Gold Analysis

Gold has been on a tear now since the first of August. We closed July 28 at 1164.50 an ounce – which was just above the 200DMS – and it has been a steady climb up since then. Overnight last night we hit 1365.90 – a >$200/oz gain in less than 2 months, (17%). In nominal terms, Gold has been making all time highs since breaking 1250 an ounce on September 1 – a solid month of continuous new highs. In real (inflation-adjusted) terms however, the All-Time high for gold is $2252, so we are a long, long, LONG ways from challenging the all-time high.

So now what?

From a technical standpoint, Gold is certainly overbought. A 20-day/2 Standard Deviation Bollinger Band shows gold trading right at the upper band. In fact, the overnight action blew right out the top of the band. (Today’s retrace brings us back inside the top.) The 50 Day Moving Average is at 1252, which seems a long ways off until you remember we were barely above the 200DMA just 2 short months ago. The bottom side of the BB is 1240 and a swing low at $1238 on September 10. A return to the bottom of the BB would not invalidate the continual upward trend. We’re gonna have to break below the 200DMA to think that the bull run is over. And that’s just the technical aspect. We’ve got the specter of yet more “flooding the market” coming from the Fed.

If (when) the Federal Reserve announces another round of Monetary Inflation – err, I mean – “Quantitative Easing”, Gold will rise even more. The first round of official QE started March 19 2009 when Gold was trading around $900/oz. In round numbers, we are up about $450 an ounce since then, or 50%. That number is a fairly accurate reflection of the quantity of new money the Fed created – $1.2 trillion – which doubled the monetary base. This new round of “stimulus” is expected to be around $1T, which would add 50% to the monetary base. If we get a similar response from gold in the next 18 months, we should see prices another 25% higher by March 2012. That would put us around $1687 – nowhere near the all-time high.

So based on this back-of-the-napkin analysis, we’ve got gold in a channel that goes back 18 months, we’ve got technical support for a continued rise, we have fundamental reasons for a continued rise and we have a price target of almost $1700 within 18 months even if nothing else happens. Gold will undoubtedly correct it’s overbought condition – in fact – we dropped into the 1330s as I was writing this – but the long-term view has an awful lot of room on the top end.

Finally, here’s a chart from Minyanville comparing the relative “bubbleness” of Gold with a number of other financial instruments that truly were bubble in the last decade.

Gold and Stocks – Analysis

Today, gold hit an all-time nominal high of $1310 an ounce. I make a distinction between the nominal high and the inflation-adjusted high. Gold actually hit $1000 an ounce in 1980. Adjusted for inflation – using the Bureau of Labor Statistics Inflation Calculator – the 1980 high expressed in 2010 dollars is a little more than $2600.

If you compare the value of an ounce of gold to the prices of the various stock indexes, this is what we see at close of business in September 2008 and close of business today, two years later:

Closing Price 9/30/2008 Closing Price 9/28/2010 Price Change 2008-2010 2008 Gold Ratio 2010 Gold Ratio Gold Ratio Change
Gold 895.90 1310.00 32%
DOW 10850.66 10858.00 0% 12.11 8.29 68%
SP500 1101.50 1147.00 4% 1.23 0.88 71%
NASDAQ Composite 1596.25 2011.00 21% 1.78 1.54 86%
Russell 2000 658.20 672.00 2% 0.73 0.51 70%

The DOW, the SP500 and the Russell 2000 are all essentially unchanged since the market crash 2 years ago. Only the tech-heavy NASDAQ has advanced: 21% versus a 32% gain for gold. And the NASDAQ number is heavily skewed by the presence of Apple (APPL) which makes up fully 20% of the index.

The Gold Ratios tell the picture another way.

At close of business September 30 2008, it took 12.11 ounces of gold to buy the DOW. Today, it takes only 8.29 ounces. It took 1.23 ounces of gold to buy the SP500, today it takes only .88 ounces. You can see the NASDAQ and Russell 2000 numbers there as well. For the DOW to be as “valuable” today as it was 2 years ago, it would have to be trading at 12.11 times the value of an ounce of gold, or 15864. The SP500 would have to be at 1611, the NASDAQ at 2017 and the Russell 2000 at 668.

The National Bureau of Economic Research tells us that the recession is over, but our dollars are buying a whole lot less than they did two years ago.

9/30/08 2008 Gold Ratio 09/28/10 2010 Gold Ratio Change from 2008
Gold 895.90 1310.00 32%
DOW 10850.66 12.11 10858.00 8.29 0%
SP500 1101.50 1.23 1147.00 0.88 4%
NASDAQ Composite 1596.25 1.78 2011.00 1.54 21%
Russell 2000 658.20 0.73 672.00 0.51 2%