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What Gold's Rally Is Telling Us

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One must look at historical action to determine where we go from here.

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I was wrong about gold breaking out last month. See Gold to Break $1,000 This August . Turns out the yellow metal didn't break out over $1000 until eight days later (i.e. today).

Now that we've gotten that out of the way, what now? A vast amount of ink has been spilled over the past several days by analysts trying to divine what gold's rally "means." The most popular opinion appears to be that it's just random noise and means nothing. However, let's go to the scoreboard and see if that view is generally correct.

First, let's start with a little history. Gold peaked at $850 in 1980 after its 2400% romp in the 1970s and then cratered. At the time, inflation was the big concern, and many claimed gold's decline was just a bubble collapsing and that inflation would be a problem forever going forward. Turned out that 1980 was the peak in long-term interest rates and most commodity prices per the CCI equal-weighted commodity index. Gold went nowhere but down from 1980 to 2001, just as the CCI and inflation did. So in a very real sense, gold told you quite accurately that inflation was falling and would keep falling.


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Gold bottomed in 1999 with the announcement of the Washington agreement and then retested that low in early 2001, where it then began to rally and has posted a positive annual return every year since. When gold turned up in 2001, once again the herd claimed it was just noise (most didn't even notice it to be honest) and that deflation emanating from the collapse of the tech stock bubble was the big concern.

Interestingly, the CCI kept going lower and seemed to "confirm" this theory until it finally bottomed in late 2001 (oil hit $20). The dollar index then topped out in early 2002 and began a secular bear market that we're still in the grips of today. A few years later, oil hit new all-time highs as did every other commodity on the planet (see the CCI), and those prices would continue higher for the next six years. Meanwhile, the dollar also made new all-time lows against many currencies during the same period.

So did gold tell us anything when it turned down meaningfully in 1980? Did it tell us anything when it turned up in 2001 despite not being accompanied by a strong rise in the CCI or any other commodity price? Or was it just all "noise" and random chance that investors were "dumb enough" to sell gold at certain times and buy it at others?

If your answer is "yes, it apparently did tell us something," then you know that it's telling us something again today, just as its $50 rally last week told us the dollar would be making new lows soon and has now done so today. As for what that "something" is, time will tell, but given that investors only typically buy gold for a couple of reasons -- (1) fear of inflation or (2) fear of currency depreciation, which leads to number 1 -- it's probably telling us something about inflation going forward.

Hint: It's headed higher, and that's the lens that one should look through when making any investment decisions.

Editor's Note: For more on where the metal is headed, see Will September Patterns Hold for Gold?
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Position in gold, gold stocks

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