Gold is currently languishing in a trading range between $1,366 to $1,049. This trading range is thought by many to be a pause before the eventual increase above the previous high at $1,895. After all, the price of gold had managed to decline from $1,895 to the low of $1,049.40, a drop of –44.62%. Part of the thinking of a new high in gold is predicated on the idea that we are entering a phase of rising inflation after years of decreasing inflation from the 1980 peak.
Introduction
If the thinking is that gold is on the cusp of new highs, there is one question that we need to answer. The question is, “What happens with the price of gold in the early stages of an inflation cycle?” What is amazing about this question is that in the early stages of the last inflation cycle from 1939 to 1942, gold was fixed at $35 until 1971.
Never in the history of the United States have investors seen the reaction of the price of gold to the early stages of rising interest rates. In this posting, we’ll attempt to show a reasonable benchmark for gauging what would happen if there weren’t restriction on the price of gold.
Silver is the perfect means to convey the message of what would have happened to the price of gold if it were allowed to navigate the whims of Mr. Market. While silver is more volatile than gold and prone to extremes it still tells the story of gold when gold did not have a voice.
Interest Rate and Inflation Cycle
We start with the price of silver from the peak in 1925 because, according to Dewey and Dakin's in their 1947 book Cycles: The Science of Prediction, the last peak in wholesale prices, which generally corresponds to interest rates. If you have a beat on interest rates, you can get a better sense of where we are and where we might be going as it relates to precious metals.
Remember, you don’t have to be a fan of cycle theory to appreciate the quality of analysis that reflects what has already happened from a book written in 1947. Calling the peak in 1979 and the trough at 2006, while not exact, is the best way to learn from the past. Looking at the 3-month Treasury, we can see the fulfillment of an entire cycle in rates from 1940 to 2009.
Just think, there is no official data that extends from prior to 1934 to the present. Without this important continuous information, it is difficult to find data that we can compare like-for-like stages in the cycle. However, we do have data from the price of silver in the previous cycle top to the low that corresponds to the low in interest rates and silver. This will be our introduction to the secret history of gold.
Silver: 1924-1933
Below is the price of silver from 1924 to 1933 (green). Included is an equal weighted price of gold and silver stocks with and without Homestake Mining (HM).
From the peak in 1925, silver declined –63% while the gold and silver stock index declined –64.80% with Homestake Mining (HM) and –76.47% without HM. Because we know that the price of silver is more volatile, we expect that gold would have decreased over the same timeframe but by a smaller amount. This concept will be put to the test when we compare the price of silver to gold in the equivalent cycle peak to trough from 1980 to 1999.
Just to refresh, the prevailing theory is that if an investor holds gold, silver, and precious metals stocks in a crashing stock market then they will be protected from the fallout. In the case of silver, from 1929 to the 1932 low, the decline was –57.32%. If silver was reflective of the general price action of gold then we can safely guess that gold would not have provided any protection in the crash of 1929 to 1932.
At the Low: 1931-1941
Depending on the source, the price of silver managed to attain a low from 1931 to 1941. Looking at silver compared to the 3-month Treasury from 1919 to 1971, we seen that the 3-month Treasury rates bottomed from 1939-1941 along with a general basing pattern in the price of silver. After reaching the low, we see that the price and rate of both increase dramatically by 1967 and 1970, respectively.
Again, we’re taking it on faith that the price of silver would generally reflect what the price of gold would have done if allowed to freely trade on the open market. This chart ends at the point when the “gold window” was closed by Richard Nixon in August 1971. In the 36-year period from 1941 to 1967, the price of silver managed to increase approximately +546%. How did the Barron’s Gold Mining Index (BGMI) do in the period from 1941 to its respective peak?
First, the BGMI managed to sneak in a crash of –40% before going on a grueling 20-year trading range and then breaking out to the upside starting in 1960. However, once getting out of the trading range, the BGMI catapulted to an ultimate gain of +720%. To put the gains in perspective, we show the amount of change in the Dow Jones Industrial Average (DJIA) from January 10, 1941 to March 8, 1968. What is clear is that the DJIA did not beat the BGMI in the same period of time. However, what is not included is the compounding of income that comes along with the DJIA and the gold and silver stocks during that period.
Additionally, not included is the performance of the DJIA from January 10, 1941 to February 9, 1966. In that period, the DJIA gained +644% as compared to the BGMI gain of +284% (excluding dividends). These perspective are necessary to further aid in the decision making process. Without these comparisons, an investor with a gold bias might say, “I’m buying the precious metal sector because it does well during high inflation,” when in reality, it is strictly a function of timing and alternatives that make the difference.
Up to this point, we have not had the benefit of gold to compare to the price of silver to confirm our thesis, which states that:
“Silver is the perfect means to convey the message of what would have happened to the price of gold if it were allowed to navigate the whims of Mr. Market. While silver is more volatile than gold and prone to extremes it still tells the story of gold when gold did not have a voice.”
Going forward, we will compare silver to gold which should, based on our claim, show a high degree of correlation in terms of price, but not magnitude.
Intermediate Peak and Low: 1971-1976
After the window on gold was closed by Richard Nixon in August 1971, the market price for gold went on an adjustment phase which was necessary for the price of gold and silver.
In the chart above, from August 1971 to the respective highs, we can see that gold increased +337% while at the same time silver increased +262%. As if to prove that gold had gotten ahead of itself, gold declined from its peak by more than –44%. At the same time, silver declined only –25%. The more important point is that the price of silver mirrored that of gold. Because gold had not traded in the U.S. prior to 1971, the gains in the price of gold in excess of silver were a natural reaction.
Meanwhile, the Barron’s Gold Mining Index went through its own dramatic swings as seen below.
The index increased +485% from 1971 to the 1974 peak. During the declining phase, the BGMI fell as much as –68.43%. On the whole, what happened in precious metal prices was reflected in the gold and silver stock index.
The Breakout Phase: 1976-1980
The introduction of gold was a game changer as few had experience with the metal being openly traded.
After the adjustment phase came the breakout phase where gold and silver shared in the bull market for precious metals during the high inflationary period from 1976 to 1980. As seen in the chart above, gold increased +527% and silver increased +703%. These gains were more in line with what individuals should expect when comparing the free floating price of gold and silver.
Surprisingly, in the same period of time, the Barron’s Gold Mining Index underperformed the change in silver and slightly better than the percentage change in gold.
The Declining Phase: 1980-2001
After gold and silver went parabolic, the decline was inexorable and steep.
Bringing all of this work full circle, we can plainly see that in the period from 1980 to 2001, the price of silver declines approximately -89% and gold fell -62.11% from the high. Meanwhile, what did the Barron’s Gold Mining Index do in the same peak to trough period?
The Barron’s Gold Mining Index declined –82.52%. This price action was not unlike the equal weighted Gold and Silver Stock Index from 1925 to the low in 1933, where the price of silver fell –63% and the precious metal index fell –64% (with HM).
Conclusion
There is a lot that precious metal investors need to take into consideration before looking to higher gold and silver prices. With this in mind, we hope that we have drawn out what would have happened to the price of gold were it not fixed, rigged, or manipulated at a set price.
The very first consideration is a comparable period in history. In this case, we believe that a comparable period to evaluate where gold and silver might be going is to look at the period from 1933 to 1980. After establishing a relative basis of comparison, we can now determine, based on what happened in the prior period to the price of silver and interest rates, what is most likely to happen going forward. Any evaluations that exclude a full cycle analysis without consideration of the commodities and interest rates will be poorly reasoned guesses, at best.
With the above data in mind, our next posting on the same topic will highlight specific scenarios that are required considerations of responsible investors who are willing accept the potential risks of buying gold, silver and precious metal stocks.