A Bull Market in Gold — Technically Speaking

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There is always a bull market somewhere in the economy. It could be junk bonds, real estate, a particular currency, tech stocks, foreign markets, land, blue chips, or small caps. Today we are in a bull market in gold and commodities. Oil and gas are at all-time highs while metals such as silver are up more than 25% in 2004.

Gold had been in a secular bear market and is now in a secular bull market. Market technicians use the term secular not in the religious sense, but to indicate a long time period. Not an entire century, but perhaps to represent events that occur "once in a lifetime" because they are so long. The chart below shows the bubble in gold forming in the late 1970s, the bust in 1980, and a subsequent 20-plus-year downtrend in gold prices.

I’ve drawn three trend lines from the bubble to the present. Trend lines are figments for illustration purposes. What they show in this case is that the price of gold has trended downward for the last 23 years. The trend lines start from the very top of the bubble and the next two "tops" in the early 1980s. Starting from the top of the bubble, the trend line intersects the gold price (in red) in early 2001 at around $265/oz. Gold lost 70% of its value over this 20-year period, more if you account for the depreciation in the dollar. The second trend line starting at the next top intersects the gold price in early 2002 at around $300/oz. and the third trend line, starting from the second peak and touching all subsequent peaks, intersects the gold price in early 2003 at around $350/oz.

Trend lines are not magical, nor do they predict the future. They only help you visualize the past. Within the secular bear trend there were are four complete cycles of cyclical bull and bear markets with peaks in early 1980, 1983, 1988, and 1996. The trend lines suggest that the bear market is over, that a cyclical bull market is in progress and that it might be the beginning of a secular bull market. Trend lines don’t come with a money-back guarantee. If the price of gold were to go to $200/oz. these trend lines would disappear and new ones would emerge in their place.

The graph below shows the price of gold over the last decade. It displays one major cyclical bear market from early 1996 to early 2000 and a major cyclical bull market from early 2001 to the present. The graph presents a pattern of prices that looks like a "W" or what in technical analysis is referred to as a "double bottom." This is a highly favorable pattern, and gold prices have increased by over $150 since their low point in early 2001. Technical analysis would suggest a high probability that gold prices will go higher, but do not expect to get rich in a matter of days.

The price of gold obviously has a big influence on the price of gold mining stocks. Below is a graph of the Philadelphia Gold and Silver Stock Index (XAU), which is an index of the stock prices of the major precious metals producers. For much of this period the index was valued between 65 and 150.

For more than the last six years the XAU stayed below 90, but has recently been trading at over 100. It is hard to see, but the last six years have established what is called a "head and shoulder bottom" and that is a very bullish chart pattern. The left shoulder was formed in 1998—1999 when the index generally stayed in the range of 65—90. The head formed — upside down — during 2000—2001 when the index was in the range of 41—65. The right shoulder formed in 2002—2003 when the index again stayed in the rage of 65—90. It broke above the 90 range in late 2003 and has remained above that level ever since.

The price movements in gold and gold stocks can also be seen in the market for US dollars. The price of gold bottomed out between mid-1999 and early 2001. The XAU stock index bottomed in late 2000, while the US Dollar index topped off with a double top between mid-2001 and early 2002.

Technical analysis paints a picture of the past and provides a few clues to the future direction of markets. However, fundamental economic analysis is a far more important tool both for constructing technical analysis and for anticipating future changes in markets. My best guess based on fundamental economic analysis is that we have indeed begun a secular bull market in gold. Both the dollar and gold could stabilize for some time before continuing their present long-term courses. In the case of the dollar it is in a downward trend, and in the case of gold there is an upward trend. These trends are fundamentally based on the inflationary policy of the Federal Reserve, the deficit spending of the federal government, and the continued weakening of the US economy. Other events will no doubt play a role. Remember that the secular bear market (20—23 years) in gold included a few significant cyclical bull markets (1—4 years) in gold.

Disclaimer: Technical analysis is not science and cannot predict the future. Burt Blumert thinks it is all a bunch of gobbledygook. Fundamental economic analysis also cannot divine the future with any numerical accuracy. We do not know how high the gold price will go or how volatile it will be, or even how long the bull market will last. This will depend on the course of monetary policy, government spending, global conflict, and particular issues such as how will we respond to the looming bankruptcy of Social Security. For answers to these questions, stay tuned to LewRockwell.com for the next 20 years or so. I do own some gold and silver but so far my purchases seem to have had little impact on world prices. I think the prices will go much higher, but I hope I’m wrong.

Mark Thornton [send him mail] is an economist who lives in Auburn, Alabama. He is author of The Economics of Prohibition, is a senior fellow with the Ludwig von Mises Institute, and is the Book Review Editor for the Quarterly Journal of Austrian Economics. He is co-author of Tariffs, Blockades, and Inflation: The Economics of the Civil War.

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