How hight can gold

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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.
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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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