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AUGUST 26, 2006
In the last newsletter we discussed how investments generally go through 3 stages during their bull markets. If you have not had a chance to read the article or would like to review it please click here: Three Stages of a Bull Market, Part I.
As you think about these phases consider the geometric shape of a parabola. Phase 1 is the relatively flat sloped portion, Phase 2 is where the slope starts to arc higher and Phase 3 is where the angle becomes very steep.
To get a historical perspective on what a precious metals bull market looks like let's take a look at the last one. From 1970 to 1980 the gold market went from $35 to $850 a 2,350% gain and during this same period silver rose from $1.30 to $50 a 3,750% gain. Look at the following chart and note two things. One, overall the shape of gold's ascent is very much like a parabola. Two, there were several hair-raising exceptions where gold diverged from its course for a period of time scaring many investors out of the market only to later resume the parabolic shape.
A saying of successful investors is "A bull market's job is to throw you off and your job is to hang on." This is another way of saying that as soon as you start feeling good about your investment the market will turn the other way and make you doubt your decision, trying to cause you to sell. I would add that this saying applies during phase 1 and 2 because this is when it does not feel good to be an investor in that particular sector. You will be told by the media and your friends that investing in that sector is not a good idea (the list of reasons will be long and told with much authority). Keep in mind that these 3 phases and the sentiments attached to them apply to all kinds of investment arenas. I can personally testify to this fact regarding the real estate sector during phase 1 and 2. It was a lonely place to be with most people thinking that being in the business was not a very distinguished way to make a buck. Now who are the celebrities on TV, and who draw 40,000 people to their investing conferences? Donald Trump and the other real estate gurus.
During phase 3 is where I feel this bull market saying does not apply. It actually will seem like a great idea to be in this market but phase 3 is where you need to start devising an exit strategy. However it will be difficult to even consider getting out of the market because finally it will feel good to be in the market. Your friends and family will congratulate you for your foresight and pat you on the back as they now see the light and rush to get into the market. However, precisely when you feel like standing up, telling your great story of triumph and taking your bows in the limelight is when you should be figuring out if you really are willing to sit tight through the down side of the market. If you prefer to see your assets grow rather than shrink as the market shifts gears your next question should be figuring out what your next sector should be and how to efficiently get out of the current one and into the new one. In other words when riding the bull becomes comfortable you need to make sure you are on the right bull.
This phase started in 2001 with the bottoming out of the last gold bear market and, as Mike Maloney points out, ended in June of 2005. No one in the public seemed to notice, let alone care. Only people actively looking for this rise paid any attention. Mike also points out an interesting aspect of phase 1. Even though gold and silver had been rising in U.S. dollars it was not rising nearly as quickly in terms of other currencies, notably the Euro. If you were a European investor between 2001 and June of 2005 you would have noticed that gold kept rising to 350 euros but would 'bump its head' and quit rising. During this same time gold measured in US dollars rose from $256 to $440 (a 72% increase)". In other words gold and silver had been rising basically because the US dollar had been dropping. This demonstrated how the precious metals are "the-anti dollar" investment but for the whole world to become interested in the precious metals and push us into phase 2 of this bull market the metals had to take on a life of their own and rise against all major currencies.
Here is a five year chart of gold in U.S. dollars
But take a look at this five year chart of gold denominated in euros.
This phase started in June of 2005 when gold broke out against all major currencies. Even though smart money from Europe and Asia had already been buying, the average European and Asian investor did not see the gold and silver prices increase appreciably in euros and yen so they did not get very interested. This changed when the precious metals started increasing in terms of their local currencies and was one of the factors that led to the acceleration of precious metals prices so far in 2006. Along with the new strength of the precious metals markets has come the expected volatility of the hedge funds jumping in and out trying to time the market. However the long term trend remains fully intact. The market continues to act in a classic fashion. The gold and silver markets race forward then fall back to their 200 day moving averages only to repeat the process over again. As this market progresses we expect the metals to fall back to their 200 day moving averages less often as the markets heat up.
There is a lot that can be written about what this precious metals phase 3 will most likely be like but to keep it simple and short I think it can be simplified to one idea. When the public becomes aware that precious metals offer the best hedge against fiat currency meltdown and the intense inflation that seems almost certain to be in our future then it will become "obvious" that this is where a person has to keep their wealth if they are going to preserve it. Just as it became "obvious" that tech investing was where a person had to invest in the 90's and "obvious" last year that Real Estate is where a person has to invest in they want to accumulate wealth. Of course these sectors are cyclical and any one way to wealth has its ups and downs- but no one seems to pay any attention to the possibility of a down segment during phase 3. This is where a disciplined sell plan will have to come into play.
Of course, since we just started phase 2, we are no where near phase 3 but there will be a time where you will need to transfer your wealth in the precious metals back into real estate and paper wealth. Let me just warn you now that when we issue the sell recommendation it will seem like we are throwing cold water on the party just like it did when Mike Maloney made his recommendation to get out of stocks and in to precious metals.
We are also working on strategies to deal with significant changes in the ratio between silver and gold. If this occurs we will let you know, but for now silver is still very undervalued and should be the majority of your precious metals portfolio.
In summary, the public is just getting involved in the precious metals so we just entered phase 2 of this bull market. There will be hair raising ups and downs during this phase but the time to get invested is now. Don't wait until the precious metals seem like the "can't lose" investment or you will be buying too close to the top of the market.
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