„Forecast are difficult, especially when they concern the future!“

Niels Bohr, physicist and Nobel Prize winner

Forecasts about financial markets have led to the failure of whole generations of investors and financial market analysts have been made fools by an ape throwing darts at an index sheet for picking stocks. The hit ratio of so-called investment gurus is being tracked on a website. Average hit ratio is at 48%. Flipping a coin would be more accurate at 50% without effort, PCs and charts. Nonetheless, millions of investors and consultants are heeding these experts of prognostication:

http://www.cxoadvisory.com/gurus/

Hence, forecasts regarding gold are always to be considered with extreme caution. The purchase of physical gold should also be driven by other motivations than to expect  rates to rise extremely  in the short term. From a historic perspective, the conditions for that are indeed fulfilled, but there is no guarantee for that. Still, an assessment of the position of the gold price is very interesting, especially in comparison to other financial instruments.

Precious metals, as well as big stock indexes such as, e.g. the Dow Jones of the S&P 500 have in the long term moved in so-called cycles. These last 15-20 years and may have upward (so-called secular bull market) or downward/sideways (so-called secular bear market) direction. The interesting thing about that is that the most recent secular cycles in stocks and precious metals took almost exactly opposite courses.  While stocks were rather out in the 70′s, gold boomed from 35$ to over 800$ per ounce. The great stock-decades began at the beginning of the 80′s. Gold dwindled from 800$ to 250$ in that period. Since 2001, the gold price in US dollars has been rising continuously, while stocks prices, on the average, have not. New secular trends have established themselves within the last 8 years. The probability, that these tendencies are ending already, is not very high. Secular trends last longer than 8 years, usually rather twice that long.

People who tend to see only the best side of a financial instrument are also called perma-bulls. They can be found in the gold sector as well. However, by closer examination of the secular gold trend since 2001, one thing must be stated clearly. Calculating in Euros, nothing much happened from 2001 to 2005, because due to the heavy decline of the US$ in relation to the Euro, the index increase was almost entirely consumed by the currency exchange.

In that context, the development after 2005 is remarkable. Gold prices have been rising in virtually every currency. Technically speaking, this is a so-called relative strength. If it consolidates, it usually also prevails. While paper currencies are more and more doubted, gold is increasingly being accumulated as an investment vehicle world-wide.

Another trend typical for a so-called bull market: Something rises slowly for years, then receives attention (perception), which eventually leads to an implementation phase with investors. If gold prices quadruple in 8 years, there might just be “something in it”.
Secular trends tend to end with so-called euphoria phases, in the course of which price increases several 100% may occur in relatively short time periods. Remember the so-called Neuer Markt in 1999/2000, Japanese second tier stocks in 1990, or, a little more exotic, the stocks for firearms with revolving cylinders (revolvers) after the invention of the six-shooter by Samuel Colt in 1836.

Gold has left the perception phase and has entered the implementation phase. There is no sign at all, however, of euphoric daily quotation jumps. While the current quotation peak may numerically be impressive, not very much has really happened.

One thing has happened, though, and relative strength is indeed a strong signal in favor of gold. It should not be as high as it is! Why?

The financial crisis was accompanied by deflation tendencies. Nearly every asset is below its historic peak – stocks, real estate and most raw materials. Gold, however, is at a historic peak and has not only recouped the price decline of the fall of 2008, when virtually everything but government bonds was falling, but has climbed to a new peak. Slowly and trend-like, not euphorically and explosively. This is a typical feature of an intact secular trend.

Arguments are easily found, why gold will soar or drop soon. A secular trend in the implementation phase – a phase in which only few small percentage units of the virtually unweighted risks in portfolios were considered – cannot be easily reverted.

However: Secular trends do have setbacks, too. There was one involving stocks in 1987. The crash of October 1987 led to a sudden price drop of 30%, but did not turn around the secular stocks bull market, that had only started in 1982. A decline of gold prices from 1,050$ to 700$ in one year is possible, just as a rise from 1,050$ to 1300$ is equally possible – both would fit into the context of a secular upward trend. It will be crucial to observe, how gold performs in relation to other currencies.

An interesting comparison, from which trends may be deducted well, is the so-called Dow/gold ratio. It measures, how many ounces of gold are needed to buy one Dow Jones.  Because the Dow Jones is a relatively old index, it allows for measuring the exchange ratio between gold and stocks. This ratio has been fluctuating between 1 (meaning one ounce can buy one Dow Jones) and around 44 for over 100 years now. The underlying idea was to exchange gold for stocks in times when one could acquire lots of stocks for little gold (e.g. in 1979/1980) – when  a Dow Jones could be traded for 1-2 ounces and be traded back, when one Dow Jones could buy many ounces of gold (1997-2000). This system would have caused very few transactions in the past 100 years and was pretty much perfect regarding timing.  At the moment, the Dow/gold ratio (November 2009) is at around 10.

Very many investors are not really wondering, if there will be an upward or downward movement in the short-term. The majority does not hold precious metals. The omission of a so-called asset class, however, is not sensible with regard to diversification. Just because precious metals have been “out” for over 20 years, a new trend is currently establishing – if the majority is underweighted or unweighted, a trend is bound to occur at one time.

This is similar to the trend in narrow and broad ties. Every once in a while, trends reoccur. In 2001 derision was certain, if one as much as mentioned gold as an asset class. This has somewhat subsided by now.