Gold’s performance over the past month has truly been epic. Since late October, it has soared 18.2% higher. Over a 21-trading-day span, no fewer than 16 days achieved closes at new nominal all-time-record highs! Even the perpetual gold disdain from Wall Street and the financial media is fading.
With gold surging so rapidly and relentlessly, growing numbers of investors and speculators are wondering if we are now entering the long-awaited Stage Three gold bull. Over 5 years ago, when gold was trading at $400, I wrote an essay describing the evolution of a secular gold bull through 3 distinct stages.
Stage One stealthily emerges out of a secular-bear low when everyone loathes gold. In response to a stgaluation in the dominant currency, this metal starts quietly creeping higher. Stage One in today’s bull began in April 2001 and ran for over 4 years. It was marked by modest yet consistent gains in gold.
Once global investors figure out that gold is moving up on its own supply-and-demand-driven fundamental merits, Stage Two dawns. More and more investors “discover” gold and deploy increasing amounts of capital in it. Today’s bull transitioned into Stage Two shortly after euro gold broke decisively above €350 in June 2005.
A gold breakout in a secondary currency may not sound like much, but it was a game-changing event that finally convinced global investors that the young gold bull was the real deal. Before that to everyone but Americans (who see gold through a dollar-centric lens), gold’s strength was perceived as nothing more than the other side of the dollar-bear coin. They thought gold was only rising because the dollar was falling.
Stage Two can run for many years, it is the longest phase of a gold bull’s lifespan by far. It persists for so long due to the way bull markets affect investor psychology. Early on in a bull, few investors believe it is real so little capital chases it. But as a price powers higher, more and more investors start to believe which gradually yet relentlessly increases capital inflows. This drives prices even higher, forming a virtuous circle that attracts in even more investors. All this takes a long time.
Some bulls end at Stage Two, but the truly great ones ultimately transition into Stage Three. Lasting less than a year, this is the terminal phase of a secular bull. After professional investors are already fully deployed in gold, the general public soon grows enamored with it and wants in at any price. The resulting massive influx of capital drives a popular speculative mania and its resulting parabolic blowoff.
Think of the NASDAQ tech-stock mania in early 2000. Tech stocks were all over the mainstream news, and everyone wanted in no matter how little capital they had. People were mortgaging their houses to buy speculative tech stocks trading at hundreds of times earnings. Conversations everywhere in all walks of life eagerly discussed the tech-stock boom. There is nothing else like a Stage Three speculative mania, they are impossible to miss.
So much capital flooding in so fast drives vertical price gains, a parabolic ascent. The last Stage Three gold parabola unfolded over several months climaxing in January 1980 at $850 (just under $2400 in today’s dollars). That event was blisteringly fast, gone in the blink of an eye. Over the final 10 trading days leading to the end of its bull, gold soared 34.1%. Over the final 20 trading days, it was up 80.3%. And over the final 30, just 6 short weeks, it nearly doubled with a 95.9% gain!
Now despite November 2009 being exciting, it was nothing remotely like a Stage Three blowoff top. At best over the past month, gold’s gains over any 10-trading-day, 20d, or 30d span ran 8.8%, 15.7%, and 15.1%. These are obviously a far cry from the last Stage Three climax’s 34%, 80%, and 96%. So there is no doubt at all that we have not witnessed anything Stage-Three-like in the recent exceptional gold strength.
But even though gold clearly hasn’t entered Stage Three, could it be on the cusp of rocketing parabolic as many analysts assert today? The only honest answer is sure, of course it could. Anything can happen in the markets, and none of us mere mortals can see the future. It is even the right time of the year, a seasonally-strong period for gold that also happens to coincide with the last Stage Three climax from November 1979 through January 1980.
Nevertheless, for a variety of reasons I am almost certain our current gold bull is nowhere close to Stage Three yet. Gold isn’t going parabolic anytime soon, so if you are planning on retiring in early 2010 from the next few months’ gold gains I suspect you’ll be sorely disappointed. As any student of the markets who has studied history and psychology can tell you, today’s conditions are all wrong for Stage Three dawning.
Think of bull markets as popularity contests. The higher prices go, the more popular those assets get. And the more popular the bull gets, the more investors deploy more capital to chase the gains. Stage Two chronicles this journey from relative obscurity among investors to widespread adoration. This long stage lasts until professional investors are fully invested. Has this happened yet with gold? No way.
There are many ways to illustrate this truth. In the new December issue of our Zeal Intelligence monthly newsletter, I outlined a couple key ones. Despite the GLD gold ETF’s huge success in enticing stock-market capital into gold, stock investors are still incredibly underinvested. At the end of November, the market capitalization of GLD only ran about 0.4% of the combined market cap of the elite S&P 500 stocks.
Are stock investors fully invested in gold yet at an allocation of under a half percent? At today’s levels they have barely even started deploying in gold! I don’t know if “fully invested” in this bull will ultimately cap out at 5%, 10%, or even 20%, but it is certainly not going to be 0.4%. Central banks are also big gold investors, and the growing Eastern CBs are woefully underinvested in gold. The top 5 Asian CBs in terms of gold holdings now have an average of just 3.5% of their foreign-exchange reserves in gold.
Is this fully-invested? Certainly not. For comparison the top 5 Western CBs have an average of 64.8% of their forex reserves in gold bullion today! Given the Eastern CBs’ undiversified heavy exposure to the ailing US dollar, which has been in a brutal secular bear since July 2001, it is impossible to imagine them not wanting to sell more dollars and buy more gold. Like American stock investors, Asia has barely even started investing in gold.
How can Stage Two transition into Stage Three when the only investors with heavy gold exposure today remain a relatively small fraction of contrarians? It can’t. Stage Two will not reach maturity until large professional investors all over the world have great-enough allocations in gold to consider themselves fully invested. I suspect it will be many years yet before professionals reach this milestone.
And simply having professionals fully invested in gold is not enough to spark Stage Three on its own. Even more important is popular psychology. For a Stage Three parabola to ignite, ordinary folks who aren’t even serious investors have to utterly fall in love with gold. We need to see a popular gold rush flare up across the vast majority of the populace that doesn’t even follow the financial markets on a regular basis.
As the NASDAQ bubble proved, the seeds for a popular speculative mania are not sown overnight (or even in a few months). It really takes years to prepare the soil of popular psychology for a mania. While gold’s favorable exposure in the financial media has grown considerably over this past month, all this coverage is just a drop in the bucket compared to what is necessary to enthrall the people.
Leading up to the early-2000 NASDAQ bubble, tech stocks had at least 18 months of all-the-time everywhere coverage in both the financial and mainstream media. Over this long span, CNBC talked about tech stocks all day everyday. Nearly every cover of every financial magazine, and many non-financial ones, featured the tech boom and profiled the vast riches to be made. Mainstream newspapers, news shows, and even afternoon talk shows spent endless time exciting people about tech stocks.
Back in early 2000, if you had picked random people and asked them what they thought of tech stocks, nearly all would have been eagerly trying to invest. The popular enthusiasm was pervasive and overwhelming, impossible to escape. Contrast that with gold today. If you ask the average person you see anywhere whether they are excited about gold investing, the vast majority will give you a dumb stare.
While today’s hardcore investors and speculators who religiously follow the markets and financial media may feel like gold is becoming popular, our perceptions are skewed. Sure, gold is more popular in this specialized realm than ever before in this bull. But to an average casual investor who doesn’t follow these things, at best all they’ve seen is some sporadic gold-coin and scrap-gold commercials on mainstream TV. Popular psychology among normal folks has barely even started considering gold, let alone getting excited about it.
And without people who’ve never been gold investors rushing in to become new gold investors solely to plow their lives’ savings into gold, we won’t see a Stage Three parabolic blowoff. They are called popular speculative manias for a reason, because they extend far beyond contrarians, professional investors, and even mainstream investors to a general populace that isn’t yet in the gold market in any meaningful way.
Professionals are not fully invested in gold and mainstream casual investors still largely aren’t paying attention to it. So neither the capital foundation nor sentiment foundation necessary to undergird a Stage Three superspike have been laid yet. This is all well and good, but it still doesn’t address gold’s awesome gains in this past month. After seeing such “unprecedented” gold activity, doesn’t it still behoove us to accept that “this time is different, gold really could be going parabolic”.
I mentioned that at best in the past month, gold’s 10d, 20d, and 30d gains ran 8.8%, 15.7%, and 15.1% respectively. This may seem impressive if you haven’t been actively trading this gold bull very long, but it really isn’t exceptional in context. And despite perceptions in the financial media which is full of reporters and analysts only “discovering” gold now, there is nothing unprecedented at all about gold’s recent gains.
This chart documents the entire secular gold bull to date. Underneath the gold price in blue, I rendered gold’s 10-trading-day (yellow), 20d (orange), and 30d (red) returns over every such span in this bull. When you study this history, it quickly becomes apparent that gold’s behavior over the past month is not exceptional. In fact, gold’s recent returns don’t even jump out as particularly impressive relative to this bull.
Let’s start by establishing some context here. Stage One ran from April 2001 to June 2005 when euro gold broke out above €350. Note that gold’s progress was relatively muted when it was primarily just mirroring the dollar’s decline. When global investors started chasing gold and transitioning it into Stage Two, the magnitude of its uplegs multiplied considerably. There have been 3 large Stage Three uplegs that are all labeled above. And both previous ones conveniently ended without a Stage Three parabolic blowoff.
Check out the first Stage Two upleg that ended in May 2006. On the day that gold upleg climaxed at $720, its 10d, 20d, and 30d returns ran 13.6%, 20.6%, and 25.6%. This translates into 1.6x, 1.3x, and 1.7x gold’s best gains over this past month. And this was a perfectly normal Stage Two upleg, gold wasn’t emerging out of a stock panic like it was in early 2009. Yet Stage Three didn’t ignite.
If you were trading gold and gold stocks back in May 2006 though, you remember that the hype then was very comparable to recent weeks’. Like today, gold was getting increasing face time on CNBC. Like today, predictions for imminent parabolic-type price surges abounded. Like today, momentum-seeking traders believed gold was on the verge of a superspike and chose to buy most aggressively right when gold was topping.
Sadly the markets always work this way. Most investors are not willing to put in the time and effort to train themselves to be emotionally neutral, nor to study market history to recognize what it looks like when greed or fear start to get out of hand. Thus most buy in near tops and get killed in the subsequent sharp corrections, and then they sell in disgust at the resulting interim lows. It’s the recipe for financial ruin.
Since Stage Three bull-ending parabolas are such exceedingly rare events, once every third of a century or so on average, the probabilities wildly favor any sharp move higher merely representing a short-term overbought condition within a bull instead of the precursor to the end of that bull. And when you consider that Stage Two hasn’t matured yet and the groundwork for a popular mania hasn’t been laid yet, it is almost certain that gold’s big gains today also merely represent overboughtness.
A key peculiar tendency in overbought times is the widespread attempts to justify further technical gains with fundamental arguments. You’ve heard them, gold will continue higher because the dollar is weak, or central banks are buying, or mining it is getting harder, etc. All these things are certainly true, and bullish. But realize gold’s fundamentals were just as bullish in past overbought times yet the metal still corrected hard. Long-term fundamentals never override necessary rebalancings of extreme short-term sentiment!
The bottom line is gold is not going parabolic despite all the hype today. Only a popular speculative mania can drive a bull-ending vertical superspike, and we are still years away from one. Not only are professional investors barely starting to buy into this gold bull now, but it remains largely unknown among casual mainstream investors. While the recent gold surge was exciting, it isn’t exceptional for this bull.
Gold has indeed rallied far and fast, but rather than a bull-ending omen it merely looks like a mature upleg in need of a breather. Both the recent surge and its likely consequences are typical when short-term greed leads to prices becoming overbought. So be wary of all the gold hype today. Remember that the financial media always gets the most excited at exactly the wrong times, just before highs yield to pullbacks.
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