Introduction

Gold has recently rallied to a new high of $475.50 an ounce per the London Fix. The price action has induced speculation as to whether gold is in stage one or two of its bull market. Obviously, one’s definition of stage one or two has a lot to do with the determination.

Some pundits say yes, others say no. The parameters vary widely: from comparisons to past bull markets, to wave counts, to sentiment readings, to fundamental analysis as to exactly what makes a bull market in gold occur.

Our choice is: maybe yes, maybe no. It’s a little too early to tell for sure.

If we had to choose one or the other, we would say – no, with the caveat that we may be in the very beginning of stage two. However, one cannot be certain without the forgiveness afforded by hindsight – at least according to the reasons we have read so far.

The above are not excuses or hedges, just the plain truth that no one can predict the future with any degree of certainty or precision, nor is such prediction needed.

We will explain the reasons why we do not believe that stage two has yet to begin, although it may very well be in the transition of so doing.

We will also explain why one doesn’t need to predict the future for successful investing. All that is required is to be able to recognize the proper opportunity when it presents itself – as it is occurring - not ipso facto, not beforehand, but during.

The Golden Key

The key to a gold bull market is same as the key to any bull market – the demand of investors for the investment under consideration.

In the case of a gold bull, it is the demand for gold. As with any market or commodity, buyers have to be willing to pay a higher price, as compared to what sellers are willing to accept as a lower price.

It’s the age-old battle between buyers and sellers. If buyers predominate, it’s a bull. If sellers predominate, it’s a bear.

Gold is the ultimate form of money, providing historical evidence and a proven track record dating back thousands of years. It is important to remember that gold is priced in the reserve currency of the world – U.S. Dollar bills, a.k.a. Federal Reserve Notes.

The Constitution does not price gold in dollars, it prices dollars in silver and gold, according to a silver standard. See Honest Money and Can the U.S. Return to a Gold Standard? But that’s another story, so back to the task at hand.

Also of note is the fact that the U.S. dollar is paper fiat money – just as all other currencies are. It has been pointed in out in the media that one of the initial reasons that gold goes up is because the currency it is priced in (U.S. dollars) is experiencing devaluation.

In other words, the purchasing power of the U.S. dollar is falling, causing more units of money (quantity) or a higher price, needed to buy gold. This is also known as currency debasement, a.k.a. inflation.

However, there is not a one-to-one causal ratio between currency devaluation and the increase in the price of gold as denominated in that same currency.

For example, the price of gold in U.S. dollar bills has increased from a low of $257 in 2001, to a recent high of $475.50 in 2005. This represents an increase of approximately 86%.

During the same 4-year span of time (2001-2005), the U.S. dollar has fallen approximately 33%. This means the price of gold has gone up 2.6 times more compared to the rate the dollar has gone down. Clearly there is more involved then just the existing devaluation of the reserve currency.

Expectations And Fundamentals

What are involved are the expectations of investors regarding future debasement and loss of purchasing power of the U.S. currency. Markets look ahead to try and discern what is coming – not what has already passed.

It has been said that if the gold bull is for real it is because of its own fundamental reasons and not merely due to the U.S. dollar bear market. So the question naturally arises – what are the fundamental reasons?

Gold is the ultimate form of money; it has been for thousands of years. Why? - Because gold retains its purchasing power better than any form of paper fiat money.

Since 1913, the U.S. dollar has lost 95% of its purchasing power. Total U.S. debt has soared during this same period. Wealth is not determined by the quantity of money that one has, but by the quality (purchasing power) of the money. The quality (purchasing power) is what is of value, the value that money has to be used to exchange for all goods.

Gold is the Sovereign of Sovereigns. Gold is the best store of wealth. This is why gold is in demand – to provide protection from not only past currency devaluation, but also from anticipated future loss of purchasing power as well.

All world currencies are paper fiat currencies; and as such, they are all subject to devaluation and loss of purchasing power.

Because the U.S. dollar is the reserve currency of the world, all other fiat currencies are based in pyramid fashion upon the dollar; resulting in an increased demand for the dollar, and a subsequent increase in supply.

Price inflation has not occurred to any great “reported” degree within the United States due to the fact that the U.S. has exported most of its inflation to other foreign countries.

Foreign currencies that are pyramid on top of the dollar seek out a market large enough to accept their massive flows of supply: viz. the U.S. bond/debt market. This causes asset inflation in the U.S. bond and real estate markets – the Greenspan put if you will.

As we enter stage two of the bull market, it is true that gold will be rising against most major world currencies. The primary reason will be that investor’s demand for gold will have risen – worldwide.

The Driver

The driver of the demand is not only the present loss of purchasing power of their respective currency, but more importantly – the future expected losses as well.

Recall that a dollar bill is not a dollar. The dollar of the Constitution and the Coinage Act, 1792 (The Mint Act) is a weight of silver: 371.25 grains of pure silver – the Silver Dollar.

All paper fiat money is debasing and loosing purchasing power – it can be no other way, such is the way of fiat. Paper fiat debt-money has a built-in self-destruct mechanism.

All foreign currencies have an exchange rate with the U.S. dollar bill. The exchange rate can be widening or narrowing, as in increasing or decreasing. Not only is there an exchange rate between currencies, there is also a rate of change regarding the exchange rates.

They are two different ratio’s, representing two different entities. One represents the rate of exchange; the other represents the rate of change of the rate of exchange.

Recall that gold is priced in U.S. dollar bills. Eventually, as all world currencies lose value, what is important is which currencies are loosing value faster than the dollar is loosing value. Loss of purchasing power is key.

Whichever currencies are loosing value compared to the dollar, it will then require more units of that currency to exchange for one U.S. dollar bill or Federal Reserve Note.

Since gold is priced in dollars, it will take more units of the foreign currency to first exchange for dollars, to then buy gold with. Hence, the price of gold will be rising in that currency.

So, what is occurring, and what is most likely to increase, is a competitive global devaluation currency game of musical chairs. All world currencies are loosing value; the $64 dollar question is: when the music stops – who will be left standing without a chair?

In other words – he who looses the least makes out the best. In a bear market, the one who loses the least wins.

Relativity

All paper fiat debt-money is in a bear market. All paper fiat is loosing value or purchasing power. The currency that looses the least will be performing the best, relative to all other paper fiat currencies.

As long as gold continues to be priced in U.S. Federal Reserve Notes (dollar bills), whichever currency looses the least in comparison to the U.S. currency, that currency will have the lowest appreciation in terms of the price of gold.

The currency that looses the most in comparison to the U.S. currency will have the highest appreciation in terms of the price of gold.

This is why the price of gold in the Australian Dollar and the South African Rand have been under performing compared to other currencies, as both currencies have been appreciating compared to the U.S. dollar. The same is true of the Canadian Dollar, but to a lesser extent.

Gold is the money par excellance. Gold is the supreme store of wealth. Gold is the ultimate store of value. Gold retains its purchasing power throughout the ages. Gold is the Sovereign of Sovereigns. These are the reasons the demand for gold is increasing.

Paper is nothing compared to gold – never has been – never will be. 

So, what is the ultimate driver of all investors worldwide for gold? It is the same as that for U.S. investors – the loss of the purchasing power of paper fiat currency.

Because gold is priced in U.S. dollar bills, gold cannot decouple from the U.S. currency.

All fiat currencies must first be exchanged for U.S. currency before buying gold.

As explained above: the currency that performs the best against the dollar actually performs the least compared to gold, viz. the Australian Dollar and The SA Rand.

To say that a bull market in gold is occurring in other currencies means that the value of these currencies is falling compared to the U.S. dollar; and that all of them, including the U.S. currency, are loosing purchasing power compared to gold as money; some more than others – some less.

Price Fixing Scheme

Recall that the U.S. currency is the reserve currency of the world and that gold is priced in dollars. All other currencies must first be exchanged for U.S. currency before gold is purchased. The reserve currency/gold price fixing scheme masks or lessens the true nature of what is occurring:

Global currency debasement on a massive scale: loss of purchasing power and wealth of unprecedented proportions.

In paper fiat land, what matters the most is whether the U.S. currency is loosing purchasing power faster or slower compared to other currencies.

All currencies are loosing purchasing power compared to gold, but the fact that the U.S. currency is the reserve currency of the world confuses and compounds the issue, which it is meant to do.

It is true that stage two of the gold bull will be powered by an increased demand for gold.

The increased demand will be driven by the expected future loss of purchasing power of any given currency relative to the purchasing power of the U.S. currency, as long as gold is priced in U.S. Federal Reserve Notes.

Price Action

What other markers or indicators might there be that gold is entering stage two of its bull market? Well, when all is said and done, what matters the most is price action. So, let’s look at a chart of the price action of gold to see what it is saying.

The chart below is the price of gold from 1985 to 2005. Notice to the far left of the chart the highest price, which was back in January of 1988, at approximately $500 per ounce.

Now look to the far right of the chart. You can see the price is approaching the $500 level again for the first time in twenty years.

Chart Courtesy of Kitco

Stand back if you will, and take the entire chart/picture in at one time. What does the formation of the entire chart look similar to?

It starts out high on the left, travels down, bottoms out, and then moves sideways, and finally up – approaching nearly the same height as on the left.

This is called a cup formation. One of the most powerful chart formations is known as a cup with a handle. The handle is usually sideways action to the right of the chart (present price action) just before the price breaks out above the rim of the cup – the highest level reached on the chart, i.e. $500 per ounce.

From this long-term chart, it is obvious that the price level of $500 is important if the gold bull is to stay intact. When the price breaks through this level, stage two will definitely be starting.

When $500 becomes support rather than resistance – stage two will be here. 

The Price Level

Below is a chart of gold from 1975 to 2005. Notice the spike high up to $800 per ounce on the left hand side of the chart. Follow the price action down to the first bottom near $300 per ounce. Note where gold then rallied to - $500 per ounce.

From here, it then fell back to the $300 level. It then rallied back up to the same $500 price level. For the next 18 years, the price has never risen back to the $500 level – until now, as we are getting closer by the day.

Chart Courtesy of Kitco

This is why the $500 level is of significance. Once this level is breached and becomes support – stage two is here. Make no doubt about it.

We may very well be on the verge of breaking into stage two – a transition appears most likely from stage one to stage two. However, that doesn’t mean that the coast is all clear, and that an intermediate term correction cannot still take hold of the ship.

Markets do not just move in one direction – even powerful bull markets. There is an ebb and a flow to the markets, between buyers and sellers, as that’s what makes a market – differences of opinion. All moves get corrected, in either direction, sooner or later.

Perhaps we are in stage two – perhaps not. Time will tell as it always does. If you want to know for sure that stage two is occurring, the crossing of the $500 level and the change from that level being resistance to support – will undoubtedly indicate stage two.

Two things are certain: all paper fiat ends with its own self-destruction.

Gold always withstands the test of time.