Adam Hamilton: Real Gold Highs 3
Another good article by Adam Hamilton of Zeal that looks at the technicals of gold but also the inflation-adjusted (real price) of gold.
Real Gold Highs 3 - http://www.zealllc.com/2009/cpigold3.htm
by Adam Hamilton
September 18, 2009
One-thousand Federal Reserve Notes per troy ounce! This past week gold edged over $1000 to close at its highest levels ever witnessed. This much-maligned investment has nearly quadrupled since its secular bull's humble beginnings in April 2001, a fantastic 297% gain compared to the S&P 500's pathetic 7% loss over this 8+ year span.
With gold being the best-performing major asset of this decade, and now surpassing the once-unthinkable $1000 mark, many investors are growing wary of its future prospects. Is gold too high today? Are $1000+ levels unsustainable? Is gold's secular bull nearing its end after this metal's epic run? These first tentative steps over $1000 are really fanning the flames of doubt.
One major reason is the financial media's coverage of gold's all-time-record-high closes. Most investors know enough about contrarian theory to be instinctively nervous about any price hitting its highest levels in history. A price that soars to extremes soon comes back down. And gold's recent closes have edged above its previous record from March 2008 of $1005, not to mention January 1980's famous $850 that held for a whopping 28 years before being exceeded.
While this week's $1018 was indeed gold's best close ever, the media's insinuation from this true statement is pretty misleading. Comparing prices today with prices in the past is certainly not a clean apples-to-apples exercise. Due to the Federal Reserve's relentless and endless expansion of the US money supply, the dollar yardstick for measuring nominal prices is perpetually changing.
If you were old enough in early 1980 to remember price levels, you know exactly what I mean. Back when gold hit $850 initially, the US median household income was under $18k. Across the US, new houses averaged $76k while new cars were less than $6k! A candy bar only cost a quarter. It was a different world back then, with each dollar being far more valuable. So $850 today is worth much less than $850 then.
In order to account for the endless flood of new fiat-paper dollars distorting the price yardstick, the impact of inflation must be considered in any long-term analysis. $1000 gold today is only relevant and meaningful if we recast historical gold prices into today's inflated dollars. When gold's history is viewed in inflation-adjusted ("real") terms, it radically alters the perceptions of and implications for today's prices.
I first started building inflation-adjusted gold charts back in mid-2000 when gold was trading in the $290s. As I've updated this thread of research over the last 9 years, I've almost always used the US Consumer Price Index to adjust gold for inflation. This surprises some hardcore contrarians, because the CPI is horribly flawed and consistently understates true monetary inflation. I certainly agree, I hate the CPI!
Having the same government that is recklessly printing excess money purporting to objectively and honestly measure its economic impact is like the fox guarding the hen house. The conflicts of interest are egregious. The CPI seriously understates true inflation because the government has vast incentives to lowball it. Much of the federal government's non-discretionary budget is effectively indexed to the CPI.
Therefore higher CPI numbers mean higher welfare payments and less money for politicians to spend on their pet projects. Higher CPI numbers translate into higher interest rates, driving up the carrying cost of Washington's massive debt and again leaving politicians with less money for pork to bribe voters. Higher CPI numbers spook the financial markets and upset voters, reducing incumbents' odds for re-election. And higher CPI numbers alert the populace to the devastating confiscatory stealth tax levied by Washington that is relentlessly eroding our hard-earned savings.
Anyone who believes Washington's own CPI numbers are honest probably still believes big government is benevolent and "here to help". The CPI is a joke. Still, I use it for my real analyses for two key reasons. First, despite the CPI's countless problems it remains the most-widely-accepted definition of "inflation" by Wall Street and mainstream investors. Second, it is very conservative since true inflation is always higher than the government reports.
So the following CPI-inflated gold charts really understate gold's true potential and ought to be very credible even to mainstreamers. Real gold is rendered in blue, with the normal non-inflation-adjusted ("nominal") gold price rendered in red. When you look at gold's entire modern history with a far-more-comparable pricing yardstick, today's $1000 levels don't look so intimidating after all.
January 21st, 1980's legendary gold close of $850 translates into $2358 in today's dollars! So what the financial media is gleefully calling an all-time high today, insinuating gold is radically overbought and due for a plunge, isn't even halfway up to this metal's real all-time high. As of Wednesday's $1018 close, gold had merely climbed to 43% of the climax of its previous secular bull.
And provocatively, since I am using the flawed CPI to approximate real gold, this $2350ish terminal peak is also very conservative. Excessive monetary growth, something we've seen in spades since the stock panic, is the sole driver of inflation. When the money supply grows at a faster rate than the underlying pool of goods and services on which to spend it, relatively more money competes for relatively less products. This bidding drives up general price levels. Inflation is exclusively a monetary phenomenon!
Since January 1980, the CPI has multiplied by 2.8x. This equates to a compound annual growth rate of 3.5% over the 29+ years since. Meanwhile, the broad MZM money supply has ballooned by 11.2x since January 1980! This requires a compound annual growth rate of 8.5%. So obviously the US money supply has been growing at a much faster pace than where Washington claims inflation is running. This monetary growth rate, less the economic growth, is much closer to true inflation than the lowballed CPI.
All over the world, broad money supplies nearly always grow by at least 7% annually. So over the 29+ years since early 1980, a conservative 7% average growth rate yields a 7.4x multiplication of the global supply of fiat currencies. Meanwhile the above-ground global gold supply, since this metal is so incredibly challenging to find and mine, tends to only grow by about 1% a year. This is why gold is so valuable. 1% growth over this same span yields a gold supply today about 1.3x as large as January 1980's.
So with 7.4x more paper money available to bid on 1.3x more gold, monetary growth has outpaced gold growth by 5.7x per these rough estimates. If you multiply the January 1980 gold high of $850 by 5.7x, it yields almost $4850 per ounce! The key takeaway is that today's $1000 gold is really no big deal relative to gold's real price history. At the end of gold's last secular bull, this metal soared to multiples of $1000 in terms of today's currencies' actual purchasing power.
But while $1000 isn't extreme in the secular-bull-ending sense, it is certainly on the high side of gold's historical range. This metal spent many more years under $1000 real than over it. But there is a big difference between being high and being extreme. While extreme prices are unsustainable, merely high prices can persist for years. This next chart zooms in to that early-1980s gold superspike to illustrate this point.
Gold bulls have three stages. Stage One sees moderate gains out of secular-bear lows driven primarily by a devaluation of the dominant currency. In Stage Two, investors gradually start bidding up gold for its own inherent fundamental merits independent of currency movements. This is the longest stage. Finally in Stage Three, the general public floods in near the very end of the bull sparking a popular speculative mania and vertical parabolic blowoff.
Late in Stage Two of the last bull, gold first climbed over $1000 in today's dollars in September 1979. In fact it was 30 years ago this week. Not long after, Stage Three arrived when gold investing became as popular in mainstream culture as the tech stocks were in the early-2000 NASDAQ bubble. Between November 1979 and January 1980, gold skyrocketed by 128% in less than 11 weeks! This alone offers great insights.
Over the years since 2001, many investors have asked me how we will know when today's gold bull has run its course. When do we exit for good? The answer is surprisingly easy. When gold investing becomes the most popular thing around, discussed everywhere by everyone and on the mainstream news constantly, get ready. Soon after when gold rockets parabolic, more than doubles in a matter of weeks, get out. Bull-ending superspikes on rampantly euphoric popular psychology are impossible to miss!
But for our purposes today, look how long gold lingered over $1000 real despite the last secular bull being over. After that initial September 1979 journey over $1000, gold closed over this level continuously without exception for the next 21 months until June 1981. Over this entire span, gold averaged $1425 in today's dollars. Any price level that can persist for nearly 2 years, even after a secular bull has ended, is simply not extreme. So don't fall into the media's trap today of assuming $1000 equals extreme.
In fact, from a pure technical perspective a price of $1000 is no more special than any of the other 743 numbers between $257 and today. $1000 only feels special because we humans naturally have a curious fascination with big round numbers. It is a psychological milestone, but not a technical one. A couple months ago I predicted $1000 gold would be achieved and sustained soon simply because it was finally within trend for the first time ever. And indeed it came to pass as expected.
I was hesitant to run this 1979 chart because I don't want people to misinterpret it. So please hear me loud and clear on this. Just because gold is going over $1000 now doesn't mean we will soon enter Stage Three like in late 1979. On the contrary, for many reasons I expect today's secular gold bull to persist for years yet before the general public gets involved and ignites a bull-ending speculative mania. My point today is simply that $1000+ gold in today's dollars was easily sustainable in the past.
This final chart zooms in to today's real gold bull. We have seen the moderate initial uptrend driven by the Stage One currency devaluation and now we are in the investment-demand-driven Stage Two. Yet clearly nowhere in this bull has gold even come close to more than doubling in a matter of weeks. There has been no popular mania and no parabolic blowoff. We are merely somewhere in the middle of this bull.
Back in early 2008, gold did launch a sharp rally higher to make its first-ever $1000+ close. Between August 2007 and March 2008, gold climbed 54% higher over 146 trading days. Thus its average daily gain over this admittedly very-impressive rally was 0.4%. In comparison, that late-1979 parabolic blowoff rocketed 128% higher in 53 trading days, or a staggering 2.4% per day! So the best rally of this entire bull so far was only 1/6th as fast and 3/7ths as large as the terminal one from the previous bull.
Back in early 2008, after that relatively fast 54% gain, $1000 was indeed overextended and overbought. But today that is no longer the case. Instead of basing between $650 and $700 like in 2007, during most of 2009 gold based between $900 and $950. It wasn't far from there to $1000, so gold is not overextended at all today technically. And there is certainly no euphoria now, not even long-time gold investors are all that excited. Everyone fears a plunge.
Yet one is probably not coming. Gold is just entering its strongest time of the year seasonally, when it is driven 14% higher on average between September and February by end-of-financial-year and festival-season buying. While there is typically a minor seasonal pullback in early October, odds are after that $1000+ gold is here to stay. Instead of being extreme as the financial media implies, it will become the new norm.
Why? Gold's fundamentals remain awesomely bullish, and ultimately global supply and demand determine prevailing price levels. Gold is so difficult to find and mine that its annual mined production has actually been declining for most of this secular bull despite the incredible price incentives to produce more. Meanwhile the European central banks are warming to gold's potential and seriously reducing their official gold sales. Slowing gold supply growth is very bullish, especially when demand growth is accelerating.
Across the globe, investment capital is increasingly seeking to deploy into gold. Not only is it the best-performing major asset of this decade, it will protect capital from government inflationary predation. And despite gold's quadrupling since 2001, most investors still have zero gold exposure. While the contrarians like me have already made fortunes in this bull, general investment levels in gold remain extremely low.
The elite stocks of the S&P 500 currently have a collective market capitalization near $9878b. Meanwhile the highly-successful GLD gold ETF (the second largest ETF in the world now) has net assets near $34b. This simple comparison implies that mainstream stock investors' exposure to gold is probably under 0.5% of their assets right now. Before the end of this gold bull, it could approach 5.0%! With a potential 10x increase in the capital invested in gold in the US alone, this metal should continue climbing for years yet.
And there are some major advantages this gold bull has that the 1970s one didn't, implying today's bull will ultimately be larger. For example, in the 1970s Asians were poor and weren't in a position to invest in gold despite their cultural affinities for it. Today mainstream Asian investors have surplus income, and gold is not only readily available but governments like China are actively encouraging their citizens to buy it.
In the 1970s, ETFs didn't exist. Thus first-world stock-market capital had no quick and easy way to flow into gold. If investors back then didn't want to trade futures, or weren't comfortable going to coin stores to buy physical coins (high premiums and transaction costs), they were out of luck. Today's gold bull is the first one in history where stock-market capital can easily flood into gold via the mechanism of the gold ETFs. This direct conduit into the immense pools of stock-market capital is very bullish for gold.
And how about the Information Age's impact? Back in the 1970s, it was very hard for an average mainstream investor anywhere in the world to learn about gold and its potential. Thanks to the Internet, this certainly isn't the case today. Not only are the odds far higher that an average investor will hear about gold in this media-dominated era, but he will have no problem Googling it and learning of its great future potential.
Today's $1000 gold is not some frightening unsustainable extreme, but just another stepping stone in gold's powerful secular bull. Gold's last secular bull in the 1970s, which had a lot less going for it than today's bull, led to gold exceeding $1000 in today's dollars for the better part of 2 years. And this is via the inherently conservative CPI method of approximating real gold prices which really lowballs them.
While a nominal all-time gold high was indeed hit this week, in apples-to-apples inflation-adjusted real terms gold isn't even halfway to hitting new record highs yet. $1000 gold is truly no big deal, and fundamentals, technicals, and sentiment point to this metal continuing to march higher on balance in the months and years ahead. At some point soon, $1000+ gold will be here to stay for years.
At Zeal, we have been actively studying and trading this gold bull since its very beginning. I first recommended buying physical gold to our subscribers in May 2001 when it was trading at $264. Since then I have spent years researching this gold bull, writing hundreds of essays like this and hundreds more newsletters actively trading it. Over the years we've led our subscribers to multiply their capital in gold (and silver and precious-metals stocks) during a challenging secular bear market in general stocks.
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The bottom line is $1000 gold is certainly not the extreme the financial media is portraying. In the real inflation-adjusted terms that matter, gold is nowhere close to hitting new records. Using the watered-down CPI, gold's all-time high is closer to $2350. And during and after the 1970s gold bull this metal spent the better part of 2 years continuously over $1000 in today's dollars. This week's $1000 is not excessive at all.
The bullish fundamental forces driving this gold bull remain very much alive and well. Until global gold supply growth exceeds demand growth, probably years away yet, the gold price has no choice but to continue climbing on balance. While $1000 is a sexy number exuding big psychological gravity, it is nothing special in a pure technical sense. It is just another temporary step on a long bullish journey.