Don’t Believe Today’s Gold Hype: Gold is NOT Going Parabolic Any Time Soon!

For a variety of reasons I am almost certain our on-going gold bull is nowhere close to Stage Three yet. Gold isn’t going parabolic anytime soon, so if you are planning on retiring in 2010 from this years’ gold gains I suspect you’ll be sorely disappointed. www.zealllc.com; By: Adam Hamilton; Words: 1616

In further edited excerpts from the original article* Hamilton goes on to say:

[Let’s review the 3 stages in the price escalation of gold and see where we are at and why.]

Stage One
Stage One stealthily emerges out of a secular-bear low when everyone loathes gold. In response to a devaluation in the dominant currency it quietly begins to creep higher. Stage One in today’s bull began in April 2001 and ran for over 4 years. It was marked by modest yet consistent gains in gold.

Stage Two
Once global investors figure out that gold is moving up on its own supply-and-demand-driven fundamental merits, Stage Two dawns. More and more investors “discover” gold and deploy increasing amounts of capital in it. Today’s bull transitioned into Stage Two shortly after the euro gold broke decisively above €350 in June 2005.

A gold breakout in a secondary currency may not sound like much but it was a game-changing event that finally convinced global investors that the young gold bull was the real deal. Before that, to everyone but Americans (who see gold through a dollar-centric lens), gold’s strength was perceived as nothing more than the other side of the dollar-bear coin. They thought gold was only rising because the dollar was falling.

Stage Two can run for many years and is the longest phase of a gold bull’s lifespan by far. It persists for so long due to the way bull markets affect investor psychology. Early on in a bull, few investors believe it is real so little capital chases it but as a price powers higher, more and more investors start to believe which gradually yet relentlessly increases capital inflows. This drives prices even higher, forming a virtuous circle that attracts in even more investors. All this takes a long time.

Stage Three
Some bulls end at Stage Two but the truly great ones ultimately transition into Stage Three. Lasting less than a year, this is the terminal phase of a secular bull. After professional investors are already fully deployed in gold, the general public soon grows enamored with it and wants in at any price. The resulting massive influx of capital drives a popular speculative mania and its resulting parabolic blowoff. There is nothing else like a Stage Three speculative mania. They are impossible to miss.

So much capital flooding in so fast drives vertical price gains into a parabolic ascent. The last Stage Three gold parabola unfolded over several months climaxing in January 1980 at $850 (just under $2400 in today’s dollars). That event was blisteringly fast – gone in the blink of an eye. Over the final 10 trading days leading to the end of its bull, gold soared 34.1%. Over the final 20 trading days, it was up 80.3% and over the final 30, just 6 short weeks, it nearly doubled with a 95.9% gain!

Where Are We Today?
We are obviously a far cry from the last Stage Three climax’s 34%, 80%, and 96% so there is no doubt at all that we have not witnessed anything Stage-Three-like in the recent exceptional gold strength.

Even though gold clearly hasn’t entered Stage Three, could it be on the cusp of rocketing parabolic as many analysts assert today? The only honest answer is sure, of course it could. Anything can happen in the markets, and none of us mere mortals can see the future.

Nevertheless, for a variety of reasons I am almost certain our current gold bull is nowhere close to Stage Three yet. Gold isn’t going parabolic anytime soon, so if you are planning on retiring in 2010 from this years’ gold gains I suspect you’ll be sorely disappointed. As any student of the markets who has studied history and psychology can tell you, today’s conditions are all wrong for Stage Three dawning.

Gold is Still Grossly Underinvested
Think of bull markets as popularity contests. The higher prices go, the more popular those assets get and the more popular the bull gets, the more investors deploy more capital to chase the gains. Stage Two chronicles this journey from relative obscurity among investors to widespread adoration. This long stage lasts until professional investors are fully invested. Has this happened yet with gold? No way.

There are many ways to illustrate this truth. Despite the GLD gold ETF’s huge success in enticing stock-market capital into gold, stock investors are still incredibly underinvested. Stock investors are hardly fully invested in gold yet with a current allocation of under a half percent. At today’s levels they have barely even started deploying in gold! I don’t know if “fully invested” in this bull will ultimately cap out at 5%, 10%, or even 20%, but it is certainly not going to be 0.4%.

Central banks are also big gold investors, and the growing Eastern central banks (CBs) are woefully underinvested in gold. The top 5 Asian CBs in terms of gold holdings now have an average of just 3.5% of their foreign-exchange reserves in gold. Is this fully-invested? Certainly not. For comparison the top 5 Western CBs have an average of 64.8% of their forex reserves in gold bullion today! Given the Eastern CBs’ undiversified heavy exposure to the ailing US dollar it is impossible to imagine them not wanting to sell more dollars and buy more gold. Like American stock investors, Asia has barely even started investing in gold.

How can Stage Two transition into Stage Three when the only investors with heavy gold exposure today remain a relatively small fraction of contrarians? It can’t. Stage Two will not reach maturity until large professional investors all over the world have great-enough allocations in gold to consider themselves fully invested. I suspect it will be many years yet before professionals reach this milestone.

No Love Affair Yet With Gold
Simply having professionals fully invested in gold is not enough to spark Stage Three on its own. Even more important is popular psychology. For a Stage Three parabola to ignite, ordinary folks who aren’t even serious investors have to utterly fall in love with gold. We need to see a popular gold rush flare up across the vast majority of the populace that doesn’t even follow the financial markets on a regular basis.

As the NASDAQ bubble proved, the seeds for a popular speculative mania are not sown overnight (or even in a few months). It really takes years to prepare the soil of popular psychology for a mania. While gold’s favorable exposure in the financial media has grown considerably over the past few months, all this coverage is just a drop in the bucket compared to what is necessary to enthrall the people. If you ask the average person you see anywhere whether they are excited about gold investing, the vast majority will give you a dumb stare.

While today’s hardcore investors and speculators who religiously follow the markets and financial media may feel like gold is becoming popular, our perceptions are skewed. Sure, gold is more popular in this specialized realm than ever before in this bull but to an average casual investor who doesn’t follow these things, at best all they’ve seen is some sporadic gold-coin and scrap-gold commercials on mainstream TV. Popular psychology among normal folks has barely even started considering gold, let alone getting excited about it.

Without people who’ve never been gold investors rushing in to become new gold investors solely to plow their lives’ savings into gold, we won’t see a Stage Three parabolic blowoff. They are called popular speculative manias for a reason. They extend far beyond contrarians, professional investors, and even mainstream investors to a general populace that isn’t yet in the gold market in any meaningful way.

Groundwork Not Yet Ready for Stage Three
Professionals are not fully invested in gold and mainstream casual investors still largely aren’t paying attention to it so neither the capital foundation nor sentiment foundation necessary to undergird a Stage Three superspike have been laid yet.

Since Stage Three bull-ending parabolas are such exceedingly rare events, once every third of a century or so on average, the probabilities wildly favor any sharp move higher merely representing a short-term overbought condition within a bull instead of the precursor to the end of that bull. When you consider that Stage Two hasn’t matured yet and the groundwork for a popular mania hasn’t been laid yet, it is almost certain that gold’s big gains today also merely represent overboughtness.

A key peculiar tendency in overbought times is the widespread attempts to justify further technical gains with fundamental arguments. You’ve heard them; gold will continue higher because the dollar is weak; central banks are buying; mining it is getting harder; etc. All these things are certainly true, and bullish, but realize gold’s fundamentals were just as bullish in past overbought times yet the metal still corrected hard. Long-term fundamentals never override necessary rebalancings of extreme short-term sentiment!

The bottom line is gold is not going parabolic despite all the hype today. Only a popular speculative mania can drive a bull-ending vertical superspike, and we are still years away from one. While gold has indeed rallied far and fast in the past few months it hardly looks like a bull-ending omen. It merely looks like a mature upleg taking a breather so be wary of all the gold hype today.

*http://www.zealllc.com/2009/goldpara.htm

Editor’s Note: The above article consists of edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered. (editor@MunKnee.com)

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