The 1970s Road Map

Here is an extract from commentary that was posted at www.speculative-investor.com on 13th June 2002. 

There is no point in looking at what happened over the past 20 years as a guide to what is going to happen over the remainder of this decade. The secular bull market in financial assets that dominated the markets during the 1980s and 1990s has ended and new secular trends are emerging. Based on evidence gathered over the past two years these new trends will encompass a strengthening gold price and a weakening US$. As a result of the massive inflation that has occurred over the past few years and the requirement of the world's monetary authorities to keep the supply of fiat currency expanding at all costs, two other trends that will almost certainly become apparent as the current decade progresses are the trends towards higher interest rates and higher commodity prices. So, we think it is fair to say that the first decade of this century will have a lot more in common with the 1970s than with either the 1980s or 1990s. As such, in an attempt to develop some sort of road map regarding what we should expect to happen over the next few years it makes some sense to look at what happened during the 1970s. With this concept in mind we have, over the past several weeks, done a couple of comparisons between the rally in gold stocks that began at the major bottom in November of 2000 and the gold stock rally that began at the major bottom in January of 1972. 

The below chart shows how the current rally in the HUI (AMEX Gold BUGS Index) is proceeding relative to the great gold stock rally of 1972-1974. 

At this stage of the 72-74 rally there was a 3 month correction followed by an almost vertical rise. If a similar situation developed now we would see gold stocks drift lower into late-August and then rocket higher during the September-November period. Since gold stocks have been traveling in the opposite direction to both the US$ and the overall stock market a 3-month correction in gold stocks would be unlikely to occur unless there was a 3-month recovery in the Dollar and the stock market.

Multi-month counter-trend moves in the gold, stock and currency markets at this time would mesh almost perfectly with our original forecasts for this year (we forecast that the biggest downward moves in the Dollar and stocks and the biggest upward move in the gold price would occur during the final few months of the year). However, although a prolonged correction in the gold market would not be unusual given the preceding strength and the huge speculative long positions that will need to be unwound at some point, we can't envisage the stock market or the US$ beginning multi-month recoveries from current levels. As such, the odds favour the current correction in the gold market being considerably shorter than 3 months.

It is probably going to be over much sooner but we suggest keeping late-August in mind as a worst case end-date for the current correction in the gold market. This is a correction in an on-going bull market, but bull markets never make it easy for investors to hang on for the ride. Peter Lynch, one of the most successful mutual fund managers of all time, said that during the period when he managed Fidelity's Magellan Fund more people lost money investing in this fund than made money despite the fund's exceptional performance. This is because a lot of people would always jump into the fund after a period of high returns and exit after experiencing a significant draw-down.

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