How to Pass the Gold Bull Market Test

Last week in the financial markets was unsatisfactory. No clear trend announced itself. The Dow should have gone down. Gold should have gone down too. But they diddled around…and on Friday, both seemed to be back in counter-trends, moving against the direction we think they OUGHT to go.

As for stocks, everything we’ve found out about the economy since 2007 suggests that our Great Correction view is right. This market aims to correct something; we just don’t know what.

Whatever it is doing, it is NOT responding in a typical post-war recovery manner. The feds have pumped trillions into the economy. They’ve gotten nothing for it except more debt.

Which was just what they DIDN’T need. The real problem — or at least the most obvious problem — is too much debt. Adding more, the feds aren’t doing anyone any favors, except the banks themselves.

It’s just a matter of time before investors realize that stocks are not worth prices in the top of the range. In a correction, they’re worth prices in the bottom of the range. And eventually they should fall to the very bottom of the range…where you can buy the entire Dow group for only one ounce of gold.

But that is still a long way away. And in the meantime, what about gold?

Well, bull markets — like lovers — always test their admirers. Remember the stock market crash of ’87? Stocks had been rising for five years. Then came Black Monday. The Dow lost 508 points in a single day. By the end of October, the Dow had lost nearly a quarter of its value.

Naturally, a group of 30 prominent economists got together and made fools of themselves. They announced that “the next few years could be the most troubling since the ’30s.”

And naturally, faint-hearted investors failed the test. They left the stock market — fearful that another Great Depression…or maybe a repeat of a ’70s-style slump…was coming.

When the crash was over, the Dow stood at only 1,738. Investors who had bought stocks 5 years previously were still up 70%. And the bull market had scarcely even begun. Instead of going down, stocks rallied…and never looked back. The Dow rose to over 11,000 in January 2000 — the most spectacular stock market success story in history. The economy, too, roared ahead.

Stock market investors may anticipate a replay of that post-crash world. They’ll be disappointed. Our world today has nothing in common with 1987. To make a long story short, then we were coming out of a long bear market. Now, we are coming out of a long bull market. Then, we were at the beginning of a long bull market in bonds. Now, we must be near the end of it. And then, households and the government could still borrow in order to keep spending. Now, the private sector is played out; government continues to borrow at record levels….but that’s a different story.

The last bull market in gold tested its admirers too. The price had risen from $41 an ounce — when Richard Nixon cut the last link to the dollar in August ’71 — to nearly $200 in 1975. Thereupon began a sell-off, in which gold lost 40% of its value…coming to rest around $100.

Weak sisters, johnnies-come-lately, and camp followers got shaken out. They gave up on gold at $100 an ounce…before it began its real push to the top, which eventually put the price over $800.

Our guess is that this bull market in gold will test its admirers too. So far, it has closed every year higher than the last. Making money was easy. Our faith was never seriously challenged. Even now, the price of gold is close to $1,800. It’s still ahead for the year. It’s still in its upward channel, well above its 160-day moving average.

Gold is still a winner. Gold investors are still winners. There is no reason to doubt that they will be winners this year…just like they have been every year this century.

But that’s not how it works. Not usually. The gold market needs to make its admirers feel like losers. It needs to cause them to wonder…and question their own faith and judgment.

How so? By letting the price fall to…$1,200…or even $1,000. Then, we will be ready for the third and final stage of this great bull market.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning