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.
How are we going to explore the price of gold in a period when there was not a free floating price for the metal? By examining what the price of silver has done in the period when interest rates rise in response to increasing inflation.
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.
Continue reading →
