Are we in for a Gold Bubble?

As I'm typing this article Gold has been plummeting...Are we in for a Gold Bubble?

I think not.

Of all your family members, what percentage have told you they own gold in any form?

Of all your friends, how many have told you they've purchased gold or gold stocks?

Of all your co-workers, how many have discussed anything positive related to gold?

Of the neighbours you talk with regularly, how many have initiated conversation about any topic centering on gold?

How many conversations have you had with any other party (at work, at a gym, on an airplane, after a religious service, etc...) who spoke positively about gold in any way?


Excluding any gold-related websites or publications you regularly read, what percentage of all the materials you read (magazines, newspapers, online articles, etc.) discuss gold in a positive way?

What percentage of the investment vehicles available through your company's IRA, 401k or other retirement plan include something explicitly related to gold?

The markets are convinced that the financial crisis is over and are celebrating the fall in commodity prices. When they realise that the financial crisis isn't over and that falling commodity prices aren't being created by rising supply but by falling demand, get ready for a jaw-dropping, bone-crunching collapse in equity prices.

The FTSE - which is heavy both on financials and commodities - is particularly vulnerable. For the first time this year, both groups will be going down together - think about it.

That said if the prices of gold keeps going down I won't be losing 50% of my investment in gold, a) because it won't be falling by 50%; b) because, even if it does, I operate stop-losses under all my positions, so I will be out of gold if it falls by more than 20%. I operate even tighter stop-losses on my short equity positions, so I will be out of those, too, if the market rises by more than 15% from here. And I won't need to sell anything to "catch the surge in equities", since a considerable part of my portfolio is in cash.

Turning to the wider markets, a) the difference between secular and cyclical bull and bear markets, and b) the fact that in the year 2000 the world left an 18-year secular bull market in stocks and entered a 15-20-year secular bull market in commodities.

After the 1929-1932 Wall Street Crash (DJIA: 343 -> 43: -87%), the Dow returned to 186 on Jan. 2nd 1937. It did not exceed 200 until January 1950. That's a 21-year secular bear market in stocks. It was perfectly matched to a secular bull market for commodities which lasted from 1929 to 1950.

From 1965 onwards, there was a similar secular bear market in stocks. The Dow peaked at 969 on Oct. 1st 1965. It did not exceed 1020 until October 1982. That's a 17-year secular bear market for stocks. Again, it was almost perfectly matched to a secular bull market in commodities which lasted from 1963 until 1980.

In 1999, a new secular commodity bull market began after a 19-year secular bear market. Just one year later, in 2000, the peak of the 18-year secular bull market in stocks occurred. Over the last 200 years, the shortest secular bull market in commodities is 15 years (1823-1838); the longest is 40 years (1878-1918); the average is 22 years.

Could this be the shortest secular commodity bull market in history? Yes, anything is possible. Is it probable? No it isn't.

"Buying and holding" equities is acceptable in secular equity bull markets (though avoiding the cyclical bear markets which occur within secular bull markets is even better). "Buying and holding" is a lousy strategy in secular equity bear markets.

The world's leading stock index (the S&P 500) stands on a forward P/E of 22. Between 1871 and 2007, when the US stockmarket stood at a P/E of 22, it averaged 3.2% annual growth over the next 10 years. When it stood at a P/E of 15 (where FTSE stands now), it averaged 6.1% annual growth over the next 10 years. You only get to 8% average annual growth over 10 years (what most financial advisors currently aim for) when the P/E stands at 12. And if you are aiming for more than 10% annual growth (which I am), you should wait until the FORWARD P/E reaches 8.5 before investing.

It is thought that Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. Some analysts predict that this secular trend may peak sometime between 2014 and 2020. (Last update: 22 October 2007).

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