Rarely does it make any sense to talk about an asset appreciating by 500 percent. In this case – for gold, today – it isn’t as extraordinary as you might think.
A lot of investors dismiss gold as jewelry. And they dismiss “gold bugs” – investors who believe gold is the answer to all financial ills and is the key to surviving the impending financial apocalypse (in any era or decade) – as slightly crazy.
But gold bugs haven’t always been wrong. In 1971 gold traded at US$35. By the end of that decade, gold touched US$850. That’s a 2,300 percent gain in the 1970s. Meanwhile, for stock investors in the west, the ‘70s were pretty much a lost decade with lots of volatility, but flat returns.
The world didn’t end in the 1970s, but double-digit inflation, oil price shocks, a weak dollar, and political instability made investors fearful and nervous. With rising fear and uncertainly investors bought more gold, since it is a tangible store of wealth. As the ‘70s drew to a close, people stampeded to own it.
It happened once – and it could happen again.
The current gold rally bears some remarkable resemblances to what happened to gold prices in the ‘70s. For example:
- Crisis of Confidence
While the specific economic problems of the ‘70s in the west – inflation, recession, oil crisis – were different than today, there are broad parallels between now and then. In 1979, then U.S. President Jimmy Carter talked about a “crisis of confidence” in government and the future. This erosion of confidence extended to Carter himself – he lost the 1980 election to Ronald Reagan.
And what was Reagan’s campaign slogan in 1980? “Make America Great Again” – the same slogan that Donald Trump has borrowed as he taps into populist anxiety eerily similar to that of the ‘70s. Today’s crisis of confidence is a global phenomenon, extending from Washington to London to Beijing. The ‘70s crisis of confidence reached a boiling point in 1979 – when, not coincidentally, gold surged. We could be on a similar trajectory today.
- Broken Central Bank Policy
When the U.S. abandoned the gold standard in August 1971, the U.S. Federal Reserve took on an expanded role managing the U.S. economy. The Fed at the time adhered to the Keynesian school of economic thought. This theory, named after British economist John Maynard Keynes, states that growth in the money supply will increase employment and economic growth.
So when unemployment in the U.S. accelerated in the early ‘70s, the Fed and other global central banks responded by printing more money. But it didn’t work. Instead, the world experienced “stagflation,” a combination of stagnant economic growth and rising inflation. Then to help control inflation, central banks raised interest rates. In 1971, the U.S. Fed funds rate was under 4 percent. By the end of the decade it was over 13 percent.
Today, we are seven years into another central bank experiment that doesn’t seem to be working. The world is again facing stagnant economic growth, but inflation is not the problem – deflation, or falling prices, is a real possibility. To combat this, global bankers have aggressively expanded the money supply and lowered interest rates.
Some countries now even employ NIRP – negative interest rate policy. So, not only is the U.S. Fed funds rate at historic lows (about 0.4 percent), but may governments’ bonds pay negative interest.
Negative interest rates silence a typical complaint about gold – that it doesn’t pay interest or dividends. But in a NIRP world, at least gold doesn’t guarantee a loss – unlike some government bonds that guarantee you will get less back than what you invested.
- Strikingly similar price patterns
The rise and fall of market prices often display patterns that repeat over the years. And we could be seeing that happen with gold prices.
In the 1970s, gold rose from a low of US$35 per ounce in 1971, to a peak of US$180 in late 1974. From there gold experienced a correction, falling nearly 40 percent to US$110 in August 1976. But from that low, gold mounted an historic rally. By June 1978 it was back to its previous high.
Then gold went nearly parabolic, with a frenzied surge to US$850 in January 1980.
It’s fascinating to see that the current gold bull market shares a very similar pattern – to this point – of the ‘70s gold market.
- 1970s: US$35 in 1971 to US$180 in 1974 (414 percent gain)
- Now: US$280 in 2000 to US$1,888 in August of 2011 (574 percent gain)
- 1970s: Correction 1974-76 US$197 to US$110 (44 percent loss)
- Now: Correction 2011-15 US$1,888 to US$1,056 (44 percent loss)
Gold is currently about 26 percent above its November 2015 low. This is equivalent to gold being at US$132 in November 1976. If today’s pattern repeats that of the 70s, gold would peak at around US$6,800 over the next three or four years. The chart below compares the percent change in gold prices of the two bull markets, 1970s vs 2000s.
If history repeats itself, a huge jump in gold prices is coming.
In the current bull market, gold reached an all-time high in August of 2011 of US$1,888, but fell to a low of US$1,056 in November 2015. Is it possible that the November 2015 low marked the end of the correction phase of another long-term gold bull market? Will US$6,800 gold become a reality over the next few years?
It’s possible. But to soar like in the late 70s, gold will have to move into the “mania phase.” This is where gold investors lose contact with economic reality, and chase prices ever higher in a feedback loop of soaring prices, “new era” thinking and greed. Think Tulip Mania in the 17th Century, internet stocks in 2000, and Chinese stocks last year.
In 1979, a second oil spike after years of global energy inflation, in conjunction with global political instability, sent gold investors into a final buying panic which ultimately led to the January 1980 peak in gold prices.
A similar type of economic shock could be the trigger for another massive spike in gold prices.
So is it probable that gold will repeat the historic gains of the 1970s? No. Is it a legitimate possibility? Yes. Conditions are favourable for gold… and getting more favourable by the day.
As we’ve said repeatedly, it’s prudent to hold gold and gold stocks as part of a diversified portfolio. Because if/when the global economy unravels, gold will be one of the few places to hide. It happened in the ‘70s, and it’s looking like it could happen again. The gold bugs could finally be right.