Trader: Gold

Joseph Kennedy, JFK’s father and a legendary Wall Street speculator, famously decided that the 1920s bull market in equities was out of hand when his shoe-shine boy gave him stock tips.

Were he around today, he might get a similar twinge about gold. The metal is being hawked to the German public through vending machines in airports, while British daytime television carries ads encouraging punters to cash in on the bonanza by selling off any unwanted jewellery.

Gold’s glittering ascent to an all-time high this week of $1,214.80 – in nominal prices – has further emboldened the bulls. There is serious talk that it could double or even treble from current levels. The rampant creation of paper money by central banks around the world is the most popular justification for such predictions.

As Dylan Grice of Société Générale pointed out last month, gold remains reassuringly scarce in the face of dollar proliferation. Decades ago, every dollar issued was backed by gold. To back the $1,700bn dollars in existence today, given the current level of American gold reserves, the gold price would need to rise to $6,300.

Scarce as gold may be, this does not make it a good store of value. My research shows gold has failed to maintain its purchasing power over the long run. And its record during shorter bursts of high inflation is no better. In seven such periods since 1775, gold’s real value fell every time but once: during the most recent episode in the late 1970s.

Gold’s January 1980 peak of $835 works out as $2,312 in today’s money. So, it has a long way to go before matching that level. With hindsight, though, 1980 was clearly a bubble. The price doubled in just five weeks. And it did not retain its glory for long. Seven weeks after its zenith, it had shed 43 per cent. It then took 27 years to recover those losses.

Determining whether we are in a new gold bubble today is tricky. The metal has no cash flow that we can use to value it. Comparing it to other investments – such as the stock market – is the best we can do. But since gold has been in a declining trend versus shares for two-and-a-half centuries, it is meaningless to say that gold is still lowly priced in terms of equities.

Instead, we should probably look at the gold/stock market relationship and compare that to its 10-year average. On that basis, gold is 131 per cent above trend. Although that’s high by past standards, this relationship went 500 per cent above trend in 1980. This also leaves scope for further gold gains this time round.

On March 7, with gold around $900, I highlighted my technical targets at $1,140 and $1,279. My next objectives are $1,381-$1,405 followed by $1,536. With the metal very overbought, a big sell-off may come first, which I will probably seek to use as a buying opportunity.