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 THE LIBERTARIAN ENTERPRISE Number 371, June 11, 2006 "A lot of controversy"
The Gold Price Trend
Attribute to The Libertarian Enterprise The price of gold has risen dramatically since December 2005. It has also fallen substantially since 12 May 2006. What should we expect? Based on my review of the factors forming the current price trend, a look at the apparent channel markers around that trend, and the Fibonacci sequence which is often a guide to price changes, I would regard a near term bottom at around $608 per ounce to be possible, substantial support below $600 as very likely, and any price below $581 as very unlikely. There is no royal road to price analysis, and I am not blessed with divine guidance in this matter. Trends do change and factors which contribute to a long term trend sometimes change dramatically. So, I could be wrong. I offer my analysis here as an opportunity for further discussion, criticism, and review. The long term trend for the price of gold is up. The price hit bottom in 1999 and has risen every year since then. Many factors contribute to the current long term trend in the price of gold. Since that price is measured in dollars, some of those factors reflect supply and demand for dollars. Since 1999, the supply of dollars has grown, the demand for dollars has not been stable, and we call the resulting effect monetary inflation. Monetary inflation by all available measures is up. Of course, the available measures are from the government, and the government lies. They have changed the way they measure price inflation as often as they could get away with it, and the Federal Reserve has stopped publishing measures of monetary inflation such as L (a broad liquidity measure not published since 1998) and M3 (the broadest money supply figure, not published since March 2006). Keep in mind that my view of government is not merely jaded or cynical, but completely jaundiced. I am disgusted and sickened by all externally imposed, coercive forms of government. I am utterly hostile to their claims, assertions, and statistics. As Nietzche once wrote, they lie through stolen teeth, and lie easily. Some years ago, I learned about a very early government in Egypt. The priest kings there decreed taxes would be owed on the production from the land of each land owner. Since the flooding of the Nile River was instrumental in crop production, and since irrigation canals could be shut off to punish disobedient landowners, the government had a stable base of taxes. With taxes and slaves, the pharoahs erected enormous monuments which still stand today. Taxes were allocated by the size of the property farmed by each landowner. Conveniently, the government had trained artisans who could measure the size of each plot of land. The priests of the Temple of the Pyramid collected taxes based on their measurements, which in some cases dated back about five thousand years. Around 280 BC, a mathematician named Aristarchus of Samos used those tax records to attempt to calculate the size of the Earth. He had already concluded that the Earth was a sphere, that the Moon orbited the Earth and the Earth orbited the Sun. His essays on the shape of partial lunar and solar eclipses reveal how he arrived at these conclusions. When he heard about a well near Cyene which had the unusual property of casting no shadow when the Sun was directly overhead at each equinox, he realized that the well was on the northern tropic line, which today we call the Tropic of Cancer. He knew that a pole held vertical at the equinox at Alexandria, hundreds of miles further north, did cast a shadow. He was able to use trigonometry to work out the relationship between the height of his pole and the distance from Alexandria to Cyene to establish the curvature of the Earth and thereby come up with its circumference. His math was impeccable, but his answer was wrong. His value was too high by 10%. His answer was wrong because he relied upon the tax records of the Temple of the Pyramid rather than measuring the distance from Alexandria to Cyene. He simply added up the relevant north to South distances along the Nile River valley between the two cities using the tax records. It turns out that later surveyors were able to prove that the tax records had inflated each property by 10% both in the north to South direction and in the east to West direction, so a total of 21% overstatement in the size of each property was common, and the Temple priests were collecting about a fifth more taxes than were actually due. So, the supply of dollars is up, and it is up much more than the government admits. During the 1965 to 1980 period when the price of gold went from $35 to $850, the monetary inflation as measured by gold was 155% per annum on average, whereas the government sometimes admitted to 20% inflation. We now know they were lying then, we should assume the government is lying now, and is going to go right on telling lies until it is prevented from doing so. What about the supply of gold? Well, the long term trend from 1980 to 1999 was down. So, there wasn't as much exploration. From 1996 to 2003, the price of gold was very low, and there was little reason to go out exploring for gold. Also during the generation from 1980 to 1999, people who might have pursued careers in geology and geophysics exploring for gold found other markets for their skills. About a generation of gold explorers retired without providing their knowledge to their replacements. Since 2003, the price of gold has been high enough to sustain considerable exploration. But, finding a major gold discovery does not produce gold bullion on the street to bring down the price right away. The new discovery has to be defined, surveyed, measured, and the measurements run against standards such as Canada's 43-101 standard. Financing has to be arranged. Permits for mining involving lots of environmental studies are needed. Many of the places where gold is found are not very stable politically, so further challenges are involved. It may take five to ten years to go from a new gold discovery to gold production bringing down the price, which means that we have a conservative date of 2008 before significant new gold production reduces the price. We're not there yet. Demand for gold hasn't dropped. Indeed, demand for gold as an investment increases as the price increases. Demand for gold as jewelry in many countries such as India and Thailand reflects the use of 24 karat gold jewelry as a store of value in those cultures. As well, demand for gold as jewelry in Western cultures is higher when the price is higher—it has more perceived value so it is regarded as more glamorous to wear. Demand for gold is greater than the supply of gold, so the price is going up. Nothing has happened to change these factors in the long term trend. So, the long term trend is going to continue up, and it is going to show significant changes of slope to go up more and more steeply. At various points, there are going to be market manias to reflect exuberance about the price. We've just experienced a brief episode of that sort. The short term trend from early March to about 12 May was up at a steeper slope. I think part of that was a rational response to the Federal Reserve turning the lights out on the M3 money supply figure. Part of it was other rational fears over saber rattling about Iran and sundry other idiocies of the Bush administration which affect the value of the dollar (supply, demand). Much of that steeper trend was irrational exuberance. Remember that a year ago, June 2005, gold was about $420. It cut through $500 per ounce in December, took a brief pause, then cut through $600 per ounce in early April, and did not pause for breath until it had cut through $700 per ounce. Very evidently, most of the $600 to $729 price was market exuberance. Mania. Tulip bulb stuff. All of the $660 to $729 part of that curve lies above the upper channel marker of the longer term trend of the last 12 months. Which means that the price is now reverting to trend. It is also doing so at the traditional Summer-time doldrums when we see the price of gold take a breather. Silver is even more clearly seasonal in this respect. Last year, we had a short doldrums which ended very early in the season. I expect this year is going to show the same brevity, or perhaps an even briefer doldrums. When the price comes alive later this Summer, it is going to go much, much higher. Another tool we can use, for a little while longer, is the path downward which gold followed in 1980 after it hit the peak price in January. One of the pauses was around $715 per ounce. So, we had reason to expect overhead resistance at prices above $715, and we saw that very clearly in May 2006. I should point out that when that overhead resistance is breached as I expect shall happen in a few months, we'll enter into terra incognita or unknown territory. The map from 1980's peak down to 1999's valley won't work after we cut through the last known overhead resistance level. From then on, we're off the map, charting new territory. If you take a look at a one-year chart of the gold price and lay a piece of paper or straight edge along the line formed by the bottoms of that red curve, you get four good taps. The first bottom event that matches comes around October to early November 2005, the drop at 21 December 2005 hits that straight line, and there are two drops in early March and late March 2006 which meet that same trend line. I would say those four events are a good definition for a bottom channel marker. If you then extend that line to the present, you find it hits just below $600 per ounce. The trend of the last 12 months is also a steeper slope than the trend for the last five years. If you go to a five-year chart, you find a definite slope change in August 2005. We are on a steeper slope this year than we had been in the past five years. If the price were to revert to the even longer term trend, and hit the bottom channel marker of that five year path—which would suggest that nearly everything since August 2005 is market mania, then the curve might conceivably tap $480 before resuming its trend back up. But, I regard such a change to be unlikely, because there are no events pointing to fundamental changes which would cause the price trend to revert to its lower slope. I would expect that any fundamental changes would so dramatically affect the price that we'd see a complete trend reversal. Meanwhile, we can expect the slope to get steeper for the next 18 months or so, not shallower. Let's also do the Fibonacci math. For the 45 days from about 1 February to 15 March, the price of gold showed overhead resistance above $565 or so. The price ran down to $534 per ounce on 10 March 2006. I mark that point as the beginning of the wave which crested almost exactly 60 days later on 12 May 2006 at an intra-day high of $729. If we take the height of that wave to be $195 and we assume that the market is going to give up 61.803% of that gain, or $120.52, we get $608.48. What's so special about 61.803%? It happens to be the ratio of any two adjacent, large numbers in the Fibonacci sequence. The same ratio is often identified as "the golden mean" or "golden section" and is found in many highly regarded works of art and architecture. The Fibonacci sequence was discussed about the time of Aristarchus of Samos, in a work in Sanskrit called "The Art of Prosody." It was rediscovered and thoroughly analyzed around AD 1202 by Fibonacci. The application of the sequence to finance is more recent. Many analysts expect a price trend to show significant retracement, and expect the values of that retracement to relate to the peak price by the golden mean. The price could hold above $608 per ounce, but it hasn't done so today. On 8 June 2006, the price fell below $608, reaching a low of $607.30. The day isn't over, and the price has recovered substantially from that low. During this week's trading we've seen overhead resistance at $644 per ounce and support below $608. I have no direct knowledge of any programmed trading schemes by institutional investors, but the recent rise in the price of gold has clearly attracted the attention of a lot of money managers. I would not be surprised to learn that they are buying now on the assumption that $608 was the low point. It seems clear to me that they were selling earlier this week at $644. And the Fibonacci sequence is well known in investment management circles. (Which makes it a good strong candidate for self-fulfilling prophecy— the price recovers from $608 because many investors expect it should and buy on that expectation.) A problem I have with the Fibonacci sequence analysis is not the math, but picking the starting and ending points. If we were to assert that the last decisive peak was in mid-December and the price dropped on 21 December 2005 to just below $490, then we get a height of the current wave of $239 and we'd expect $581 to be the point below which the market doesn't give up any more. I regard this lower price as a definite lower bound. If the price penetrates below $581, then conditions in the market have changed so fundamentally that I would have to say at that point that I don't know what to expect. Based on all these thoughts, it is my view that gold won't drop below $595. I would think that $608 is a fairly critical value, and if the price penetrates to $605 it is likely to also penetrate $600. But, any of these prices down to $581 would be a strong buy signal. Any price from $581 to $480 at this point or in the near future would be a source of confusion, and I would say at that point, "I don't know what to tell you." So, then, what is the high likely to be, and when is it likely to occur? That's of considerable interest to thoughtful investors. By the end of 2008, every existing mine is going to be going full bore to produce gold while the price is high; every workable mine that was closed in the 1990s should have been re-opened; every major discovery that was made since January 2003 is going to be nearing production or in actual production. So, supply is going to be coming available to quench the thirsty demand by then. Where should we expect to see the price go? My oldest guess is $6400 per ounce. My current thinking is beyond $5000 per ounce, probably at least $8500 and possibly beyond $10,000. The value $8500 was arrived at some years ago when I considered that the dollar of 2000 had about the value of the dime of 1970. A number of actual measurements supported this observation. For example, there was the 1971 model year Lincoln Crowne Victoria LTD luxury sedan which sold for around $2800 and the same vehicle in its 2001 model year incarnation which sold for $28,000 or more. Forecasting a crisis thirty years on from 1980 would give a peak price about ten times as high. On 21 January 1980 the London afternoon fix was $850. That same day the April 1980 delivery gold futures contract price reached $895 per ounce. So, my tenfold model gives us a price of $8500 per ounce at the peak, possibly $8950. Another similar analysis is to look at the price increase from 1965 to 1980. The base price was $35 per ounce by government decree, and was supported with considerable gold sales by the "London gold pool" of the 1960s. GATA.org has detailed similar machinations in the 1996 to 2003 period, and subsequently, suggesting a price fixing scheme at least involving central banks. I gather that Barrick and JP Morgan Chase have defended the allegations against them in a private suit brought by the Blanchard Companies in New Orleans by asserting that their restraint of trade had official government sanction (and should, in their view, be protected by the sovereign immunity of the government!). So, a similar pattern of attempted (and failed) price fixing exists. The base price in 1999 at the nadir seems to be $252.80 per ounce. The change from $35 to $850 is 24.29 times the base value. So, 24.29 * 252.80 gives us a value of $6140.51. If we use the futures index price of $895 per ounce, we get a factor of 25.57 for the change, and $6464.10 for the new peak. This range of values from $6140 to $8500 is quite narrow as astronomers measure things. They are not only within the same order of magnitude, but they are related by a factor of 1.38. In astronomy we were taught to regard 11 and 99 as the same number, since they are the same order of magnitude—things in the universe are quite spread out once you get beyond Earth orbit (something humans have neglected to do since 1972) so it makes a certain kind of sense. With the two values so close together, it seemed like I might have some idea of where things were going—especially as the two methods for estimation were not identical. More recently, however, I was reminded of an exceptionally embarrassing moment in my first year of business school. I was expected to perform statistical analysis on a large number of economic factors from recent history (1965 to 1985) and give a five minute presentation on the economic factors driving the price of oil. The exercise boiled down to what, if any, advice would one give to Big Oil companies in Houston about how to predict the price of oil in coming decades. (Readers may recall the price of oil per barrel was fairly low in 1986.) In my presentation, I pointed out that the only factor in the economy which had any meaningful predictive value was the rate of interest. Nothing else even came close. So, if one knew where interest rates were going, one could anticipate the direction of the price of oil. My instructor used my presentation as an opportunity to illustrate how exceptionally silly my comment was, perhaps to stave off some similar conclusions by the other forty members of our required class. He noted that nobody but the Federal Reserve can predict interest rates. In a stunning moment of clarity, I realized that interest rates are the key to predicting a great deal of information in the economy, so being able to set interest rates is a significant power. (Indeed, I would rate it up there with the issue power of money in establishing whether we'll have free enterprise or a command economy, and, thus, whether we have a civilization or chaos.) So, the price of gold? It'll be a consequence of the choices of the central bankers—they claim to have many metric tonnes of gold to sell if they want it lower. It'll be significantly determined by the coming high interest rates which are going to be alleged to be vital to recovering from inflation, just as they were so alleged in the late 1970s. (Curious, then, that there were two oil price shocks in 1973 and 1979, masking the monetary inflation of the day. Were the international politics manipulated to disguise the deliberate policy of monetary inflation?) Of course, the central bankers pretend they aren't focused on gold. But gold and silver remain the only form of money that central bankers don't directly control. Their policies influence the prices of everything, but the market still has its say. And, in spite of their enormous power, or because of it, central bankers remain fallible. They have no source of omniscience and no greater ability to hire talent than anyone else. The experiences of Weimar Germany, Austria, the Republic of China, South Vietnam, and Yugoslavia, to take a handful of examples from the 20th Century alone, suggest that central bankers err. They tend to err by creating hyperinflation rather than other problems (though the Great Depression stands as an example of their inconsistent fallibility) and we seem to be dancing on the edge of a severe hyperinflation. It is nothing more than a hunch, but gold could go well beyond ten thousand dollars per ounce. At levels above $32,000 per ounce, which are within the span of my recent thinking, the dollar as we know it ceases to function as a workable medium of exchange. (It already fails as a unit of account across any period of more than a year; it is miserable as a store of value for any term longer than a few weeks these days.) When it ceases to function as a medium of exchange, the bankers will replace it with something else. Maybe their long awaited "bancor." Happily, it is in moments of widespread tumult implied in the collapse of the dollar that free market alternatives become interesting to a broader audience. We happen to be prepared, just now, with several free market alternatives based on gold and silver which offer workable media of exchange not only for online commerce but for all commerce. Since we are ready for it, the balance of this century may be the era of free market money. That would be a consummation devoutly to be desired. Finally, we have to ask, "When would these things likely come to pass?" The bankers evidently want to inflate the dollar, now. They seem satisfied with the idea of monetizing the debt, possibly to make the dollar value of their claim even higher—however meaningless that is to sensible people reading this newsletter it may impress the general public. The monetary inflation is happening now, and the price of gold has responded. The vast majority of gold and silver are in private hands, so the central bankers won't be able to bottle up the price forever. As a further aside, I would note that I expect the price of gold in terms of ounces of silver to approach 15. That is to say, we should expect at the peak that 15 ounces of silver would buy an ounce of gold. At $6400 per ounce gold, that suggests $427 per ounce silver. Another ratio to anticipate is a return to 3 ounces or less of gold to buy the Dow Jones Industrials. At a Dow:Au ratio of 2.5:1 and a gold price of $6400, we would expect a 16,000 Dow. A few paragraphs above, I noted that the crisis seems to be coming after three decades from the previous peak. I should now like to put an error bar on that estimate. Thirty years from 21 January 1980 plus or minus two and a half years. Yes, an error bar five years wide gives me a 17% fiddle factor. More exactly, the new peak would be 21 January 2010 plus or minus 914 days. So, the crisis occurs during the period 22 July 2007 and 23 July 2012. Why? Several things come together in this period. I've described elsewhere the slave rebellion and civil rioting cycle. This cycle reaches a new peak during the five years around 2010. Perhaps the return of debt peonage and open slavery would do the trick this time? There's also clearly a crisis brewing in the financial system itself, not just the markets. Think of a spinning top balanced on its tip—the tip of real money and actual productive resources. Layered on top of that tip are some really useful financing schemes which allow resources to be hedged, borrowed against, and invested for various purposes. Credit card debt for working people is a way of borrowing against their future income stream. Real estate debt assumes that the value of the underlying asset won't deteriorate faster than the money supply inflates—though a crisis in real estate assets seems to be upon us. But, also layered on top of that tip and the sensible financing tools which allow for rapid economic growth are a whole lot of other things. Social welfare programs. Payments to the elderly extracted from the pay of the young. An enormous and growing bureaucracy. Incredibly corrupt defense contractor companies and the even more corrupt military agencies that corruptly allocate contracts among them. Staggering levels of debt with secondary and tertiary obligations coming due. A rapidly retiring Baby Boom generation followed by a gap, with a very hard pressed boomlet expected to finance a growing horde of retirees. Another round of endless war, this time again a land war in Asia. An incredibly corrupt war on drugs and criminal drug cartels managed by USA espionage agencies. Layers and layers of derivatives, hedges, securitized assets, margins, futures, and short positions. Visualize all those elements as structures, some sticking out on one side, some on another, some at one level, some up higher, some joined together vertically or horizontally or diagonally. The top is spinning, and there is a great deal of angular momentum, but all these superstructural elements have been growing while the top is spinning. So the angle of contact with the platform is no longer perfectly vertical. There's tilt and drift and what we used to call "coning" in the rocketry business, meaning an unstable precession of the nodes. Instead of rotating about its central axis, it is now also yawing and pitching, and these other motions are not dynamically stable. Remember, this model isn't the market for gold or the market for real estate or some other particular market. It is the financial structure of the entire economy. With 83% or more of world trade denominated in USA dollars, and dollars backed by nothing more than the ability of the USA government to collect taxes, and taxes dependent on nothing but trade and commerce to generate jobs and income to pay the taxes, there is nothing to the tautology. It comes full circle and you find yourself with paper obligations to adhere to legislated requirements to meet bureaucratic red tape to escheat assets or encumber incomes which only exist if there are willing buyers and willing sellers. In other words, large sections of these structures evaporate or separate from the spinning top, further destabilizing it. Without dynamic stability, the system reset is at a much lower, slower level of spin—possibly stationary. And, of course, nothing in nature requires that a reset be available—the dynamically unstable system may fly apart in a supernova. The sky is littered with nebulae which are the remnants of dynamically unstable stars that left the Main Sequence and tore themselves apart. Robert Landis explained why the system survived last time. The dollar was exported to a lot of places where the local currency was much worse. Creating worldwide demand for dollars allowed a lot more supply to come into existence. But the dollar is no longer unique, nor even particularly well formed. Other paper currencies, such as the EU euro have more useful denominations. The digital gold industry reveals for anyone who cares to look that any asset can be monetized—gold and silver work extremely well in this respect. And, the global demand for dollars doesn't have a lot of new market to be created—there are very few places where economic activity is significant that aren't using dollars in trade right now. So, there's no easy out. We shall have the catastrophe. If politicians, bureau-rats, contract officers, bankers, and central bankers seem to be openly and obnoxiously grabbing for all the loot they can get, it is simply Louis Quatorze behavior. Louis XIV of France once said, "Apres moi, le deluge." After me comes the flood. Well, he was never, ever observed to scrimp on luxuries. His grandson succeeded him and his great grandson lost his head in the French Revolution followed by much chaos and bloodshed. To fight Napoleon, men and women from every city in Europe gave their lives, their children, their property, and their measuring systems. At the end of Louis XIV's reign, he authorized John Law's Banque Royale to issue "Mississippi money" backed in theory by the value of France's land holdings in the Mississippi River Valley, but in practice redeemable for nothing. An enormous inflation resulted, culminating in the 1720-era collapse of the South Sea Bubble. That collapse was followed by a sixty-year depression until 1782—the longest and deepest economic depression for which we have reliable records. As a result, in part, of that economic depression, the American colonies had their revolution and separated from England. The French people had their revolution, lost their grasp on history and had another fiat money inflation, ended up fighting and dying for Napoleon, and brought socialism out of the Paris Commune of 1848 to afflict a weary world. In other words, we are still feeling aftershocks from that choice of the Sun King to engage in radical fiat money inflation from 1690 to 1710 or so. Europe got over it, and got better, and the rest of the world moved along. But, there weren't a lot of nuclear, chemical, or biological weapons running around. There wasn't the temptation of nuclear terrorism as a foil to keep populations in line. There weren't the propaganda ministries of the mainstream media. Well, the possibilities for chaos and bloodshed are certainly magnified, but this digression began with the question of: when? My best answer is: soon. My advice: prepare.
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