Sunday, October 26, 2008

Where we could be in the gold bull market

Markets often repeat in similar patterns and recognizing the past can often lead to an understanding of potential future outcomes, something that should always be of interest to investors and speculators.

When a hard correction occurs in a bull market, people's confidence gets shaken and they wonder if they made the right decision. This is the concept of "climbing a wall of worry" that makes skepticism a healthy symptom of a bull market. When everyone is convinced an investment is a no-brainer (remember the dot coms?) and will go up forever, the end of the bull is near.

Gold is in the midst of a bull market that saw its price rise from roughly $250/oz to $1000/oz before the current correction to $700/oz. Could it be the end of gold's bull market rather than just a correction? My opinion of course is that we're not even close. An example using charts may help put things in perspective.

Look at the two charts below, both part of historical bull markets. I have covered up the dates and names of the items being charted.

Both items went up over 300% then corrected roughly 30% or so. Somewhat similar, though there are clearly some differences. So what happens next? For the first chart, which is the Dow Jones from 1982 through the 1987 crash, this is what happened next:

So, when everyone was in a panic at the end of the 1987 crash, the smart thing to do would have been to buy even more at the temporary discount price and hold on for another decade or so. Because the long-term cyclical pendulum has swung in the direction of gold and away from stocks, the smart thing to do now is buy gold at the new discounted price and hold on for several more years (the second chart above by the way is the price of gold charted over the last 8 years or so). Once the price of an ounce of gold is almost equal to the headline price of the Dow Jones, everyone at work and on television will be saying that gold is going to $10,000/ounce and stocks are going to zero. At this point, calmly sell your gold and use the proceeds to buy stocks hand over fist.

However, we are not even close to this point yet. Gold is still considered a bizarre, outdated investment with no role in modern portfolios by a large percentage of investors. How many people do you encounter in your life who want to talk about buying gold bars and coins instead of their 401k when the subject of investing comes up? Big bull markets do not end until there is near universal participation. Gold went through a 20 year bear market from 1980-2000. It was overdue for a new bull market and one clearly started around 2001. The bear mentality towards gold persists in most mainstream circles despite a strong first leg of its new bull market. This is healthy, normal and indicates the end of the gold bull market is a long ways off from here.

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