The Golden Cycle
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Posted 05/07/2013
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The Golden Cycle
by Peter Schiff of Euro Pacific Capital,
The New York Times had the definitive take on the vicious sell off in gold. To summarize
one of their articles:
Two years ago gold bugs ran wild as the price of gold rose nearly six times. But since
cresting two years ago it has steadily declined, almost by half, putting the gold bugs in
flight. The most recent advisory from a leading Wall Street firm suggests that the price
will continue to drift downward, and may ultimately settle 40% below current levels.
The rout says a lot about consumer confidence in the worldwide recovery. The sharply
reduced rates of inflation combined with resurgence of other, more economically
productive investments, such as stocks, real estate, and bank savings have combined to
eliminate gold's allure.
Although the American economy has reduced its rapid rate of recovery, it is still on a
firm expansionary course. The fear that dominated two years ago has largely vanished,
replaced by a recovery that has turned the gold speculators' dreams into a nightmare.
This analysis provides a good representation of the current conventional wisdom. The
only twist here is that the article from which this summary is derived appeared in the
August 29, 1976 edition of The New York Times. At that time gold was preparing to
embark on an historic rally that would push it up more than 700% a little over three
years later. Is it possible that the history is about to repeat itself?
At the time The Times article was written gold had fallen to $103 per ounce, a decline of
nearly 50% from the roughly $200 it had sold for in the closing days of 1974. The $200
price had capped a furious three-year rally that began in August of 1971 when President
Nixon "temporarily" closed the gold window and allowed gold to float freely. Prior to that
decision gold had been fixed at $35 per ounce for nearly two generations. That initial
three year 450% rally had validated the forecasts of the "gold bugs" who had
predicted a rapid rise in gold prices should the dollar's link to gold be severed.
The accuracy of these formerly marginalized analysts proved to be a bitter pill for the
mainstream voices in Washington and Wall Street who, for reasons of power, politics and
profit, were anxious to confine the "barbarous relic" to the dustbin of history.
Incredulous as it may seem now, with gold still priced at $35 per ounce, official forecasts
of both the Secretary of the Treasury and the Chairman of the Federal Reserve were that
demonetizing gold would undermine its value, and that its price would actually fall as a
result.
Of course government experts could not have been more wrong. Once uncoupled
from the dollar, gold's initial ascent in the early 1970's was fueled by the highest
inflation in generations and the deteriorating health of the U.S. economy that had been
ravaged by the "guns and butter" policies of the 1960's. But the American economy
stabilized during the mid-years of the 1970's and both inflation and unemployment fell.
When gold reversed course in 1975 the voices of traditional power elite could not contain
their glee. When the gold price approached $100 per ounce, a nearly 50% decline, the
obituaries came fast and furious. Everyone assumed that the gold mania would never
return.
Although the writer of The Times piece did not yet know it, the bottom for gold
had been established four days before his article was published. Few realized at
the time that the real economic pain of the 1970's had (to paraphrase The Carpenters
1970's hit) "Only Just Begun". When inflation and recession came back with a vengeance
in the late 1970's, gold took off (to quote another 1970's gem), like a skyrocket in flight.
By January 1980, gold topped out at $850 an ounce. The second leg of the rally proved
to be bigger than the first.
The parallel between the 1970s and the current period are even more striking
when you look closely at the numbers. For example, from 1971 to 1974 gold prices
rose by 458% from $35 to $195.25, which was then followed by a two-year correction of
nearly 50%. This reduced total gains to just under 200%. The current bull market that
began back in 2000 took a bit longer to evolve, but the percentage gains are very
similar. (We should allow for a more compressed time frame in the 1970s because of the
sudden untethering of gold after decades of restraint.) From its 1999 low to its 2011
peak, gold rose by about 650% from $253 to $1895 per ounce, followed by a two year
correction of approximately 37%, down to around $1190 per ounce. The pullback has
reduced the total rally to about 370%. The mainstream is saying now, as they did
then, that the pullback has invalidated fears that rising U. S. budget deficits,
overly accommodative monetary policy, and a weakening economy will combine
to bring down the dollar and ignite inflation. But 1976 was not the end of the
game. In all likelihood, 2013 will not be either.
The biggest difference between then and now is that until 1975 ordinary
Americans were barred by law from buying and owning gold. About the only route
available to participate in the earlier stage of the precious metal rally was by hording
silver dimes, quarters and half dollars minted prior to 1965. My father indulged in this
process himself by sifting through his change, the cash registers of any merchant who
would allow him (exchanging new non-silver coins and bills for silver), and by sifting out
silver coins from rolls he bought from banks. It was a time-consuming process, and most
of his friends and family members thought he was crazy. After all, he had $10,000 worth
of pocket change earning no interest.But the $10,000 face value worth of those coins he
collected had a melt value of over $350,000 when silver hit its peak.
By the mid 1970's none of the problems that initially led to the recession in the early
years of the decade had been solved. Contrary to the claims of the "experts" things
got much worse in the years ahead. It took the much deeper recession of the late
1970's and early 1980's, which at the time was the worst economic down-turn since the
great Depression, to finally purge the economy of all the excesses. The lower marginal
tax rates and cuts in regulation implemented by President Reagan and tight money
under Volcker helped get the economy back on track and create investment
opportunities that drew money away from gold. As a result gold fell hard during the early
1980's. But even after the declines, gold maintained levels for the next 20 years that
were three to four times as high as the 1976 lows.
Although the economy improved in the 1980's, the cure was not complete.
Government spending, budget and trade deficits continued to take a heavy toll.
The U.S. was transformed from the world's largest creditor to its largest debtor. When
the time came to face the music in 2001, the Fed kept the party going by opening the
monetary spigots. Then when decades of monetary excess finally came to a head in
2008, the Fed open up its monetary spigots even wider, flooding the economy with even
more cheap money.
Unfortunately just like 1976, a true economic recovery is not just around the
corner. More likely we are in the eye of an economic storm that will blow much harder
than the stagflation winds of the Jimmy Carter years. And once again the establishment
is using the decline it the price of gold to validate its misguided policies and discredit its
critics. But none of the problems that led me and other modern day gold bugs to buy
gold ten years ago have been solved. In fact, monetary and fiscal policies have actually
made them much worse. The sad truth is that as bad as things were back in 1976, they
are much worse now. Whether as a nation we will be able to rise to the occasion, and
actually finish the job that Ronald Reagan and Paul Volcker started remains to be seen.
But I am confident that the price of gold will rise much higher, and that its final ascent
will be that much more spectacular the longer we continue on our current policy path.
Don't believe the mainstream. Just as before, they will likely be wrong again.