Guest Commentary - Secular Bull - Focused Investments

Gold, Silver, and Stock Bears

Contrarian precious-metals enthusiasts find themselves in a difficult position today psychologically. On one hand, global precious-metals fundamentals remain incredibly bullish with demand growth far outpacing supply growth. But on the other hand, what if the precious metals are sucked into the black hole of another worldwide stock-market selloff?

How can investors and speculators weigh the relative risks of a precious-metals bull powering higher for fundamental reasons versus the PMs plummeting for sentimental reasons? Stated in more direct terms, will precious metals and PM stocks be a good place to park capital if the general stock markets are entering a bear?

The latter stock-bear-market concern is certainly very valid. Today’s US stock markets are near the same point in time in their current Long Valuation Wave cycle where a particularly brutal cyclical bear market erupted about this time in the last valuation wave a third of a century ago. The comparison between the stock action leading up to this point in the last few years and the corresponding point of the early 1970s is disturbingly uncanny.

Because the financial markets are ultimately driven by the competing human emotions of greed and fear, and because these emotions never change regardless of era or technology, examining the past is a great way to increase insight into probable market behavior in the present. If we are in fact near the same point in our current cycle that last hit in the mid-1970s, then taking a look at those years should offer insight into the present.

In particular the behavior of gold and silver during the infamous 1973 to 1974 stock bear is very intriguing, because the primary driver of PM stocks is the price action in gold and silver. If PM prices are rising on balance, so will PM stock prices. This is due to the tremendous profits leverage that gold and silver miners have to the underlying prices of gold and silver.

Time and time again, in past and present bear markets, PM stocks have defied the persistent general-stock weakness to rise with gold and silver. In fact, back from 2000 to 2002 the primary reason most contrarians flocked to the young PM-stock bull in the first place was to find refuge from the accelerating general-stock bear. Believe it or not, only five years ago PM-stock investors used to wish for general-stock bear markets!

But I digress. PM stocks follow PM prices, their primary driver. So how did gold and silver fare in the wicked 1973 to 1974 general-stock-market bear, which was the spiritual ancestor of where we are today? The answer is phenomenally well! In fact, I can’t imagine any better place to be invested than in the precious metals during those years.

My charts this week superimpose gold and silver, and their various technicals, over the Dow 30 in 1973 and 1974. In the 1970s the S&P 500 wasn’t very popular yet even among professionals so the flagship Dow 30 dominated headlines as the stock-market measuring rod of choice. Like today, back then the gold and silver bulls remained young and faced a towering wall of worries and endless skepticism.

Before we delve in though, one attribute of a stock bear erupting at this stage in a valuation wave cycle is crucial to understand. These stock bears are slow and gradual, grinding lower on balance for years. They could not be farther from a crash. On the red Dow 30 lines below, note that the US stocks really only fell steeply during 2 months out of 24. The rest of the time was largely a measured slow boil that gave bulls just enough hope to stay fully invested until the bottom.

In a study I did a couple months ago on our previous bear, 2000 to 2002, I found that PM stocks were largely immune to stock-market selloffs unless they got really steep. And even then, as soon as the short-lived fear-laden sentiment storm blew past, the PM stocks resumed their march higher on balance.

So if PM stocks only tend to get caught up in the bear-market hype at the darkest moments, but those are few and far between in a bear at this stage in the valuation waves, then the probability of general fear spilling over into PM stocks and blasting them out of the water is vanishingly low. Precious metals, and their miners, are refuges of choice during long slow bears and they tend to thrive as alternative investments in such times.

So while the Dow 30 shed 45% in 1973 and 1974, an enormous and devastating loss, did gold plunge in sympathy like it did for a few days five weeks ago in the latest mini-panic? Heck no! Gold soared in a majestic and powerful bull market and more than tripled while the general stocks swooned. The curious popular belief today that precious metals will suffer during a general-stock bear is a total myth, pure fabrication.

This red Dow 30 line from 1973 to 1974 represents a very typical cyclical bear market. Although there are some periodic sharp moves down, numbered above, most of the time prices just kind of drift lower. This gradual decline is a diabolically exquisite example of bear-market psychological warfare. Without many sharp plunges lower to spawn intense fear, most investors are tricked into holding on as the bear slowly feasts on their capital.

But the blue gold line shows how the Ancient Metal of Kings held up in such a dangerous general-market environment. Gold actually climbed up in a beautiful and powerful uptrend, carving higher highs and higher lows in a well-defined channel. The longer the stock bear lingered, the more investors grew interested in gold as an alternative investment and safe haven and the higher they drove its price.

Now overall, gold rose 205% at best within these two years. But even if the gold prices on the very days the general-stock bear began and ended are considered, gold was still up 177% in less than two years during one of the worst bear markets in modern history. Stock bear markets don’t starve the gold price as is widely believed today, they feed it!

Gold’s uptrend in 1973 and 1974 was nice and linear but it wasn’t continuous. As in all bulls, gold would rise in an upleg and then retreat in a necessary and healthy correction to rebalance sentiment. Bull markets move two steps forward followed by one step back, it was always thus. This is critical to realize because there are times within stock bears when gold seems to be unduly influenced by stock declines.

For example, in late February and early March of this year gold swooned with general stocks and seemed to be trapped within their gravity well. There were times like this three decades ago too. Note that gold corrected from June 1973 to November 1973, seemingly following the Dow 30. Gold was in another correction from April 1974 to July 1974, drifting lower in correlation with general stocks.

Now a stock bear trends down, no big surprise here. And a correction within a bull trends down too. So when one price is drifting lower in a bear and another is correcting, they are moving in the same direction. This is correlation but not necessarily causation. Gold wasn’t drifting lower in these corrections because its fundamentals were bearish, but because it needed to bleed off some temporarily overbought sentiment from its previous upleg.

I am belaboring this point because countless folks today will look at the stock markets and gold over some ridiculously small period of time, like one week, and see that they have both moved lower. Then they will take this small sample and extrapolate it out into infinity. “Well, gold sold off with the stocks last week, so therefore gold is doomed in a general-stock bear. Woe is me!”

Since myopic observations lead to faulty views and bad trades, expanding one’s perspective corrects these deadly errors. Note in the chart above that there were also plenty of times, during the gold uplegs, when the metal climbed sharply higher despite a declining stock market. From January 1973 to June 1973, for example, gold soared 97% while the Dow 30 fell 13%. From November 1973 to April 1974, gold blasted another 99% higher while the Dow 30 fell one-half percent.

So when you are analyzing gold’s behavior relative to the stock markets in the months ahead, especially if a new cyclical bear has indeed begun, please realize that it is foolish to extrapolate too small a sample out into infinity. Gold and the stocks sold off sharply together for one day? Who cares. One week? Yawn. One month? Still too short of time to draw a valid conclusion. Trends carved over years matter, not mere months.

As traders one of the greatest risks we face is succumbing to the tyranny of the present. Whatever is on our minds right now tends to expand and gnaw on our psyches and fill our thoughts until we can consider nothing else. In the markets, the way this dysfunctional trait manifests itself is by assuming the present conditions are going to last forever. Nothing could be farther from the truth.

Gold can fall with stocks from time to time, no doubt. But if the metal’s underlying global supply and demand fundamentals remain bullish it will rise on balance regardless of whether the general stock markets are rising, falling, or trading sideways. Over time gold marches to the beat of its own drummer and it will climb higher as long as global mined-supply growth continues to lag global investment-demand growth.

Interestingly the biggest risk for gold getting caught up in general-stock selling hype happens when the general stocks fall the fastest. Out of the 24 months or so of the 1973 to 1974 stock bear, there were only 2 where the Dow 30 really slid sharply and mightily stoked the fires of fear. While the icy fingers of this fear squeezed investors’ hearts in November 1973 and August 1974, how did gold fare?

During both plunging months, gold sold off with the stock markets. Yes, the metal still can get caught up in a temporary panic just like it did five weeks ago. But the key thing to note is that gold’s declines during these two worst months of the 1973 to 1974 stock bear really weren’t all that exciting. In November 1973, the Dow 30 fell 14% but gold only bled 8% at worst then rapidly recovered. In August 1974, the Dow 30 fell 10% while gold was off just 3% at worst.

And if you examine these two months visually in this chart, it is readily apparent that gold soon recovered and started marching higher. In the first case the stock markets stabilized too but in the second they continued lower. So sure, gold can get caught up in mainstream bearishness for a spell, but it never lasts as long as gold’s fundamentals remain bullish. We will have to weather general-stock-induced gold selloffs from time to time, but they ought to be pretty mild when considered within strategic context.

So based on gold’s performance the last time general stocks were at this particular point in their long valuation cycle, I suspect we have nothing to fear this time around. Gold investment demand is rising worldwide, yet mined supply is actually declining in the top-producing countries due to low-grading and existing mines being depleted. It can take a decade for a new deposit to be brought into commercial production, so gold production responds very slowly to higher prices signaling producers to mine more. This is why secular gold bulls last so long and gold prices climb so high.

Silver’s behavior during the 1973 and 1974 stock bear is similar to gold’s in some regards, and different in others. With a vastly smaller market than gold’s, silver is much more volatile and moves much more rapidly. Speculators can drive blistering fast rises in silver and devastating plunges depending on whether their capital is flowing in or out. Silver has always been a speculators’ playground and never for the faint of heart.

Silver’s 1973 and 1974 uptrend is not as clean as gold’s, but it isn’t bad either. Silver had a common support line throughout this entire stock bear that was relentlessly rising. To the very days when the stock bear began and ended, silver was up 106%. This is really pretty darned good when general stocks’ prices have nearly been cut in half. Only a fool would pass up this kind of return.

But silver is a speculator’s metal, and it tends to explode vertically from time to time when speculators flock to it. Just such a surge happened in January and February 1974. During those two months alone, silver rocketed 104% higher at best! At the top of this textbook parabola, silver was up a whopping 241% from its lows of early 1973. By this time the Dow 30 had already ground 18% lower.

This silver parabola deep in the bowels of a wicked stock bear is very illuminating on multiple fronts. First, it looks remarkably like the silver parabola of early 2006 as well as the one before that in early 2004. Extreme silver volatility is nothing new and should be expected. Silver traders, especially the leveraged ones, have to be psychologically and financially ready for blistering moves higher or lower at any time.

Second, even though silver had a parabola its secular bull was not over in early 1974 by any means. It would ultimately climb to $48 in January 1980, roughly 10x above where it ended in 1974! While parabolas can be spawned by excessively greedy sentiment within secular bulls, their aftermaths are relatively mild and not bull-ending as long as the fundamentals still support the bull after the parabola has collapsed.

In 1974 this was certainly the case, silver ground sideways in a high consolidation in a range roughly twice as high as it traded in during 1973. So even with this general downward trend in 1974 as the markets got used to the new higher silver prices initially driven by the parabola, investors and traders who bought silver in early 1973 when the stock bear started lower still made out like bandits even after silver corrected.

While gold ran up in an orderly fashion while general stocks burned, silver’s gains were much wilder and more exaggerated, and its corrections as well. But on balance both metals performed extremely well during one of the worst stock-market bears in modern history. Investors and speculators alike could have doubled or tripled their capital in precious metals at the same time the stock markets were cut in half. They could then buy back between 4x to 6x more blue-chip shares at the bottom than they would have commanded if they had instead rode the stock bear down like a mainstreamer.

Now in an analysis like this, the first objection that arises is “this time it is different”, the five most dangerous words in investing according to Warren Buffett. Yes, many aspects of today are different from the 1970s and I am well aware of that. But many aspects are the same too, such as the Long Valuation Wave contraction now underway as well as the secular commodities bull driven by global fundamentals. And greed and fear never change.

I am not arguing that the gold and silver action will play out over the next two years, which will probably be bearish in the US stock markets, exactly like in 1973 and 1974. History never repeats exactly, but it does rhyme. Whenever general stocks are relentlessly grinding lower, investors seek alternative investments and places of refuge in which to protect and grow their capital. Gold and silver, after six millennia of performing these crucial functions beautifully, are always near the top of the list.

Gold and silver tend to thrive the most when mainstream investors focus their attention on them, and these mainstream investors usually only look to the precious metals when their beloved general stocks are not performing well. And precious-metals prices drive the profits and hence ultimately the stock prices of PM miners. So when gold and silver are driven higher as alternative investments during general-stock bears, PM stocks follow their metals higher on balance.

If a new stock bear is really dawning, gold, silver, and PM stocks are an ideal place to ride out the bear. While the metals are easy to buy at your local coin shop, in the futures markets, or via the new ETFs, stock picking is far more challenging. We spend a great deal of our time at Zeal researching countless stocks to find our favorites and we just published a new report on our 20 favorite silver stocks. If you want the fundamental lowdown on some of the most promising silver stocks in the world today, please buy our report.

We also publish an acclaimed monthly newsletter where we buy and sell elite precious-metals stocks as technical market timing allows. We weathered the last general-stock bear from 2000 to 2002 with fantastic realized profits by harboring in the PMs and PM stocks and we are going to do it again in this probable new cyclical bear. Please subscribe today so you don’t miss our coming high-potential-for-success trades.

The bottom line is gold and silver tend to thrive in stock bears, not wilt. While there are certainly short periods of time, usually weeks at most, where the precious metals can be sucked into a particularly scary stock selloff, overall they rise on balance throughout general-stock bears. While the stock markets are burning, precious metals and PM stocks become some of the best places available to protect and multiply capital.

Although many popular theses today claim that the precious metals and especially PM stocks are doomed in a new stock bear, if you dig deep to their cores you will find they are all based on very small sample sizes. Yet prudent traders model probabilities off of broad strategic trends lasting years, not isolated multi-week spells with little if any long-term relevance. And in this context, stock bears have been no threat to PMs historically.

Adam Hamilton, CPA

April 8, 2007

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