bold predictions based on these cycles and were tragically wrong. (Was it a good idea to sell everything in the late 1980s? Only if you were invested in Japan.) It all goes to show that no economic theory is foolproof. Any prediction arising from an economic theory is accompanied by many caveats.

Kondratieff himself was a conservative and skeptical scientist who repeatedly cautioned that his evidence was too incomplete to be considered conclusive. He stated that "I certainly do not claim that I now offer such a theory, fully elaborated. I am not convinced that I have succeeded in finding a satisfactory explanation for them (the long cycles). It is clear to everyone that, given the present state of knowledge, the problem of explaining the long cycles is extremely difficult. If we do not have at our disposal fully elaborated methods for the mere identification of the cycles, it is of course much more difficult to explain them." Our state of knowledge is only a little better today than it was in Kondratieff's time.

Does the vagueness of long wave cycle theory invalidate the analysis presented above? Not necessarily. There are many independent reasons to be bullish on gold mining stocks whether a depression is imminent or not. Investment decisions should be made with consideration of all the relevant data. It is best to think of cycle theory as a tendency rather than a fixed destiny and the long wave cycle tendency is currently bullish for gold mining securities. Still, the thought of experiencing another episode like the Great Depression is scary. Long wave cycle theory is not very comforting. The best that it can do is forewarn and suggest defensive strategies for leaner times. Depressions are not pleasant, but they are a necessary part of social renewal. Many people come through it stronger as a result. These are times of rest and reflection after a long economic race. They set the stage for the next upward wave as mankind lurches toward the future in fits and spurts.

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Author's Note: Nikolai Kondratieff's "The Long Wave Cycle" is a short and surprisingly readable text of only 120 pages. It is available at many libraries and I recommend it to all students of economics and history. Some of the commentary in the original text was written by a colleague D. I. Oparin, but there is no attribution to his contributions. Many of the quotes that I cited may actually be Oparin's. The excellent 1983 translation by Guy Daniels preserves much of the original language of the day yet presents the material with good clarity. The introduction by Julian M. Snyder provides much added perspective by giving a modern interpretation of Kondratieff's work. And yes, I do own gold mining stocks.

* The US gold fix was raised from $20 to $35 in 1933 which caused a big rise in US gold mining shares. However gold stocks generally rose consistently throughout the Great Depression period.


Nikolai Kondratieff, The Long Wave Cycle, 1926; tr. Guy Daniels 1983

Wesley C. Mitchell page:

Joseph Schumpeter page:

The Gold Antitrust Action Committee website:

Pure gold is so soft that a strong man can squeeze it and shape it.
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