A Potentially Misleading Analogy

15 February 2007

Puru Saxena published an excellent article on Safe Haven today. The link is below.

http://www.safehaven.com/article-6921.htm

While Mr. Saxena’s article was extremely thoughtful, it does reflect a particular error which could potentially be quite misleading to gold bulls. Mr. Saxena’s overlay (naively) makes it appear that we are now on the verge of a gold market collapse. However, if one considers the fractal analysis, referred to on my blog only yesterday, it is quite clear that something else is afoot. That is, the illustrated parallel between our present bull market in gold and the previous bull market has become distorted due to an overly literal juxtaposition of the two charts.

As you will see, the grey line is the 1970’s bull market, and the dark line our present one.

Based on the analysis about which I commented yesterday, we may very likley be at an entirely different analogous point on the chart in terms of our present gold bull market position. To make my point, some mathematical alteration of Mr. Saxena’s overlay would certainly be required (and this is well beyond the range of the tools or time I have available).

In fact, look closely, and you will see an immediate problem with the overlay. The 1970’s chart is based at exactly zero, but the current chart is based at $200. So already, the analogy is distorted.

Why then are we not in synch amplitude and timewise?

Well, to start, as many much wiser than I have observed, history doesn't repeat, it rhymes.

I think the present bull market will likely be longer, and thus stronger, than the 1970’s bull market (which occurred in conditions of global adjustment far less extreme than at present). It is therefore not at all certain that the present bull market will wrap up and flame out by 2011-14 (as using the above-illustrated analogy might lead one to conclude).

Further, inflation-adjusted charts have never to my knowledge been made with accurate estimates of the cost of living increase. While the current mantra is that the 80’s peak in the value of gold was $2000 inflation-adjusted, we probably need to move closer to $3-4000 to reflect the true cost of living increase. And given that inflation is likely to persist during the upcoming decades, further adjustments to our inflation-adjusted target also need to be considered.

I lack the tools to verify this, but my suspicion is that to graph our present market against this chart, we would have to compress the present (1980-2007) chart from decades to mere years. In that case, the first (and largest) “hump” would be the analogue of the 1980 bull market top, and our present position would be directly horizontal to that, about 4 years further forward.

That is, my intuition suggests that the 1970’s first peak near $200, which pulled back to about $100 before recovering, is analogous in our current chart to the 1980 peak, with its ultimate retreat to near $250 (much more severe in fact, particularly considering the ravages of inflation during that lengthy period).

So, in yet another fantastical leap, let me suggest that what took only 4 years to occur in the 1970’s bull market (that is, the fall from and eventual recovery to the $200 level), is in fact the analogue to the entire span of time from 1980 to the present, or 27 years. This easily implies that this gold bull market could run an additional two or more decades before exhausting itself.

My suggested time-compression ratio?

A very rough estimate is 10:1, perhaps 8:1.

The vertical multiplier?

I do not know, but the ratio is nowhere near one-to-one. A present estimate would be from 2.5:1 to 4:1, but we are 2-3 decades away from the implied target price of $2,000 - $3,500 in 2007 US dollars.

Therefore, a significant inflation adjustment will be required, and that would almost inevitably lead to an ultimate target for our present gold bull market of greater than $5,000 per ounce, with the unknowable upper limit depending upon the toll taken by continued monetary inflation.

We are further back, and have much longer to go, than a direct analogy to the 1970’s might imply. A very rough estimate, based on annual inflation at 5% (inflation is presently drastically under-reported, and I expect inflation to move higher for monetary reasons), is that somewhere around 2030, we will be seeing a gold price at ten to fifteen times today's levels ($6,000 - $10,000 per ounce), and in constant 2007 dollars, at 2.5 to 4 times 1980’s peak level ($2,000 - $3,500 per ounce).