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The Hard Assets Alliance Blog

This Too Shall Pass

Gold is down nearly 25% year to date, and down nearly 35% since its September 5, 2011 high of $1,921. The downtrend has now exceeded two years.

Hardly sounds like an asset in which you'd want to invest.

But the core reasons for holding gold haven't changed. How, exactly, do the G7 countries escape their morbidly obese levels of debt without causing serious repercussions? Can you really print money at never-before-seen levels and have no negative consequences? Interest rates may rise, what would normally detract some investors from gold, but what if inflation rises faster?

On a fundamental basis, it seems more prudent to buy gold now than it did in 2007. Which means that the two-year-plus downtrend will pass, sooner or later. No bear market (nor bull market) lasts forever.

History confirms this. Perhaps the most relevant period to today is the mid-1970s. In spite of many reasons for gold to rise then, the price fell—dramatically and determinedly. But eventually fundamentals prevailed and ushered in one of the greatest gold bull markets in modern history.

Here's how our current downtrend compares to that bear market cycle.

As you can see, during the big correction of the mid-1970s, gold declined 47% and took 187 weeks to recapture old highs. Our current downdraft hasn't been as deep, but it's lasted longer.

Based on this comparison, it thus seems reasonable to expect that gold will need another year or two to regain the $1,900 level and continue beyond. Barring a black-swan event, this year gold will likely log its first annual loss since 2000. These are not predictions, just possibilities, and a reminder that if gold is slow to recover, you'll know it's simply adhering to past trends.

However, it's not all bad news. As the chart shows, gold nearly doubled in the two years from its '76 low to its '78 former high. Investors didn't need to worry about missing the bottom, either: those who waited to buy until gold had retraced 30% of its decline still netted about a 70% gain once it returned to prior highs.

Here's the comparison with silver.

Unlike gold, our current selloff is deeper than that of the mid-'70s. But the bigger point is the lag back then: after abruptly falling over 40%, silver traded in a range for about three years.

This hints that a swift return to silver's prior peak is unlikely. It needs time to consolidate. Again, this isn't a prediction but rather a forecast based on a similar setup from history.

In the big picture, remember that silver handily outperformed gold in the last great bull market—a feat I think it will repeat.

Don't let the long recovery times shown in the charts deter you. Stay focused on the pattern; once the declines reversed, the general trend was up. Contrarians and forward-thinking investors need to prepare for that reality, rather than take umbrage with how long it might take to start a new uptrend. By the time mainstream analysts—who know little about gold in the first placedeclare it has entered a "new" bull market, the lows will be long behind us, along with the best buying opportunities.

Selloffs Can Be Profitable Setups

Once gold bottomed at $103.50 on August 25, 1976, the trend reversed and the metal rose a whopping 721% to peak at $850 on January 21, 1980. Silver's climb was even more dramatic. From its 1976 low of $4.08, it soared 1,101%. This is the 10-bagger grail of investing, where investors had the chance to add a zero to their initial investments.

But keep in mind that the process was multiyear and began after a dismal two-year decline that was punctuated with sharp selloffs. This is similar to gold's behavior since its 2011 high. Also, the biggest gains were seen in the final five months. The patience of some investors would certainly have been tested in those first three years.

Here's a look at the gains for gold and silver from their respective lows.

  At Bottom 1 Year from Bottom 2 Years from Bottom 3 Years from Bottom At 1-21-1980 Peak Silver Gain 4 Years from Bottom
  Price Date Price Gain Price Gain Price Gain Price Gain Price Gain
Gold $104 8/25/1976 $144 39.3% $198 91.3% $315 204.1% $850 721.3% $639 517.6%
Silver $4.08 9/1/1976 $4.47 9.6% $5.51 35.0% $10.90 167.2% $49 1,101.0% $15.99 291.9%
Sources: Kitco, LBMA

Both gold and silver logged double-digit returns every year after the bottom (except silver for the first year). Once the momentum had shifted, buying and holding while the fundamental forces played out led to huge profits.

No "trading" was necessary; just buy after a big correction and hold on for the ride. No need to attempt to time the bottom, either; those who bought a year after the lows still reaped gains of 490% for gold and 996% for silver. The largest chunk of profits came in the second year and beyond.

Also of note is that this second leg up in precious metals was bigger than the first one seen earlier that decade. Given that our Mt. Everest level of debt cannot and will not resolve itself without significant levels of currency dilution, there's no reason to think we won't experience a similar outcome this time around.

The messages from history are self-evident:

  • Be patient. Odds favor gold emerging from a period of price consolidation and volatility. This process will take time, but in my view is inevitable.

  • Be prepared. Big gains follow big selloffs. We can't be certain if the final bottom is in yet, but buying at these levels will ultimately net big profits.

As you consider how much to allocate to precious metals, remember that gold and silver bullion aren't really "investments." We own them because the odds of a significant financial system reset are very real, and they offer us the kind of protection no other asset can.

 

Jeff Clark is editor of BIG GOLD, and a regular contributor to the Hard Assets Alliance.


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