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The case for a long-run bull market for gold

by Wayne Cheveldayoff, 2003-10-12

The price of gold is up more than 30 per cent in the past two years and this may only be the beginning.

The case for a long-run bull market in gold rests primarily on the view that continued economic, political and military uncertainties in the world and intensified personal insecurity will drive an increasing number of investors to protect their capital with gold and gold shares.

It has happened before. In the early 1970s, gold began rising from US$40 during a particularly difficult time in the world and didn’t stop until it reached US$800 an ounce in 1980.

At the beginning of the run, the United States was entangled in the Vietnam War and was incurring huge deficits. The Federal Reserve had flooded the financial system with money to pay for the deficits and international investors were increasing reluctant to hold the U.S. dollar, causing it to fall dramatically. Later, inflation accelerated and the annual inflation rate reached more than 10 per cent by the end of the decade.

Today’s circumstances are strikingly similar. The U.S. government is at war with Islamic extremists, deficits are soaring and the Federal Reserve again is flooding the system with money. The U.S. dollar is being shunned by the international community and its value is steadily deteriorating. Could accelerating inflation again be just around the corner?

One could argue that the political and personal security situation, at least for North Americans, is even worse today than it was in the early 1970s. The U.S. government was able 30 years ago to extract itself from war by leaving Vietnam. Now, if it were to leave Iraq and Afghanistan, the war with Islamic extremists would still continue.

Gold enthusiasts maintain that history may also be repeating itself in the capital markets, particularly the U.S. stock market.

In the 1970s, while gold steadily climbed higher, the Dow Jones Industrial Average (DJIA) made no headway. It had hit 1,000 in 1966 and it was still around 1,000 when gold peaked in 1980.

Subsequently, the DJIA began a bull market that took the index to more than 10,000 in 1999, while gold slipped back to less than $300 an ounce.

Gold advocates argue that the pattern is repeating itself. For the past three years, the DJIA has stagnated as it did during the 1970s while the price of gold, again like the 1970s, has climbed. And based on past history, this could last as much as another decade.

Three times in the past century, say the gold advocates, the value of an ounce of gold has come very close to equaling the DJIA. “It happened in 1896, 1932, and 1980. Why couldn’t it happen again?”

Already, this ratio has moved significantly in gold’s favour. In 1999, the value of 44 ounces of gold was needed to match the DJIA. Currently, the value of only 25 ounces is needed (gold at US$380 an ounce and the DJIA at 9,500).

Reflecting the widening belief in gold, gold stocks have soared in the past two years. While gold rose from US$260 to $380 an ounce, the American Stock Exchange Gold Bugs Index (HUI), which consists of the shares of unhedged gold companies, has tripled.

There is no easy way for investors to figure out the future for gold. It is not like other metals, where one could look at industrial supply and demand trends and make a good guess about the future price.

The demand for gold is linked to sentiment and completely unpredictable, and the supply of gold is almost limitless, since gold held by investors and central banks exceeds annual production many times over. Indeed, the selling of gold by central banks was a factor in depressing the price until two years ago. (The Bank of Canada has virtually no gold left.)
The major central banks have an agreement to sell only a certain amount of gold each year. If that changes, accelerated central bank selling could torpedo the price, at least for a while. (Central bank selling occurred during the 1970s run up in gold but demand at that time just overwhelmed it.)

Given this situation where anything can happen, a lot of portfolio managers around the world keep a small part of their assets, say 5 to 10 per cent, in gold or gold shares as insurance, just in case. Lately, they have been adding to their gold positions as the trends have shifted firmly in gold’s favour and as they have been reminded of the 1970s by recent events.

Will investors do more of this? Will the deteriorating U.S. paper currency trigger a rush to ‘hard-money’ gold? Will something else happen that will cause buying to reach a frenzy and push the gold price to the moon?

Stay tuned.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at

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©2003 Wayne Cheveldayoff