Last week’s WrapUp put forth the case for stagflation and used the U.S. Misery Index (unemployment rate + inflation rate, %) as a measure of stagflation. The inflation rate used in last week’s Misery Index was the headline inflation rate reported by the BLS, which is severely understated due to the government’s current measuring method (click here to read why). However, using John Williams’ data from ShadowStats.com, who recalculates the CPI using the methodologies used in 1980, allows an apples-to-apples comparison of the current time period with that seen in the 1970s.
The 1970s were characterized by high unemployment and high inflation that contributed to gold’s explosive move during that period. Whenever inflation and/or the unemployment rate came down (Misery Index fell), gold sold off.
Figure 1
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Source: Bloomberg, Shadow Government Statistics
Another way to look at gold and the economy in the 1970s is how it performed relative to real interest rates (10-Yr UST less inflation rate, as measured by John Williams). Whenever real interest rates turned down, gold advanced sharply with tops in real interest rates corresponding with bottoms in gold and vice-versa. Gold’s biggest moves were seen when the real interest rates turned negative in 1973 and 1978.
Figure 2
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Source: Bloomberg, Shadow Government Statistics
So what has been the situation with gold and stagflation in the current decade? The answer lies below and it’s not surprising to see why gold has advanced so strongly when looking at the U.S. Misery Index. The index has advanced into the high teens and has displayed a relatively consistent upward trend. Thus, it is unlike the 1970s that saw two advances in the Misery Index instead of a constant upwardly trending line.
The consistently upward trending line in the U.S. Misery Index helps to explain gold’s persistent move northward without a real serious correction as it did in the middle of the 1970s. (One note to point out is that, like inflation, the unemployment rate is likely understated due to the number of self-employed housing-related contractors and mortgage brokers who didn’t pay into unemployment insurance, and thus will not show up in government statistics.)
Figure 3
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Source: Bloomberg, Shadow Government Statistics
Also corroborating the trend in the U.S. Misery Index and gold this decade is the trend in real interest rates, which has been consistently downward trending as opposed to the experience in the 1970s that saw two peaks and two troughs. Note that in both Figures 3 & 4 that the explosive move northward in the U.S. Misery Index and a recent plunge in real interest rates have corresponded with gold’s recent explosion to an all-time high near 0/oz.
Figure 4
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Source: Bloomberg, Shadow Government Statistics
There are several reasons why the current bull market in gold may surpass what was seen in the 1970s. For one, the trends in the U.S. Misery Index and real interest rates have been moving relatively in one uninterrupted direction. Additionally, gold has remained resilient despite conditions that should have led to a sharp correction. For example, the U.S. Misery Index did witness a sizeable correction in 2006 with real interest rates also spiking northward, yet on a monthly closing basis, gold only experienced an 11.7% correction while the 1975 sell-off saw gold fall 39%.
Gold has thus far displayed greater strength than it did in the 1970s and has seen no real sell-off when using the monthly closing price. While 1975 marked a bear market in gold, 2006 can only be classified as a consolidation where every dip in gold attracts more and more buyers as governments from around the globe diversify their reserves out of the dollar and into gold. The greatest returns for gold may still lie ahead as the current bull market has still not seen the blow-off phase that the later part of the 1970s witnessed. Gold may potentially rise near ,000/oz if it experiences a similar price increase as it did in the 1970s as seen in the figure below when overlapping the two bull markets.
Figure 5
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Source: Bloomberg
The true mania stage in gold will be characterized by the public piling in; where gold will become common dinner conversation as technology stocks were in the late 1990s. We are not there yet as gold, despite moving to an all-time high and nearing 0/oz, is still not creating the same type of buzz as words like “recession” and “subprime” are currently. This can be seen below when looking at the number of times “gold” is entered into Google’s search engine or appears in newspaper articles relative to other buzz words.
Figure 6. Google Trend History: “Gold”
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Source: Google Trends
Figure 7. Google Trend History: “Subprime”
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Source: Google Trends
Figure 7. Google Trend History: “Bear Market”
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Source: Google Trends
Figure 7. Google Trend History: “CDOs”
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Source: Google Trends
Despite gold advancing nearly 300% higher today than it was in early 2003, its search and news reference volume has remained relatively flat over the past four years. This indicates, despite financial pundits calling gold a “bubble” or a “mania,” that the greatest returns for gold, the true mania stage, may still lay ahead.
Today's Market
Today was another day in the markets characterized by emotion price swings and volatility. The Dow Jones Industrial Average underwent a 631.04 price swing from the lows registered near mid-day to the close, with the Dow nearly up 300 points on the day. The markets started off sharply lower after the release of a disappointing earnings report and outlook from Apple Computer after yesterday’s close that affected the markets in early trading.
The markets staged an impressive rally on news that the New York regulators and banks met to discuss plans for raising new capital for the bond insurers. The news catapulted the markets upwards and sent bond insurers MBIA (MBIA) and Ambac (ABK) up 32.56% and 71.89% respectively.
The Dow Jones Industrial Average rose 298.98 points to close at 12270.17 (+2.50%), the S&P 500 gained 28.10 points to close at 1338.60 (+2.14%), and the NASDAQ tacked on 24.14 points to close at 2316.41 (+1.05%).
Treasuries rose with the yield on the 10-year note falling 5.8 basis points to close at 3.426%. The dollar index fell on the day, down 0.05 points to close at 76.29 (-0.07%). Advancing issues represented 70% and 58% for the NYSE and NASDAQ respectively.
