DiceMagic (< 20)

Calling the Gold Top

November 30, 2009 – Comments (2)

I do wonder about where gold is going and, being in a bull market, I’m clinging on to the “wall of fear” for grim death. There are a few theories being bandied about about how gold has behaved in the past and what relevance it has to the current gold bull market. It’s worth a wild stab in the dark at each and maybe to draw some conclusions about where gold may end up. All this is, of course, wild speculation backed up by supremely unreliable figures but here goes anyway.

Scenario 1 – The Gold/Dow Ratio 
The Premise – A graph of the gold price verses the Dow Jones price over time relates very neatly to the major economic hard times over the last century, which I reckon is long enough to be relevant. The peaks are at 1929, 1960s and 2000, where 15, 25 and 40 ounces respectively were needed to buy one share in each of the Dow Jones listed companies. The troughs 1933 and 1981 Gold rose and the Dow dropped so that only 1 ounce was needed to buy the Dow.

The Target Price – A falling Dow or a rising gold. Hard to call but a combination of both perhaps The Dow at 4-6000 and gold price of $5000 is not unreasonable with this scenario. 

The Likely time scale - late 2010 early 2011

The Problem – This scenario looks all very feasible but when you look at the time scales the major movements in gold coincide with major depressions – all very well but there are other compelling events at these times. Namely the exit of the global reserve currencies from the gold standard, Sterling in 1930 and the Dollar in 1971. Some have claimed that the exit of Sterling from the gold standard caused the 1930’s depression, others that the exit was forced by the depression. Whether these events are the cause or effect the delinking of currency from gold skews the Gold/Dow Ratio to an extent that I’m not over happy to rely on such a simple ratio and I’d put no more than a 50% reliability on this.  

Scenario 2 – The Gold/Oil Argument

The Premise – Gold is just money and historically held its value over time. After all in Roman times an ounce of gold would by you a Toga, sandals and fittings, an ounce today will get you a perfectly passable suit, shirt, tie and shoes. Let’s look at the gold price against oil – they call it black gold anyway.

                    1970          1975           1980

Gold Price       31             150             650

Oil Price           3              12                35

Ratio               10              12               20

The Target Price - Extrapolate the table above out to 2012 and we get a price of 2800

                    2002          2007           2012

Gold Price       310           700           2800

Oil Price           25             65             140

Ratio               12              11               20

The Likely time scale – it is where we extrapolate it too but let’s take 2012.

The Problem – I’ve used average prices over the years to try and give a balance view. Why I don’t like this ratio – it’s too narrow and could be easily skewed and is reliant on what the Oil price might be in 2012. Is it accurate enough? Why not it’s a ratio people like and it returns a figure that these days looks increasingly possible for next year let alone 2012. I’d not take a bet at less than 3 to 1.  

Scenario 3 – 1973 and All that

The Premise – Similarities between the last Gold bull and this one are very compelling. 
Oil Price Spikes in 1973 and 2005. Foreign Wars Vietnam in 1960s/70s andIraq /Afghanistan 1990s/2000s. Major Money Supply Change/ Debasement - US exits Gold Standard (1971) and the invention of Quantitative Easing (2009). Major Equities Crashes in 1973/4 and 2008/9. Huge Relative Government Debt UK forced to go to IMF, will there come a time when no one wants to buy Gilts. There is a growing bubble in Gilts and you can’t keep borrowing for ever. Rise of a new economic power Japan last time and China this time. Housing Bubble and crash 1965 to 1973 and 2000 to 2008. Central Bank Bailouts 1974 and 2009 of comercial banks.

It could be too many similarities for a coincidence. So what happened to gold from the early to mid 1970s over the next 10 years. A quick look at some web prices tell us that gold rose from about $US70 in 1973 to about US$630 in 1980 a few extra spikes at the top end saw US$850 in early 1980 but excluding that an average of about US$630 was achieved before gold began its long bear. So the call is; where are we on this curve. I’d say we are about 1975 where gold was beginning to froth at about US$140.

The Target Price – Extrapolation of the 1975 to 1980 price would see gold quadruple from the current price to US$4500, but we could see spikes 20% higher at US$5200.

The Likely time scale – 2013 but it could be quicker.

The Problem – It all sounds very feasible but are such socio/macro economic changes going to affect gold in the same way this time round and we have yet to see a major western economy actually go bust. The fact that no western government has had to call the IMF is a problem but it may be just a matter of time. It isn’t hard figures and I’d give this scenario a 60% chance of coming true.

Scenario 4 – FIAT Currencies or Just the Numbers

The Premise – All FIAT currencies return to their intrinsic value. i.e. the value of the paper.

The Target Price – Infinity! Except that no-one is going to give you the entire world for a gram of gold. But what is the likelihood we see the Dollar actually move to Zimbabwefication mode. Is a full scale run on the dollar possible? International Debt is not always a good thing to have. Eventually people will need to be paid back with interest and the US is fast heading the way that the interest on its debt will force it into more debt. In the same way a bankrupt doesn’t way up one morning and say “I’m bust”; a country in too much debt dies a slow death. First the credit rating goes down the pan, then no one will lend you any money, then you can’t pay your bills as they fall due. Then you have to take “special measures” to survive. For an individual this means the bankruptcy court. For a nation there is a choice, first devalue your currency so you can pay the debt back or second, stop government spending and up taxes to pay the debt. In most cases governments choose a combination of both. It looks like the devaluation is well underway.

So how bad can it be and are there any historical precedents for this…. well yes, Roman Empire, Spanish Empire, British Empire you name them the end of empire is always messy and the end of empire begins with war and ends with the demise of the currency. How bad could it be for the dollar, well let’s see the numbers. All the gold mined up to 2006 totals about 158,000 tons. At a price of US$1000/oz the total value of all gold ever mined would exceed US$5 trillion. So given all the real money ever is US$5 trillion and the current US deficit is US$9 trillion and estimated to grow to 14 trillion next year. A situation the US owes twice as much in dollars as there is real money. Let’s say the US is 20% of global activity. Extrapolate those figures out…. 20% of all gold = 1 trillion against all US debt = 9 trillion. Could it be that the US$ debt is 9 times overvalued in terms of gold? is a price of US$10000 an ounce possibly feasible? If things get really messy then anything is possible. If you are firmly of the belief that only gold is real money, add in a few rumours about tungsten filled bars and you never know. But would a US government be irresponsible enough to let this happen, or might a US Government not have a choice. Let’s put a less than 10% chance.

The likely time scale – Sooner than you might think if the Chinese loose faith in the dollar and dump their Dollar reserves in favour of Gold, Euros, Oil, Copper, etc.

Scenario 5 – The Classic Bull market behaviour

The Premise – All bull markets follow a similar pattern of three phases.

Phase 1- Smart Money – forces prices to double, Phase 2- Investment Demand – forces prices to double again and Phase 3 - Popular Speculative Mania – forces prices to triple. We have seen the First part and beginning of the second part happen but I asked a London Cabbie yesterday how he was investing in Gold. He looked at me as if I had two heads, so definately not in Phase 3 yet.

The Target Price – Classic bull Market theory puts us firmly at the middle of the investment demand phase, so we have about 50% more to get to the end of this phase Say US$1800 buy mid 2010 and then a tripling to US$5400 during 2011/12 before the Bull dies and turns bearish again. And how likely is it that this bull market will follow previous ones, well if it looks like a bull and behaves like a bull then the chances are this is a bull market. I’d say at least 80% correlation between prices we see now and prices in the last gold bull market.

Conclusion 
How can we make sense of these wild postulations? Well let’s try averages.

                 Scenario     Target Price     Date % Likelihood

                 1                          5000      2011              50

                 2                         2800       2012              30

                 3                         4500       2013              60

                 4                       10000       2014              10

                 5                         5400       2012              80

                 Average                5540       2012.4         46%

So there we have it  - a 46% chance that in May 2012 gold will hit a price of US$5540 an ounce. Is this any use? No not really but I enjoyed having a think about it and to be honest it hasn’t changed my own target price of US$3300 by late 2011 early 2012 and then I can get on with some proper investing instead of currency hedging.