All That Bubbles Is Not Gold

Today let's compare the performance of gold since 2003 to its rally and decline between 1973 and 1983. Gold is advancing now. But the price has not shot up exponentially as it did between late 1978 and 1980, when it quickly reversed and then lost value for the next decade.

On the surface, the situation is different today than it was in 1979. Why?

• Because between 1973 and 1980, the value of the dollar fell 45%. In the seven years since 2003, the dollar has fallen only 3/5 as much, or 27%.
• Inflation soared to 14% in late 1979, and the core inflation rate (food and energy costs excluded) was 8%. Inflation now is about 2.7%, while core inflation is just 1.2%.
• The interest rate on the one-year constant maturity T-bill was 12% in 1979. Today it's just 0.25%.

The differences seem to be significant. However, gold is more dependent on real interest rates -- nominal interest rate minus inflation. There is very little difference between the real interest rate in 1979, which was a negative 1.85% and the real interest rate today, a negative 2.42%. So why is gold moving higher in a slow but steady fashion now, when it was clearly in a bubble in 1979?

In my last post, I explained the difference between fundamental and technical analyses. Clearly, interest rates and inflation are fundamental inputs, and they are very helpful in answering the question posed about the difference between 1979 and the present. But let's look at a strictly technical chart that confirms our observation.

This graphs the difference between 50- and 200-day moving averages for SPDR Gold Shares (NYSE: GLD) since 2004 (blue line). When any stock moves up quickly, its 50-day average moves up faster than its 200-day average, and the difference between them -- the oscillator -- climbs rapidly. When stocks gain too quickly, some traders become nervous. Others become greedy. The trick is in knowing when enough is enough. In the past, gold was about to take a rest when the oscillator reached 20%.

Right now, the oscillator is at 6.3%. It started moving higher in the past week or two. This tells me that it's still possible for gold to continue advancing in the weeks ahead. Note: I did not say this "proves that gold is a bargain and all of us should load up our portfolios." All I'm saying is that gold is not as overpriced as it has been in the past.

One difference between 1979 and the present comes down to the difference between Paul Volker and Ben Bernanke. As the Chairman of the Federal Reserve in the 70s, Volker was committed to bringing down inflation. In early 1980, he started pushing real interest rates from a negative 1.85% in December 1979 to positive 6.4% in 1981. Even more importantly, he warned everyone that he was going to do this. These events lowered inflation and increased the value of the dollar, both of which forced the price of gold lower.

Today, we have a promise interest rates will remain low "for the foreseeable future," and quantitative easing will continue at least until the end of June. However, I would pay very close attention to the current chairman of the Fed, Ben Bernanke, when he speaks later today to see if there are to be changes in policy.

Now that I've explained why gold is not in a bubble, let's look at the corresponding two charts for silver. There is a clear difference between gold and silver, with silver closely recreating its path of 1979 just before the bottom fell out. I would be much more careful with my silver investments right now than with my gold investments.

Here is the same moving average oscillator applied to the iShares Silver Trust (NYSE: SLV), which has already reached a new high at 34.4%. It reached that same high before losing more than 30% of its value between May 11 and June 20, 2006. There may still be some upside left in silver, but be prepared to beat a hasty retreat.

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