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Tom Peterson: $500 Gold vs. 1,000 Dow

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At $500, gold still appears undervalued relative to the significant highs since 1972.

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Editor's note: The following commentary is courtesy of Tom Peterson of Bulls Eye Research.

Forty years ago the Dow Industrials reached 1,000 for the first time. It spent the next sixteen years in a broad trading range before it was capable of clearing that hurdle. Gold peaked twenty-five years ago ($850) and for the past twenty-three years it has been capped at $500. In both cases the market went from a point of euphoria and overvaluation to that of undervaluation. At $500, gold still appears undervalued relative to the significant highs since 1972.

For holders of both investments they saw a significant loss of purchasing power during those two decades of consolidation. In the case of the Dow this was partially offset by dividends (3% to 7% from 1966 through 1983). Including un-invested dividends, it took until 1986 to achieve the purchasing power of 1966. Excluding dividends, it took until 1995 for the Dow to make new 'real' highs.

At $500, gold's real price (as deflated by the CPI) is still lower than the peak of every rally since 1972. It would take a nominal gold price of $860 to match the deflated $500 high of 1987 and $1,020 to match the $510 seen in 1982. In order to test the 1980 high of $850 the nominal value would need to trade at $2,177.

When we view the deflated prices of both markets some important correlations become evident. Following the Second World War the Dow staged a rally from 1949 through 1966. The ensuing bear market move into 1982 produced failed rallies (labeled 4, 6 & 8) that tested the same highs seen during the bull market. The gold rally from 1969 to 1980 and ensuing bear market into 2001 saw the same style of rallies that failed at the highs of the 1970's.

The current bull market has produced a peak (point 10) above point 8 and undergone a 23-month consolidation as was experienced in the Dow of 1983-1985.

The depth of the consolidation was more pronounced in the XAU and HUI mining indices, but has now been followed by a breakout of the major resistance lines. Look for resistance in the XAU at 150 and then 200.

The next rally phase in gold can be anticipated to produce major excitement and push technical oscillators into overbought territory for extended periods of time. Upper price targets are the (deflated) highs of 1993 and then 1987. These are labeled points 12 and 14 and due within the next two to three years. Point 12 is equal to a nominal price of $650 and is a likely target for next year. Point 14 should provide a formidable resistance. Interestingly, it will be in the $900 to $950 range in 2007, marginally above the high seen in 1980.

Eventually the price activity will deviate from this model. For now we will view any pullback that holds around $470 as maintaining the integrity of the rally.

Tom Peterson
Bulls Eye Research

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