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May 15, 2005

A Historical Perspective On A New Trend In Gold
by Captain Hook

What is the new trend in gold referred to in the title above? If one is invested in the metal, undoubtedly you are hoping it involves higher prices, and thankfully, this should be the case in coming years if observations associated with the chart panels presented below hold true. Of course it's been a battle for gold over the past 25 years, where in fact it has still not signaled it's bullish intensions with a close back over the 50 percent retracement off 1980 highs at $556 US Dollars; but again, hopefully this condition is set to change too with the impending trend change of which we speak. During the 1970's, when the US forced the world to adopt a fiat currency system by reneging on Bretton Woods, and effectively imposing hyperinflationary conditions on everyone, gold enjoyed it's most pronounced period of relative strength against the US Dollar (USD) to date due to overshoot associated with a catch-up move in coming off a long standing pegged pricing system. Therein, the understanding here is gold was both catching up to the monetary largesse of the past as well as discounting the need for much more in the future. The intensity of this situation has not occurred for the most part since the 70's, but with secularly based deflationary forces applying tremendous pressures on the current ballooning experiment, the need for another 'hyperinflationary period' appears ready to reassert itself, as an 'inflate or die' scenario becomes evident in coming years. This is the circumstance necessary for gold to really shine, where it will outperform against all fiat specie around the world, effectively breaking apart gold's restrictive currency related 'ratio box'.

To begin, let's start by taking a look at the 'big picture' with a long-term plot of gold set against an inverse view of the USD. The first thing one should notice in viewing the panel below, is that on a long-term comparative basis, gold and the USD share an inverse relationship with a fairly tight correlation, a condition that has been stretched only once over the past 30 plus years, as mentioned above. And the second thing you should notice is the most recent advance sequence in gold is the longest since the early 70's, but that the intensity of the advance is nowhere near comparable, and as alluded to, non-confirmatory from a wave related perspective in terms of defining a bull market. (See Figure 1)

Figure 1

This is likely to end up being good news for current precious metals investors ultimately however, as any corrective sequence that must be endured in coming days should turn out to be relatively mild on a percentage basis, along with being more fleeting in nature as well. Further to this, where comparisons between the early 70's and today may not prove particularly instructive in the end, you will notice we are now likely in just the beginning stages of a mid-cycle corrective sequence in gold, and that if history is a guide in this respect, it could run well into next year. It should be noted however, between November of 2000 and December of 2003, un-hedged gold stocks ran up some 650 percent against a rise of only 80 percent in gold (technically establishing a bull market in gold shares), and the top in gold came a full year after that of its related equities. Reasons for this tremendous performance disparity and lags in intra-sector trade are not important within the extents of the present study, save the knowledge gold shares can begin outperforming well ahead of the metal, and in fact can experience absolute gains while the metal completes a bottoming process. What is important for current gold investors to keep their eyes on then, is when such a trend begins developing, along with the most significant observation we will make here today covered in detail below, which will be clear signs the market sees a need for the Fed to 'hyper-inflate' the currency. Therein, both phenomena should develop progressively throughout 2005, as it becomes blatantly obvious economic conditions are deteriorating faster than anticipated once again, as was the case in latter 2000 in reference to the Presidential Cycle. i.e. the global economy is a fiat currency junkie requiring ever increasing amounts of the remedy to remain stable.

It is this understanding that brings us into the most significant observation to be derived from this study, which is gold pricing only makes exponential gains against the USD on a percentage basis while it is rising. Why is this the case? The answer to this question is primarily based in the fact since gold has been "free floating" in the early 70's, its only risen when the market has perceived extreme stress in the US economy (the consumer of last resort), and is therefore discounting the need for further increases in the debasement rate of the currency. Please make mental note of this point for future reference because it will aid your ability to understand why strange things seem to happen in the gold market. For example, if price inflation appears to be on the rise, as measured on a factual basis, but gold is not responding in a positive way, what it's saying is the price inflation you are seeing today is a result past monetary inflation, where the rate of future currency debasement is expected to recede. Going back to our example above, the reason gold's rise outpaced the relatively meager decline in the USD during the 70's was likely not so much due to all the monetary largesse since 1935, but more so a result of future considerations, where it could be argued the move discounted much of what has transpired to this day. Again, this was a grand move indeed. (See Figure 2)

Figure 2

As we moved through the 80's and 90's, each decade witnessed a period of stress, where gold was discounting the 'need for speed' on the part of the Fed's printing presses, but not to the extent conditions were expected to deteriorate past what was already discounted in the 70's. Of course the presence of secularly based deflationary forces over this period, along with increased official sales, do much to round out the 'big picture' in this regard. But, post bubble market behavioral dynamics must be considered the primary factor gold was unable to regain it's footing over the period in question, because monetary largesse was definitely befitting the move into the 1980 peak, which could just as easily have perpetuated greater swings throughout the period in question were it not for fact market behavioral post bubble dynamics associated with gold's rise in the 70's required further digestion. Furthermore, where the next three chart panels are scaled to accentuate this understanding, gold faired very well during the early 80's considering the USD ran all the way to 160 by mid-decade. This was a product of post bubble dynamics in the sense market participants were holding onto perceptions 'hay days' of the 70's would return soon. Hence, we see gold riding on top of the inverse USD plot shown above, denoting a premium was being paid given hind-sight proved this period to be the beginning stages of a long-term bear market. (See Figure 3)

Figure 3

The period between the mid 80's up to '93 provide a completely different picture however, one where there was an actual need for an accelerated currency debasement agenda on the part of Central authorities, and was a time when the presses where running all out comparatively; but again, not to the extent such circumstances were not discounted previously in total. (i.e. official manipulation was not the only reason gold didn't go up more during this period.) This is evidenced in the plot below where the gold price reaction to the increased rate of currency debasement into 1987's stock market crash was relatively subdued considering the perceived liquidity needs at the time. Therein, and accentuating our central theme here today, gold's rise during this period exhibited no premium to normal leverage against a decline in the USD, evidencing the bear market that technically exits to this day. Note the gold price is plotted under that of the rising inverse USD trace during the period in question, and that it collapsed into the early 90's against a continued slip in he USD over this period, as seen above. (See Figure 4)

Figure 4

Retrospect makes it easy to conceptualize the next move of consequence in gold, where it corrected the divergence against all time low USD prints during the '90 to '93 timeframe; a period of absolute gains that was accompanied by out-performance in the metal of kings due to the fact it was essentially held back for five years. Subsequent to the strength seen in the mid-90's however, and in discounting the deflationary implications associated with the 'Asian contagion', which was in fact a result of Greenspan taking his foot off the gas pedal, gold declined into a double bottom spaced by two years off the initial '99 low, where the final leg down into the 2001 nadir was marked by a period of out-performance due to the fact it was signaling a trend change.

Moving into the next measurable period (phase) for gold, where based on a plethora of key measures past its own performance, it's 'larger self' has transcended into a bull market (gold shares made big moves between 2000 and 2004), the yellow metal has been progressing against the Dollar's decline in subdued fashion. Gold's relatively lack luster performance against its related paper equities can be attributed to several key factors, not the least of which has been most investors like the leverage in shares, which is understandable considering the paper mania currently characterizing market psychologies. But, in a larger sense, where by the end of the secular bull market gold will be outperforming its related equities, we know that because it has been lagging an accelerated growth rate against a declining USD, the global economy has not deteriorated sufficiently to warrant investors discounting the need for another 'hyperinflation' as of yet, and that the move in gold shares was more speculation in this regard than fact. Consequently, its only when gold, the metal, begins to outstrip 'normalized' percentage gains against a generally declining USD will such a signal be triggered. Furthermore, when this occurs, and although gold shares will undoubtedly make further absolute gains eventually when the market understands this, the initial stages of such a sequence should be expected to reflect 'fear' in the trade, a real fear other measures of wealth (paper) may take big hits before the medicine takes hold. Based on this perspective, we are currently at a critical test in this regard, where gold has been relatively buoyant against an appreciating Dollar, evidencing the global economy may be in real trouble this time. (See Figure 5)

Figure 5

As you may know, we are of the opinion the world is in the process of witnessing 'Grand' scale changes at present, not the least of which include a repudiation of the USD as the world's reserve currency. As with the trading blocks now established within the European Union, and attempted with NAFTA, the various regions of the world are returning to feudal tendencies while in the midst of wringing out what little growth prospects remain in the US modeled globalization of the larger economy, with Asia no exception to this trend. Within the totality of this process, two profound developments must unfold in gold's favor before larger degree deflationary forces turn economies inward for real, the first of which, and what gold's recent out-performance against the Dollar is signaling, is a significant slowing of the global economy, possibly sparked by more Central bank medalling, but as you can see in the attached, perhaps not by the most noticed perpetrators. Wouldn't it be ironic if the high money supply growth rates in China contract too much because authorities miscalculate the 'need for speed'? This is easily done the faster an economy is growing. This could cause big problems for all the hedge funds long commodities. You know, the ones that are actually foolish enough to listen to investment bankers trying to sell their deals overseas, as demand collapses on a forced reversal of leveraged trades. Can you say, 'crank up the printing presses or we are all doomed.'

Not needing to know a root cause, as undoubtedly it is a combined effort of the collaboration global Central authorities perpetuate on the human condition, where US based Presidential Cycle considerations are undoubtedly a large factor in the equation at present, it is sufficient to understand that ultimately, when Central bank medalling in economy becomes increasingly ineffective in maintaining price stability, economies will be forced to adapt, or fail completely. This brings us to the second significant development we see eventually causing multitudes to flock to the safety of gold, both as a currency and a 'store' of wealth, which is the eventual acceleration of de-globalization, and a marked move away from the USD as the primary medium of exchange in this regard. Therein, even though this could take an inordinate amount of time, as was the case with the fall of the last true global dominators, the Roman's, process will take its course through the balance of our existence, and things could change quickly just like everything else these days. For this reason, it is best to be prepared for change, and for this reason all opportunities to invest in gold on the cheap should be grasped whole heartedly in coming days. These changes will occur whether you are prepared for them or not. You can bank on it.

Good investing all.

Special Acknowledgement: All charts provided courtesy of the Chart Store.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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