Stocks, Gold and The K-Wave

April 20, 2000

In recent weeks we have outlined our view that we stand on the cusp of a nearly 10-year deflationary period which will wipe out the values of numerous assets, most notably stocks, commodities (excepting gold), and real estate. There presently exists, however, a variety of conflicting views on where we stand in the long-wave cycle and what the next decade will bring in the way of inflation or deflation. In an effort bring balance and clarity to this debate, we are making available the findings of our latest research into this area.

The dominant factor in the analysis of any form of security (equity, currency or commodity) is the cycle, especially the long-wave cycle. An investor must know where he stands in the overall spectrum of the grand cycle in order to ensure his investment strategy is inherently sound. The starting point of any form of financial analysis, therefore, must be the determination of where we stand in the 50-60 year Kondratieff Wave cycle ("K-Wave"), which alternates equally between a 25-30 year period of inflation and a corresponding period of deflation. This discovery by the Russian economist Nikolai Kondratieff in 1926 ranks as one of the most important economic discoveries of all-time. While much research and improvements have been made to the K-Wave in the years since that time, much is still lacking in the way of a proper understanding of this important theory. This does not need to be the case, however, since the record of historical prices provides the best and surest guidelines for interpreting the K-Wave and should leave no room for debate as to its efficacy.

A great many economists, cycle theorists and investment analysts in recent years have taken to extrapolating the K-Wave using the historical record of stock market prices. This is a great mistake, as we will show, since Kondratieff himself used commodity prices as the starting point of his K-Wave research. Commodity prices, much more so than equities prices, provide a more accurate reflection of the inflationary or deflationary trends inherent within the banking system (and by extension, the general economy). Therefore, commodities—and not stocks—must be given close scrutiny when attempting any form of cyclical analysis, but more especially K-Wave analysis.

One of the most exemplary charts we have ever happened across in our research of cycles is found in a classic economic text published in 1925 by Richard T. Ely, titled "Outlines in Economics." In a chapter on the business cycle, Ely provides the following chart showing the trend of commodity prices in the United States and England from 1810 to 1921 (see chart illustration below). More than any other chart we have seen which is used to illustrate the effects of the K-Wave, this chart shows the clear, conspicuous, almost perfectly symmetrical aspects of the long-wave economic cycle. Beginning around 1815 (when general price inflation climaxed with the Napoleonic Wars and the War of 1812), the 25-30 year deflationary leg of the K-Wave commenced. It bottomed around 1845 (30 years later), then began the 25-30 year inflation leg of the K-Wave, ending in a grand inflationary climax just before the U.S. Civil War ended in 1865 (20 years). Thus, the entire K-Wave from peak to peak began in 1815 and ended in 1865, making a total of 50 years. This is the bare minimum for a K-Wave.

The next K-Wave began that same year, with commodity prices generally falling into the trough of the deflationary leg of the K-Wave in around 1895 (30 years). From there, they rebounded into the inflationary leg, which lasted until around 1920—25 years. Thus, the total duration of this second K-Wave was 55 years.

Next, the K-Wave fell from 1920 to around 1950, when prices generally stabilized, inflation slowly kicked in and prices began rising again into the inflationary part of the K-Wave. This lasted into 1980 when most commodities—led by gold—peaked out in extraordinary fashion only to fall precipitously over the better part of the next two decades. Thus, the last K-Wave lasted a full 60 years—the absolute maximum duration of a K-Wave.

Already, one can see a pattern emerging here. The K-Wave that began early in the 19th Century lasted 50 years, the next one lasted 55 years, and the last one was 60 years in length. We are already 20 years into the deflationary leg of the latest K-Wave, and while its precise bottom cannot be known, it cannot end any earlier than 2005, and can end as late as 2010. This immediately stimulates a number of questions and contentions concerning the possible length and nature of this present K-Wave. Among them: Since the established rhythm for the last three K-Waves has been a 50-year, 55-year, 60-year cycle, will the parameters of the K-Wave be broken and therefore extended to beyond 60 years? Or are we to expect a reversion to the 50-year cycle this time around? Since deflation can be expected for the better part of the next decade, will gold tumble in price along with most other commodities? Will the present K-Wave bottom be a mild, shallow one (which would imply only a mild recession with the possibility that stock prices will maintain value throughout), or will it be equally severe with the one that ended in 1920-21 (which produced the Wall Street Crash of 1929). The answers to these questions will admittedly be speculative, but we believe we have highly probable answers.

In answer to the first question, we can immediately rule out any possibility that the K-Wave will be lengthened this time around. Despite the fact that human life spans have been progressively lengthening in recent decades, a K-Wave of more than 60 years is highly improbable if for no other reason than the fact that there is only a certain point to which bank credit expansion (a principal cause of the K-Wave) can continue without eventually causing a collapse in prices. Even if it were possible for money and credit expansion to continue for decades on end, it would never be sustainable due to the basic laws of supply and demand as well as the fact that inflation has limits. Life spans have little to do with the existence of the K-Wave, and while it is true that it typically requires the passing of a generation before the second generation can repeat the mistakes the first one (i.e., speculative manias and panics), we find no indication in history that the 50-60 year long-wave cycle has ever been extended or contracted beyond these parameters. The K-Wave seems to be Divinely commissioned, and God himself has fixed these boundaries for it. The first time the existence of the 50-60 year K-Wave is even alluded to is in the Old Testament, in Leviticus 25:8-19, where God established the levitical laws concerning the Year of Jubilee to the Israelites. Therefore, it is reasonable to conclude that the present K-Wave will continue to be confined by the 50-60 year parameters.

Will the present K-Wave end up being a mild one? This is doubtful in the highest degree. From a supply/demand perspective, we observe that the K-Waves over the past 200 years that ended in mild fashion did so when commodity supplies were at fairly low levels. Conversely, the ones that were particularly vicious (such as the one of the 1930s) were augmented by the fact that supplies were at extremely high levels. Currently, global supplies of all-important grain stocks (an important measuring rod) are at or near all-time high levels, which guarantees the coming deflation will not end pleasantly.

While we have no way of knowing exactly the deflationary leg of the current K-Wave will bottom, it is reasonable to surmise that its ultimate end will be a vicious one, since the previous inflationary cycle was exceedingly powerful. The Law of Alternation governs prices for everything, and this is especially true of economic cycles. This law has its basis in the law of physics which states that "every action tends to evoke an equal and opposite reaction." Since the last 30 years or more have witnessed an unprecedented runup in prices for equities, it must follow that the coming reaction will be correspondingly severe. This suggests that the coming decade will be one of profound and prolonged economic depression.

Finally, the point that chiefly concerns us is how gold can be expected to perform during the final third of the deflationary K-Wave—the part we have now entered and will likely represent the most extreme part of the present K-Wave. It is true that gold, as a highly sensitive inflationary barometer, would normally be expected to decline in dollar value throughout the duration of the coming decade. However, a corollary to K-Wave research is that while gold is most sensitive to inflation and deflation, and while it is almost always the first major commodity to peak out in times of inflation, it is likewise the first to bottom out ahead of the K-Wave deflationary leg. We believe we have already witnessed this bottoming out process (see our recent article, "Gold has already bottomed"). There is still room for further declines, but not much more than a year's worth. If we haven't seen gold's bottom already, we will see it no later than late 2000/early 2001.

The reasons for this premature bottom are many, too many to enumerate. Suffice it to say that gold's supply/demand ratio, the fact that financial panics of a K-Wave magnitude (such as we are about to witness) engender a flight to gold (not to mention a loss of faith in government, which only exacerbates this rush to gold), plus the fact that its 20-year decline is extremely over-extended (and therefore ripe for a massive bounce-back), virtually assure it of performing admirably during the worst part of the coming deflationary collapse.

In conclusion, we acknowledge that there is much that we do not know about the K-Wave, and perhaps much that we are mistaken about. But the underlying basis that we have outlined here is based on sound economic principles and has withstood the test of time. Accordingly, we may reasonably expect the next five-to-ten years to be challenging ones in many ways. However, we can rest assure in the knowledge that our portfolios can largely survive the storms ahead if buttressed with the strong protection afforded by gold.

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 world’s largest gold nugget is 61 lbs, 11 oz and is on display in Las Vegas.