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Just How High Can Gold & Silver Go?
Courtesy of www.texashedge.com
Phase I of the bull market in precious metals has drawn to a close. No longer do people look at you funny if you suggest that gold and silver may outperform equities over the near term. The fact that the price of each metal has more than doubled over the last five years has gotten some people’s attention. Throughout the entire duration of phase I, physical bullion and high quality mining equities were accumulated by a combination of hard money advocates, sophisticated institutions and forward thinking individuals.
Today, we believe the bull market in precious metals is moving into a second phase, similar to how stocks started to regain the public’s confidence in the mid 1980s all the way through the mid 1990s. A so-called “wall of worry” remains to be climbed as phase II is sure to include several scary pullbacks over the coming years. Expect to see mainstream institutions and wealthy individuals enter the market, while the average mom and pop investor hold out faith that tech stocks and real estate will come back to the forefront.
Only when the general public starts to get in on the action will we be in the final leg of the precious metals bull market. Rather than giving you a price target, you will be able to identify this final “blow-off” phase when the price increases begin to approach those of internet stocks in the late 1990s. Moreover, there may be several cultural symptoms of a bubble in precious metals including coverage in mainstream television and radio shows, primetime dramas, and maybe even a movie about the riches to be had in gold and silver exploration. Anyone remember the short-lived television shows called The Street and Bull which went into production while the NASDAQ was topping? Turn on any AM radio station on a weekend these days, and you are bound to find multiple shows about mortgages or real estate – another sign of a topping process.
So the question we are always asked is, “Just how high do you think gold and silver will go?” The short answer is that we have no idea, but we thought it would be interesting to map out our thought process below. Let’s first take a look at the average annual prices of gold and silver over the last 45 years.
The graphs above begin in the 1960s because we wanted to remind readers that the dollar prices of gold and silver were somewhat fixed for a large portion of the decade. Anytime a foreign government wanted to redeem its dollars for gold, they were able to do so for about $35/oz. As LBJ turned on the printing presses to finance “guns and butter”, foreign governments became skeptical about the long-term viability of the fixed Dollar-Gold price. Time Magazine, in its February 12, 1965 issue, said, “Perhaps never before had a chief of state launched such an open assault on the monetary power of a friendly nation. Nor had anyone of such stature made so sweeping a criticism of the international monetary system since its founding in 1944. There was Charles de Gaulle last week proclaiming that the primacy of the Dollar in international dealings was finished, calling for an eventual return to the gold standard — which the world's nations scrapped 50 years ago — and practically inviting other countries to follow France's lead and cash in their dollars for gold.”
Nixon eventually closed the gold window and the rest is history. In 1970, the average price of gold was $36.00/oz. About a decade later, gold would break past the $800.00/oz level. So some might say that since gold recently bottomed in the $270-360 range, and equal percentage increase would cause the price to rise to at least $8,000.00/oz. This would mean a ten-fold increase from its all-time high. Using the same ten-fold increase for silver, you come up with $500/oz. Frankly, we think this ultra-bullish “equal percentage increase” method is silly and should be ignored. $800/oz and $50/oz prices for gold and silver occurred at the very top of a mania, just like when the NASDAQ hit 5000 six years ago.
Using the charts we have provided shows the average annual price rather than the daily price of each metal. If you take out the year 1980, the highest average gold price was $460. Today the price of gold is $100 higher which means that we are in pretty lofty territory on a historical basis. Silver is similar too as it has only spent a couple of years averaging more than $10/oz. So the bottom line is that, on a historical basis, gold and silver are at pretty high levels. Of course, there is the huge caveat that the prices used in our analysis are nominal, and therefore one would need to rerun the charts in 2006 dollars to get a more accurate picture.
An analyst can waste lots of time using historical price charts trying to justify a particular price target for gold or silver. Similarly, an inexperienced investor can lose quite a bit of sleep trying to figure out the future direction of various price charts. Your authors have the distinct advantage of living in Texas, where the pace of life is slower, the people are friendlier, and the volatile energy markets make the daily moves in gold and silver look tame in comparison. All you need to do is sit back and think about the gargantuan liabilities this country faces in the forms of Social Security, Medicare and the overall national debt. Throw in the unsustainable trade deficit and it should be obvious that eventually our currency will lose quite a bit of its value in terms of real money – which is of course gold and silver. It may not be tomorrow, it may not be this decade, but one day, the U.S. Dollar will end up in the same place as the German Reichsmark, the French Livre and the Roman Denarius.
Todd Stein & Steven McIntyre
Texas Hedge Report
Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets
For more information, go to http://www.texashedge.com
-- Posted Thursday, 16 March 2006
Previous Articles by Todd Stein & Steven McIntyre
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How High Can Gold Go? 8 comments
by: David Nichols March 06, 2008 | about: DGL / GLD / IAU
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an article to Font Size: PrintEmail TweetThis How high can gold go in this bull market?
The answer may surprise you on the upside, as gold is still ridiculously cheap at the current price around $974.
For gold to be equivalent to the 1980 high of $850 -- in real, inflation-adjusted terms -- it would have to rise to $6,030 per oz. That is a 6-fold rise from the current price.
There are not many things changing hands at 16% of the inflation-adjusted price, but this is the current situation in gold. This is why the current bull market will send gold prices into the stratosphere, far beyond what even the wildest bulls are predicting now.
The Consumer Price Index [CPI] currently released by the government is worthless political propaganda, so we're not going to use it to calculate the true inflation rate. Instead we're going to use the method for calculating the CPI in place in 1980 -- the year of gold's high.
Since 1980, starting with the Reagan administration, changes have been creeping into the calculation of the CPI, mostly due to a nebulous concept known as "hedonic price theory". These methodology changes have been used by every administration since 1980, Democrats and Republicans alike. It's irresistible for those in power, because there are so many political benefits to under-reporting inflation. The foremost benefit is it gets the government out of paying true cost-of-living adjustments.
I won't veer off too far into economic theory -- it's not called the "dismal science" for nothing -- but it's important to understand hedonic adjustments, as this is what makes the current CPI such a farce. Essentially the government adjusts prices down to reflect increases in quality and utility. For example, many things -- computers, autos, washing machines, even refrigerators -- have a lot more features and enhancements now than they did 20 years ago. So these technological enhancements are factored by government statisticians into the calculation of the inflation rate.
In other words, since computers and washing machines have so many more features now, the government thinks the price should be adjusted down to reflect this increased utility. So the increase in price of most goods is not due to inflation, but to an ever greater array of features and enhancements.
Of course we still just use cars to get around, and washing machines to wash clothes, and refrigerators to keep food fresh. We're not really getting any more for our money, and if we are, they are just small increases in convenience.
But these hedonic adjustments give the government all sorts of room to massage the data to fit a political agenda. It's not a surprise to learn that Alan Greenspan was a big proponent of hedonic adjustments during his tenure at the Fed.
And thus, through economic sleight-of-hand, a good chunk of the actual inflation rate magically disappears from the reported CPI.
But economists and Fed-watchers are catching on. One economist in particular -- John Williams of Shadow Government Statistics --has taken the time to calculate a CPI using the methodology from 1980, prior to all these obviously political adjustments.
Nobody was complaining back in 1980 that the CPI was incorrect and dramatically over-stating inflation. It seems logical to adjust gold for inflation using the actual method in place in 1980, especially considering the political manipulation of this statistic over the last three decades.
If you use the 1980 methodology, the current annual rate of inflation is 11%. The things we buy cost 11% more this year than they did last year. That seems just about right, too, if you're an American consumer who has to live with this wallet-draining inflation in the real world. Nobody actually lives in the low-inflation fantasy world of politicians and statisticians.
Gold hit its all-time high on January 21, 1980, at $850. It took 27 years to get back to these levels, even in nominal terms. In January 2008, gold finally busted through to new highs and kept on going higher.
However, in inflation-adjusted terms, gold isn't even close to this 1980 high water mark, because the purchasing power of the dollar has collapsed over the past 27 years.
If you use the actual CPI (1980 methodology), the price of gold would have to hit $6,030 to equal the 1980 high of $850!
So a great case can be made that gold is one of the cheapest things you can buy right now. There aren't many things that would have to rise six-fold to just get back to its price from 27 years ago. Can you imagine buying a house at 1980 prices?
This massive and systematic under-reporting of inflation also explains the huge nominal price rise in lots of other commodities and tangible assets -- they are really just moving back towards balance after a long period of undervaluation.
This is why gold has the potential to go absolutely wild to the upside over the next five years. It's got some catching up to do.
But before we get too excited and run out to convert every last dollar into gold, we have to be aware that parabolic growth patterns -- like the current one in gold -- also have a nasty tendency to periodically move into disastrous free-fall corrections.
Fortunately there is an indicator I use, called the fractal dimension, which tells us when a trend has gone so far that further upside progress is highly unlikely.
There is still energy available to push the current trend higher, possibly all the way up to $1,040 over the next 2 to 4 weeks. But once the daily fractal dimension hits the low 30s, we need to be on high alert that another nasty correction could develop in gold.
From a pattern standpoint, at some point it will be necessary for gold to come back down and test the May 2006 spike high around $730. Such a move down is going to rattle even the toughest gold bulls, as chasing bulls out of long positions is the main point of such a correction.
With a parabolic growth pattern, it's necessary to always stay one step ahead of the crowd. We should get advanced warning before a free-fall correction, as there are always subtle clues and early tremors as a market is de-stabilizing.
Related Articles
Great Basin Revisited Dec 04, 2009 More Thoughts on Gold and Inflation Dec 04, 2009 Gold Stocks' Relative Strength Dec 03, 2009 Resurrection of the Gold Standard Dec 03, 2009 Is a Gold Correction Imminent? Dec 03, 2009 Related Stocks:DGL, GLD, IAU Stock Alerts
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Register or Login to rate comments » pangloss41: Comment (1) FollowHow does one compute the fractal dimension ? 2008 Mar 06 06:13 AM | Link | Reply 00 bigdog: Comments (2) Followyou gold nuts crack me up. Using 11% inflation rate and the "tulip mania " gold high as a base for your thesis is just plain stupid. 2008 Mar 06 08:17 AM | Link | Reply 00 EE: Comments (101) FollowThe same is true for silver, but it will out perfom gold. In 2001 the gold silver ratio was 70/1, last year 56/1, now 47/1, the historic is 15/1. To learn why go to investmentrarities.com and read Butlers comments. The last for issues should do, but go back further for fun. Plus, so many still think like the 1st two there's a long way to go! 2008 Mar 06 09:36 AM | Link | Reply 00 toofan: Comments (10) Follow•madhurocommodities.com Why are you looking at the peak price in 1980 which was only an intraday high (not a closing price) and at the height of the gold frenzy. More realistic comparasion would be what it was pre 1973 (the oil shock). The CPI calculation method would not change only the base price would be a tenth of the 1980 peak 2008 Mar 07 06:40 AM | Link | Reply 00 User 161550: Comment (1) FollowYour assertion that the price level has increased by a factor of 7 since 1980 is the stupidest thing I've ever seen on the Internet. Congratulations. If this is the kind of fevered rationalizations you gold bugs are clinging to now, I suppose gold is a bubble about to pop big time.
2008 Mar 07 01:09 PM | Link | Reply 00 praha1: Comments (15) FollowUsing $850 is nonsenical since a price over $700 existed in 1981 for only 7 trading days. Somewhere between $250 and $400 makes far greater sense which would lead to an inflation adjusted price of $1200 - $2000 and probably at the lower end at that. Let's be rational please! 2008 Mar 08 08:12 PM | Link | Reply 00 User 142738: Comments (120) FollowA can of Coca-Cola didn't cost $0.10 in 1981. A loaf of bread didn't cost $0.20 in 1981. A gallon of gasoline didn't cost $0.50 in 1981. A pack of cigarettes didn't cost $0.60 in 1981. A pound of sirloin steak didn't cost $0.80 in 1981.
Where did you get the 600% CPI increase? Did it come from the same dark place your head was when you wrote this? 2008 Mar 12 04:33 PM | Link | Reply 00 Louis Paquette: Comments (39) Follow•Emerging Growth Stocks|Emerging Growth Stocks The author made an incredibly accurate call months in advance! He said it should need to come back down to around $730 and that's exactly what it did.
I would like to know what he is saying now... Feb 20 02:20 AM | Link | Reply 00Viewing Comments 1-8 out of 8
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How High Can Gold Go? 8 comments
by: David Nichols March 06, 2008 | about: DGL / GLD / IAU
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an article to Font Size: PrintEmail TweetThis How high can gold go in this bull market?
The answer may surprise you on the upside, as gold is still ridiculously cheap at the current price around $974.
For gold to be equivalent to the 1980 high of $850 -- in real, inflation-adjusted terms -- it would have to rise to $6,030 per oz. That is a 6-fold rise from the current price.
There are not many things changing hands at 16% of the inflation-adjusted price, but this is the current situation in gold. This is why the current bull market will send gold prices into the stratosphere, far beyond what even the wildest bulls are predicting now.
The Consumer Price Index [CPI] currently released by the government is worthless political propaganda, so we're not going to use it to calculate the true inflation rate. Instead we're going to use the method for calculating the CPI in place in 1980 -- the year of gold's high.
Since 1980, starting with the Reagan administration, changes have been creeping into the calculation of the CPI, mostly due to a nebulous concept known as "hedonic price theory". These methodology changes have been used by every administration since 1980, Democrats and Republicans alike. It's irresistible for those in power, because there are so many political benefits to under-reporting inflation. The foremost benefit is it gets the government out of paying true cost-of-living adjustments.
I won't veer off too far into economic theory -- it's not called the "dismal science" for nothing -- but it's important to understand hedonic adjustments, as this is what makes the current CPI such a farce. Essentially the government adjusts prices down to reflect increases in quality and utility. For example, many things -- computers, autos, washing machines, even refrigerators -- have a lot more features and enhancements now than they did 20 years ago. So these technological enhancements are factored by government statisticians into the calculation of the inflation rate.
In other words, since computers and washing machines have so many more features now, the government thinks the price should be adjusted down to reflect this increased utility. So the increase in price of most goods is not due to inflation, but to an ever greater array of features and enhancements.
Of course we still just use cars to get around, and washing machines to wash clothes, and refrigerators to keep food fresh. We're not really getting any more for our money, and if we are, they are just small increases in convenience.
But these hedonic adjustments give the government all sorts of room to massage the data to fit a political agenda. It's not a surprise to learn that Alan Greenspan was a big proponent of hedonic adjustments during his tenure at the Fed.
And thus, through economic sleight-of-hand, a good chunk of the actual inflation rate magically disappears from the reported CPI.
But economists and Fed-watchers are catching on. One economist in particular -- John Williams of Shadow Government Statistics --has taken the time to calculate a CPI using the methodology from 1980, prior to all these obviously political adjustments.
Nobody was complaining back in 1980 that the CPI was incorrect and dramatically over-stating inflation. It seems logical to adjust gold for inflation using the actual method in place in 1980, especially considering the political manipulation of this statistic over the last three decades.
If you use the 1980 methodology, the current annual rate of inflation is 11%. The things we buy cost 11% more this year than they did last year. That seems just about right, too, if you're an American consumer who has to live with this wallet-draining inflation in the real world. Nobody actually lives in the low-inflation fantasy world of politicians and statisticians.
Gold hit its all-time high on January 21, 1980, at $850. It took 27 years to get back to these levels, even in nominal terms. In January 2008, gold finally busted through to new highs and kept on going higher.
However, in inflation-adjusted terms, gold isn't even close to this 1980 high water mark, because the purchasing power of the dollar has collapsed over the past 27 years.
If you use the actual CPI (1980 methodology), the price of gold would have to hit $6,030 to equal the 1980 high of $850!
So a great case can be made that gold is one of the cheapest things you can buy right now. There aren't many things that would have to rise six-fold to just get back to its price from 27 years ago. Can you imagine buying a house at 1980 prices?
This massive and systematic under-reporting of inflation also explains the huge nominal price rise in lots of other commodities and tangible assets -- they are really just moving back towards balance after a long period of undervaluation.
This is why gold has the potential to go absolutely wild to the upside over the next five years. It's got some catching up to do.
But before we get too excited and run out to convert every last dollar into gold, we have to be aware that parabolic growth patterns -- like the current one in gold -- also have a nasty tendency to periodically move into disastrous free-fall corrections.
Fortunately there is an indicator I use, called the fractal dimension, which tells us when a trend has gone so far that further upside progress is highly unlikely.
There is still energy available to push the current trend higher, possibly all the way up to $1,040 over the next 2 to 4 weeks. But once the daily fractal dimension hits the low 30s, we need to be on high alert that another nasty correction could develop in gold.
From a pattern standpoint, at some point it will be necessary for gold to come back down and test the May 2006 spike high around $730. Such a move down is going to rattle even the toughest gold bulls, as chasing bulls out of long positions is the main point of such a correction.
With a parabolic growth pattern, it's necessary to always stay one step ahead of the crowd. We should get advanced warning before a free-fall correction, as there are always subtle clues and early tremors as a market is de-stabilizing.
Related Articles
Great Basin Revisited Dec 04, 2009 More Thoughts on Gold and Inflation Dec 04, 2009 Gold Stocks' Relative Strength Dec 03, 2009 Resurrection of the Gold Standard Dec 03, 2009 Is a Gold Correction Imminent? Dec 03, 2009 Related Stocks:DGL, GLD, IAU Stock Alerts
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Register or Login to rate comments » pangloss41: Comment (1) FollowHow does one compute the fractal dimension ? 2008 Mar 06 06:13 AM | Link | Reply 00 bigdog: Comments (2) Followyou gold nuts crack me up. Using 11% inflation rate and the "tulip mania " gold high as a base for your thesis is just plain stupid. 2008 Mar 06 08:17 AM | Link | Reply 00 EE: Comments (101) FollowThe same is true for silver, but it will out perfom gold. In 2001 the gold silver ratio was 70/1, last year 56/1, now 47/1, the historic is 15/1. To learn why go to investmentrarities.com and read Butlers comments. The last for issues should do, but go back further for fun. Plus, so many still think like the 1st two there's a long way to go! 2008 Mar 06 09:36 AM | Link | Reply 00 toofan: Comments (10) Follow•madhurocommodities.com Why are you looking at the peak price in 1980 which was only an intraday high (not a closing price) and at the height of the gold frenzy. More realistic comparasion would be what it was pre 1973 (the oil shock). The CPI calculation method would not change only the base price would be a tenth of the 1980 peak 2008 Mar 07 06:40 AM | Link | Reply 00 User 161550: Comment (1) FollowYour assertion that the price level has increased by a factor of 7 since 1980 is the stupidest thing I've ever seen on the Internet. Congratulations. If this is the kind of fevered rationalizations you gold bugs are clinging to now, I suppose gold is a bubble about to pop big time.
2008 Mar 07 01:09 PM | Link | Reply 00 praha1: Comments (15) FollowUsing $850 is nonsenical since a price over $700 existed in 1981 for only 7 trading days. Somewhere between $250 and $400 makes far greater sense which would lead to an inflation adjusted price of $1200 - $2000 and probably at the lower end at that. Let's be rational please! 2008 Mar 08 08:12 PM | Link | Reply 00 User 142738: Comments (120) FollowA can of Coca-Cola didn't cost $0.10 in 1981. A loaf of bread didn't cost $0.20 in 1981. A gallon of gasoline didn't cost $0.50 in 1981. A pack of cigarettes didn't cost $0.60 in 1981. A pound of sirloin steak didn't cost $0.80 in 1981.
Where did you get the 600% CPI increase? Did it come from the same dark place your head was when you wrote this? 2008 Mar 12 04:33 PM | Link | Reply 00 Louis Paquette: Comments (39) Follow•Emerging Growth Stocks|Emerging Growth Stocks The author made an incredibly accurate call months in advance! He said it should need to come back down to around $730 and that's exactly what it did.
I would like to know what he is saying now... Feb 20 02:20 AM | Link | Reply 00Viewing Comments 1-8 out of 8
Add Your Comment
Your Website/Blog (optional)Comment: Submitting comment, please wait ...
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Sign up for Seeking Alpha RSS FeedsRelated Themes:Gold Price (59 in last week)
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Silver (16 in last week)
More by David Nichols
Massive Inflationary Pressures Will Lead to Uptrend in Gold
Jan 15, 2009 • GLD Fed Says Buy Gold: The Start of a Bullish Pattern
Dec 18, 2008 • GLD Gold Tests Its Reversal Level: Third Time's the Charm
Nov 14, 2008 • GLD Side-Stepping the Drop in Gold
Oct 29, 2008 • GLD One Last Decline, Then the Rebound in Gold
Sep 10, 2008 • GLD,SLV,UUP Finally - Gold Options
May 28, 2008 • GDX,GLD,IAU Recession Will Be Short and Shallow
Apr 17, 2008 Other articles by David Nichols »
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Financial Sense Home l Broadcast l WrapUp l Storm Watch l About Us l Contact Us
GOLD - HOW HIGH WILL IT GO?
How about $10,000? or $1,000? Or even $100,000?
by Krassimir Petrov, PhD
The American University in Bulgaria
February 19, 2008
Calls for the price of gold vary, anywhere from $1,000 to $10,000 or even to $100,000. There is one true fundamental problem with all calls for the price of gold – they all ignore the future inflation environment.
For example, if a genuine Great-Depression-like deflation grips the U.S. economy, then $1,500 for the top of the gold bull market might be too high. On the other hand, if a long 1970 stagflation is in the cards, then $5,000 is too low. The point is that a call for the price of gold without a clear assumption for the macroeconomic environment is a wild and misleading shot in the dark.
Curiously, once gold shot up to $850, gold analysts did not waste time to update higher their long-term projections for the price of gold. My feeling based on a dozen authors is that the new consensus range for the top is in the $2,000-3,000. I beg to disagree. Their math is simple, but poor. Let me explain.
They say that gold peaked at $850 in 1980; I agree. They say that CPI is up about three times or money supply is up about four times since then; I also agree. It then follows that gold has the potential to peak in the 2,000-3,000 range; now I disagree. Here is one simple reason. We might say that this range is fair if this were the price of gold today. However, it might take four to five years to get there. The trick is that in these four or five years, price inflation and money supply may rise by another 50-100%, so by then the target moves higher, say to the $4,000-5,000 range. Then you need another 2-3-4 years to reach the target. The problem is that the target is moving; it moves approximately with the rate of inflation.
The advantage of the above approach is its simplicity and intuitiveness. However, it has obvious disadvantages. First, the target is a moving variable with unknown speed. Second, it ignores the macroeconomic environment. Clearly, deflation, stagflation, or strong inflation in coming years will make a world of difference for the target price of gold. Finally, it ignores basic market sentiment indicators like fear and greed.
Actually, a radically different approach provides a much better and much simpler answer. It also avoids the pitfalls of the previous approach. Most importantly, it tells us when the bull market is over. Thus, it tells us when to sell. It is based on the fundamental premise that in the long run, there must be a balance between the relative prices of financial assets and real assets. Roughly speaking, stocks and bonds are examples of financial assets, while commodities and real estate are real assets.
During the decades, the relative prices of real and financial assets swing wildly away from their well-established century-old mean. They inevitably revert to it, and then swing to the opposite extreme. A well-established proxy for the price of financial assets is the Dow Jones Index. The single best proxy for commodities is gold. Their price ratio, the Dow-Gold ratio, tells us how many ounces of gold buy one unit of Dow Jones. If today the Dow is 13,600 and gold is $800, the gold-Dow ratio is 17. Thus, it takes today 17 ounces of gold to buy one unit of the Dow Index.
History tells us is that secular bull markets for stocks can push this ratio high up in the range of 20-50. Look at the chart below. During the last century, there were three such secular (long-term) peaks, in 1932, 1966, and 2000. You can see the three peaks in the 20-50 range.
On the other hand, secular stock bear markets usually coincide with secular gold bull markets. At the secular peak for gold, the Gold-Dow ratio is in the range of 1-2. As you can see on the chart, 1900 recorded a low of 1.7; 1929 recorded a low of two; 1980 recorded a low of about one. This means that when the gold bull market peaks, the price of gold will roughly equal the Dow Jones Index (DJI). Thus, we should expect that gold outperform the DJI in the coming 10-15 years about 10-20 times, in order to bring that Dow-Gold Ratio down to the range of 1-2.
So, how high will gold go? The correct answer is simple: as high as Dow Jones. It is important to understand that this method does not tell us now the end of the bull market. It could be five, ten, or fifteen years from now. It also does not tell us how high. It could be $2,000, or $10,000, or $50,000. But the important point is that it tells us when we are there and inherently keeps track of the macroeconomic environment.
Which is the most likely price target will depend on how Fed will fight inflation. Based on the Fed’s reaction, there are three possible future scenarios: (1) deflation, (2) stagflation, and (3) strong inflation. Let us consider each in turn.
The first scenario, deflation, implies a major contraction in the supply of money and credit, similar to the one during the Great Depression. Consumer and commodity prices would fall rapidly; the stock market and real estate market would collapse. Back then, stock prices and real estate fell roughly 10 times and gold rose only a little. If this scenario were to play out, then a reasonable forecast for the Dow will be about $1,000-1,500, while the gold price will be likely in the range of $800-1,500. This scenario is highly unlikely as the Fed will fight tooth and nail to prevent a deflation from taking hold.
The second scenario, stagflation, is most likely. It should look similar to the 1970s. Back then, the Dow made its peak in 1966. It made little progress for about 15 years, so that in 1980 it was just about where it was in 1966, roughly around 1,000. Gold, on the other hand, rose from a low of $35 all the way to $850. This means that strong inflation during the period kept the Dow from falling, so it did not fall as it did during the Great Depression. On the other hand, inflation powered the price of gold about 25-fold. In this scenario, we should expect the Dow to remain range-bound in the 10,000-15,000 range. Then, a gold forecast of 10,000 is perfectly realistic.
The third scenario, very strong inflation, is definitely possible, although less likely than stagflation. This would mean a typical, commonly-observed inflation of a third-world country, may be 15-25% annually. This kind of inflation could easily power the Dow may be 3-4 times in the coming decade, may be all the way to $30,000-50,000. This could mean a $20 for a loaf of bread or a gallon of gasoline. This would imply a gold price in the range of 20,000-50,000. It is possible, even probable, but in my opinion, not very realistic.
To summarize, I believe that both deflation and very strong inflation are not very likely. The likely outcome will be stagflation. Then a $10,000 price of gold is consistent with this view. This is my price target for 2015-2020. My advice is simple – stay with gold and you will be fine in the long run.
© 2008 Krassimir Petrov, Ph.D.
Email l Archived Editorials
Financial Sense Home l Broadcast l WrapUp l Storm Watch l About Us l Contact Us
Copyright © James J. Puplava Financial Sense® is a Registered Trademark
P. O. Box 503147 San Diego, CA 92150-3147 USA 858.487.3939
GOLD - HOW HIGH WILL IT GO?
How about $10,000? or $1,000? Or even $100,000?
by Krassimir Petrov, PhD
The American University in Bulgaria
February 19, 2008
Calls for the price of gold vary, anywhere from $1,000 to $10,000 or even to $100,000. There is one true fundamental problem with all calls for the price of gold – they all ignore the future inflation environment.
For example, if a genuine Great-Depression-like deflation grips the U.S. economy, then $1,500 for the top of the gold bull market might be too high. On the other hand, if a long 1970 stagflation is in the cards, then $5,000 is too low. The point is that a call for the price of gold without a clear assumption for the macroeconomic environment is a wild and misleading shot in the dark.
Curiously, once gold shot up to $850, gold analysts did not waste time to update higher their long-term projections for the price of gold. My feeling based on a dozen authors is that the new consensus range for the top is in the $2,000-3,000. I beg to disagree. Their math is simple, but poor. Let me explain.
They say that gold peaked at $850 in 1980; I agree. They say that CPI is up about three times or money supply is up about four times since then; I also agree. It then follows that gold has the potential to peak in the 2,000-3,000 range; now I disagree. Here is one simple reason. We might say that this range is fair if this were the price of gold today. However, it might take four to five years to get there. The trick is that in these four or five years, price inflation and money supply may rise by another 50-100%, so by then the target moves higher, say to the $4,000-5,000 range. Then you need another 2-3-4 years to reach the target. The problem is that the target is moving; it moves approximately with the rate of inflation.
The advantage of the above approach is its simplicity and intuitiveness. However, it has obvious disadvantages. First, the target is a moving variable with unknown speed. Second, it ignores the macroeconomic environment. Clearly, deflation, stagflation, or strong inflation in coming years will make a world of difference for the target price of gold. Finally, it ignores basic market sentiment indicators like fear and greed.
Actually, a radically different approach provides a much better and much simpler answer. It also avoids the pitfalls of the previous approach. Most importantly, it tells us when the bull market is over. Thus, it tells us when to sell. It is based on the fundamental premise that in the long run, there must be a balance between the relative prices of financial assets and real assets. Roughly speaking, stocks and bonds are examples of financial assets, while commodities and real estate are real assets.
During the decades, the relative prices of real and financial assets swing wildly away from their well-established century-old mean. They inevitably revert to it, and then swing to the opposite extreme. A well-established proxy for the price of financial assets is the Dow Jones Index. The single best proxy for commodities is gold. Their price ratio, the Dow-Gold ratio, tells us how many ounces of gold buy one unit of Dow Jones. If today the Dow is 13,600 and gold is $800, the gold-Dow ratio is 17. Thus, it takes today 17 ounces of gold to buy one unit of the Dow Index.
History tells us is that secular bull markets for stocks can push this ratio high up in the range of 20-50. Look at the chart below. During the last century, there were three such secular (long-term) peaks, in 1932, 1966, and 2000. You can see the three peaks in the 20-50 range.
On the other hand, secular stock bear markets usually coincide with secular gold bull markets. At the secular peak for gold, the Gold-Dow ratio is in the range of 1-2. As you can see on the chart, 1900 recorded a low of 1.7; 1929 recorded a low of two; 1980 recorded a low of about one. This means that when the gold bull market peaks, the price of gold will roughly equal the Dow Jones Index (DJI). Thus, we should expect that gold outperform the DJI in the coming 10-15 years about 10-20 times, in order to bring that Dow-Gold Ratio down to the range of 1-2.
So, how high will gold go? The correct answer is simple: as high as Dow Jones. It is important to understand that this method does not tell us now the end of the bull market. It could be five, ten, or fifteen years from now. It also does not tell us how high. It could be $2,000, or $10,000, or $50,000. But the important point is that it tells us when we are there and inherently keeps track of the macroeconomic environment.
Which is the most likely price target will depend on how Fed will fight inflation. Based on the Fed’s reaction, there are three possible future scenarios: (1) deflation, (2) stagflation, and (3) strong inflation. Let us consider each in turn.
The first scenario, deflation, implies a major contraction in the supply of money and credit, similar to the one during the Great Depression. Consumer and commodity prices would fall rapidly; the stock market and real estate market would collapse. Back then, stock prices and real estate fell roughly 10 times and gold rose only a little. If this scenario were to play out, then a reasonable forecast for the Dow will be about $1,000-1,500, while the gold price will be likely in the range of $800-1,500. This scenario is highly unlikely as the Fed will fight tooth and nail to prevent a deflation from taking hold.
The second scenario, stagflation, is most likely. It should look similar to the 1970s. Back then, the Dow made its peak in 1966. It made little progress for about 15 years, so that in 1980 it was just about where it was in 1966, roughly around 1,000. Gold, on the other hand, rose from a low of $35 all the way to $850. This means that strong inflation during the period kept the Dow from falling, so it did not fall as it did during the Great Depression. On the other hand, inflation powered the price of gold about 25-fold. In this scenario, we should expect the Dow to remain range-bound in the 10,000-15,000 range. Then, a gold forecast of 10,000 is perfectly realistic.
The third scenario, very strong inflation, is definitely possible, although less likely than stagflation. This would mean a typical, commonly-observed inflation of a third-world country, may be 15-25% annually. This kind of inflation could easily power the Dow may be 3-4 times in the coming decade, may be all the way to $30,000-50,000. This could mean a $20 for a loaf of bread or a gallon of gasoline. This would imply a gold price in the range of 20,000-50,000. It is possible, even probable, but in my opinion, not very realistic.
To summarize, I believe that both deflation and very strong inflation are not very likely. The likely outcome will be stagflation. Then a $10,000 price of gold is consistent with this view. This is my price target for 2015-2020. My advice is simple – stay with gold and you will be fine in the long run.
© 2008 Krassimir Petrov, Ph.D.
Email l Archived Editorials
Financial Sense Home l Broadcast l WrapUp l Storm Watch l About Us l Contact Us
Copyright © James J. Puplava Financial Sense® is a Registered Trademark
P. O. Box 503147 San Diego, CA 92150-3147 USA 858.487.3939
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