Monday, November 26, 2007

A Lesson On Gold Bubbles From My Friend Steve

I am sitting on my veranda in Dominca having just read Doug Noland's latest article concerning the late great Alan Greenspan and his gratuitously self serving remarks about the state of the US and world economies. My view of Dominca and the Caribbean is asstunningly beautiful as Noland's indictment of Greenspan's policies is stunningly accurate. See: "No Regrets ".

This letter, however, is not about Mr. Greenspan. It is about gold and whether or not gold is in a continuing bull market or if in fact it has reached the bubble stage . My friend Michael has been after me to write a letter for his new blog but I have been reluctant to do so for two reasons. First because when one reduces one thoughts to writing one is much more likely to believe and defend those written thoughts long after they have been proven worthless. Second because there are truly great minds such as Bob Hoye , Jim Sinclair , Doug Noland, Mike Shedlock , and Adam Hamilton who have been writing brilliant analysis for years. Anything I may have to say is most likely my reflection on some of the thoughts of these truly original thinkers. In any event I do not believe we are in a gold bubble for the reasons that follow.

There is a difference between a bull market and a bubble. Gold has been in a bull market since at least 2001. Volatility is increasing but is not near the extremes of late 1979 and 1980. In the mid 1970s my largest stock holding was Hecla Mining. I bought it at an average price of around $5 a share. It moved in a relatively small range until late 1979 when it started moving steadily up. I sold half at around $11 and shortly thereafter I sold the balance at around $19. My sales were in November and December of 1979. In early 1980 Hecla (HL) hit $55 a share.

Gold was bouncing around with moves of $50 and more in a day not uncommon. Gold peaked at a closing daily price of about $850. The actual inter day high in the nearby futures was, close to $887.50. Clearly the volatility in precious metals and their shares was much greater in late 1979 and early 1980 than it is now. I would label 1980 as a time of a precious metals bubble. The present volatility in precious metals, while increasing, does not qualify as bubble type volatility to me. I expect that when we get to a bubble phase in gold we will begin to see "Tech Wreck" style volatility in gold and gold shares with gold trading in daily swings of $100 and more.

The second primary reason I believe gold is not yet in a bubble phase is price. Gold hit $848 in the nearby futures contract recently which caused some talk about gold possibly topping out at its old closing high of $850. Clearly there is some technical resistance in this area. The present price of gold near $850, however, does not account for inflation. In inflation adjusted terms gold would need to be in the $2,000 per ounce range to match the 1980 price of of $850.

Not only is gold far from its all time high in real inflation adjusted terms, but the potential demand for gold worldwide is significantly greater than in the 1980s. The increase in the populations and relative wealth of the emerging economies of China and India alone are huge real sources of demand for gold that were not present in 1980. Sovereign wealth funds are another enormous source of buying power not only for precious metals but also for the mines that hold them.

Volatility and price are telling me that gold is in a continuing bull market and not yet in a bubble. It is my opinion that gold has a real potential to exceed its inflation adjusted peak of $2,000 per ounce in the next few years. Volatility will certainly increase with price, so at times the down moves will be as violent or even more violent than the up moves. We may certainly enter a bubble phase in gold within the next few years, the propensity of our economy to blow bubbles has been well documented over the last decade. If fear in world politics and world market sets in Gold is certainly a likely target for the next round of fear generated bubble blowing.

If you wish to keep track daily of what is happening in gold I highly recommend Jim Sinclair's website. I have followed his writings on gold since the mid 1970s and there is no one that I know of who has more experience and insight about the price of gold. Jim Sinclair has accurately called the present gold bull market from its beginning but his excellent advice extends far beyond the gold market.



(Click for a larger image of this beautiful view)

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