By Louis James, Chief Metals & Mining Investment Strategist, Casey Research:
In April of 2008, Casey International Speculator published an article called “Gold—Relative Performance to Oil” by Professor Krassimir Petrov, then at the American University in Bulgaria, now a visiting professor at Prince of Songkla University in Thailand. He told us he thought the Mania Phase of the gold market was many years off, which was not a popular thing to say at the time:
“In about 8-10 years from now, we should expect the commodity bull market to reach a mania of historic proportions.
“It is important to emphasize that the above projection is entirely mine. I base it on my own studies of historical episodes of manias, bubbles, and more generally of cyclical analysis. In fact, it contradicts many world-renowned scholars in the field. For example, the highly regarded Frank Veneroso and Robert Prechter widely publicized their beliefs that during 2007 there was a commodity bubble; both of them called the collapse in commodity prices in mid-March of 2008 to be the bursting of the bubble. I strongly disagree with them.
“I also disagree with many highly sophisticated gold investors and with our own Doug Casey that the Mania stage, if there is one, will be in 2-3 years, and possibly even sooner… Although I disagree that we will see a mania in a couple years, I expect healthy returns for gold.”
It turned out that Dr. Petrov was right. Five and a half years later, here’s his current take on gold and the metal’s ongoing correction…
Louis James: So Krassimir, it’s been a long and interesting five years since we last spoke… Gold bugs didn’t like your answer then, but so far it seems that you were right. So what’s your take on gold today?
Krassimir Petrov: Well, most gold bugs won’t like my answer again, because I think we are still between six to ten years away from the peak of the gold bull. We are exactly in the middle of this secular bull market, and a secular bull market is usually punctuated or separated by a major cyclical bear market. I think that the ongoing 24-month correction is that typical big major cyclical correction—a cyclical bear market within the context of the secular bull market.
Thinking in terms of behavioral analysis, most investors are very, very bearish on gold. People who are not gold bugs overall still dismiss gold as a good or even as a legitimate investment. That, too, is typical of a mid-cycle. So as far as I’m concerned, we are somewhere in the middle of the cycle, which may easily go for another 10 years.
I expect that this secular bull market for gold will last a total of 20 to 25 years, dating back to its beginning in 2000. Some people like to date the beginning of this secular bull market at the cyclical bottom in 1999, while others date it at the cyclical bottom in 2001. I prefer to date it at 2000, so that the secular bottom for gold coincides with the secular top of the stock market in 2000.
L: That’s interesting. But I’m not sure gold bugs would find this to be bad news. The thing they’re afraid to hear is that the market has peaked already—that the $1,900 nominal price peak in 2011 was the top, and that it’s downhill for the next two decades. To hear you say that there is a basis in more than one type of analysis for arguing that we’re still in the middle of the bull cycle—and that it should go upwards over the next 10 years—that’s actually quite welcome.
Petrov: Yes, it’s great news. But we’re still not going to get to the Mania Phase for at least another two, but more likely four to six years from now.
Now, we should clarify what we mean by the Mania Phase. Last time, it was the 1979 to early 1980 period. It’s the last phase of the cycle when the price goes parabolic. Past cycles show that the Mania Phase is typically 10% or 15% of the total cycle. So it’s important to pick the proper dates for defining a gold bull market. I prefer to date the previous one from 1966 as the beginning of the market, to January of 1980 as the top of the cycle. That means that the previous bull market lasted 14 years, and it’s fair to say that the Mania Phase lasted about 18 months, or just under 15% of the cycle.
So I expect the Mania Phase for the current bull cycle to last about two to three years, and it’s many years yet until we reach it.
In terms of market psychology, we still have many people who believe in real estate; we still have many people buying and believing in the safety of bonds; we still have many people who believe in stocks. All of these people still outright dismiss gold as a legitimate investment. So, to get to the Mania Phase, we need all of these people to convert to gold bull market thinking, and that’s going to be six to eight years from now. No sooner.
L: Hm. Your analysis is a combination of what we might call the fundamentals and the technicals. Looking at the market today—
Petrov: Let’s clarify. When I say fundamental analysis, I mean strictly relevant valuation ratios. For example, according to the valuation of gold relative to the stock market, i.e., the Dow/gold ratio, gold is extremely undervalued, easily by about 10 times, relative to the stock market.
Fundamental analysis can also mean the relative price of gold to real estate—the number of ounces necessary to buy a house. Looked at this way, gold is still roughly about 10 times undervalued.
Thus, fundamental analysis refers to the valuation of gold relative to the other asset classes (stocks, bonds, real estate, and currencies), and each of these analyses suggests that gold is undervalued about 10 times.
In terms of portfolio analysis, gold today is probably about one percent of an average investor’s portfolio.
L: Right; it’s underrepresented. But before we go there, while we are defining things, can you define how you look at these time periods? Most people would say that the last great bull market of the 1970s began in 1971, when Richard Nixon closed the gold window, not back in 1966, when the price of gold was fixed. Can you explain that to us, please?
Petrov: Well, first of all, we had the London Gold Pool, established in 1961 to maintain the price of gold stable at $35. But just because the price was fixed legally and maintained by the pool at $35 doesn’t mean that there was no underlying bull market. The mere fact that the London Gold Pool was manipulating gold in the late 1960s, before the pool collapsed in 1968, should tell us for sure that we already had an incipient, ongoing secular bull market.
The other argument is that while the London Gold Pool price was fixed at $35, there were freely traded markets in gold outside the participating countries, and the market price at that moment was steadily rising. So, around 1968 we had a two-tiered gold market: the fixed government price at $35 and the free-market price—and these two prices were diverging, with the free price moving steadily higher and higher.
L: Do you have data on that? I never thought about it, but surely the gold souks and other markets must have been going nuts before Nixon took the dollar completely off the gold standard.
Petrov: Yes. There have been and still are many gold markets in the Arab world, and there have been many gold markets in Europe, including Switzerland. Free-market prices were ranging significantly higher than the fixed price: up to 10, 20, or 30% premiums.
There’s also a completely different way to think about it: in order to time gold secular bull and bear markets properly, it would make the most sense that they would be the inverse of stock market secular bull and bear markets. Thus, a secular bottom for gold should coincide with the secular top for stocks. And based on the work of many stock market analysts, it is generally accepted that the secular bear market in stocks began in 1966 and ended in 1980 to 1982. This again suggests to me that it would make a lot of sense to use 1966 for dating the beginning of the gold bull market.
L: Understood. On this subject of dating markets, what is it that makes you think this one’s going to be a 25-year cycle? That’s substantially longer than the last one. We have a different world today, sure, but can you explain why you think this cycle will be that long?
Petrov: Well, based on all the types of analyses I use—cyclical analysis, behavioral analysis, portfolio analysis, fundamental analysis, and technical analysis—this bull market is developing a lot slower, so it will take a lot longer.
The correction from 1973 to 1975 was the major cyclical correction of the last gold bull cycle, from roughly $200 down to roughly $100. Back then, it took from 1966 to 1973—about six to seven years—for the correction to begin. This time, it took roughly 11 years to begin, so I think the length of this cycle could be anywhere between 50 and 60% longer than the last one.
Let’s clarify this, because it’s very important for gold bulls who are suffering through the pain of correction now. If we are facing a 50-60% extended time frame of this cycle and the major correction in the previous bull market was roughly two years, we could easily have the ongoing correction last 30 to 35 months. Given the starting point in 2011, the correction could last another six, eight, or ten more months before we hit rock bottom.
L: Another six to ten months before this correction hits bottom is definitely not what gold investors want to hear.
Petrov: I’m not saying that I expect it, but another six to ten months should not surprise us at all. A lot of people jumped on the gold bull market in 2008, 2009, 2010, 2011, and these people haven’t given up yet. Behaviorally, we expect that these latecomers—maybe 80-90% of them—should and would give up on gold and sell before the new cyclical bull resumes.
L: Whoa—now that would be a bloodbath. Can we go back to your version of fundamental analysis for a moment and compare gold to other metrics? You mentioned that gold is still relatively undervalued in terms of houses and stocks and some things, but I’ve heard from other analysts that it’s relatively high compared to other things—loaves of bread, oil, and more.
Petrov: Let’s take oil, for example. We have a very stable long-term ratio between oil and silver, and that ratio is roughly one to one. For a long time, silver was about $1.20, and oil was roughly $1.20. At the peak in 1980, silver was about $45, and oil was about $45. Right now, silver is four to five times undervalued compared to oil, so in terms of oil, I would disagree for silver. The long-term ratio of gold to oil is about 15 to 20, depending on the time frame, so gold may not be cheap, but it’s not overvalued relative to oil either.
But suppose gold were overvalued relative to other commodities—which I doubt, but even if we suppose that it’s correct, it simply doesn’t mean that gold is generally overvalued. The other commodities could be even more—meaning 10, 15, 20 times—undervalued relative to the stock market, or real estate, or bonds. There is no contradiction. In fundamental analysis, it is illegitimate to compare gold, which is largely viewed as a commodity, to other commodities. We should compare it as one asset class against other asset classes.
For example, we could compare gold relative to real estate. By this measure, it is easily five to ten times undervalued. Separately, we could evaluate it relative to stocks. When you compare gold to stocks in terms of the Dow/gold ratio, it’s easily five to ten times undervalued. Separately again, we could evaluate it relative to bonds, but the valuation is much more complicated, because we need to impute a proper inflation-adjusted long-term yield, so it’s better not to get into this now. And finally, we could evaluate it separately against currencies. More on that later.
Now, I believe that when this cycle is over, we are going to reach a Dow/gold ratio far lower than in previous cycles, which have ended with a Dow/gold ratio of about 2:1 (two ounces of gold for one unit of Dow). This time, we are going to end up with a ratio of 1:2—one ounce of gold is going to buy two units of Dow. So, if the ratio right now is about 8:1, I think gold could go up 16 times relative to the stock market today.
L: That’s quite a statement. Government intervention today is so extreme and stocks in general seem so overvalued, I can believe the Dow/gold ratio could reach a new extreme—but I have to follow up on such an aggressive statement. What do you base that on? Why do you think it will go to 1:2 instead of 2:1?
Petrov: If I remember correctly, we had a 2:1 ratio during the first bottom in 1932; the Dow Jones bottomed out at $42 and gold was roughly about $20 before Roosevelt devalued the dollar. That was also the beginning of the so-called “paper world,” when we embarked on the current paper cycle.
The next cycle bottomed in 1980; gold was roughly 850 and the stock market was roughly 850, yielding a ratio of 1:1. Now, if we look at it in terms of the “paper” supercycle, beginning in the early 20th century and extending to the early 21st century, you can draw a technical line of support levels for the Dow/gold ratio. If you do this, you end up with Dow/gold bottoming at 2:1 (in 1932), then at 1:1 (in 1980), and you can project the next one to bottom at 1:2.
Another way to think about it is that we are currently in a so-called supercycle—whether it’s a gold supercycle or a commodity supercycle—and this supercycle should last 50 to 70% longer than the previous one. It will overcorrect for the whole period of paper money over the last 80 years.
From a behavioral perspective, I could easily see people overreacting; we could easily see that at the peak we’re going to have a major panic with overshooting. I expect the overshooting to be roughly proportional to the length of the whole corrective process.
In other words, if this cycle is extended in time frame, we would expect the overshooting of the Mania Phase to be significantly larger. It should be no surprise, then, if we get a ratio of 1:1.5 or 1:2, with gold valued more than the Dow.
L: That’s a scary world you’re describing, but the argument makes sense. How many cycles do you have to base your cyclical analysis on, to be able to say that the average Mania Phase is 15% of the cycle?
Petrov: Well, gold is the most complicated investment asset. It is half commodity, and it behaves as a commodity, but it’s also half currency. It’s the only asset that belongs in two asset classes, properly considered to be a financial asset (money) and at the same time a real asset (commodity). So, even though gold prices were fixed in the 20th century, you can get proper cycles for commodities over the time period and include gold in them. If you look into commodity cycles historically, there are four to five longer (AKA Kondratieff) commodity cycles you can use to infer what the behavior for gold as a commodity might be.
L: So would it be fair, then, to characterize your projections as saying, “As long as gold is treated by investors as a commodity, then these are the time frames and the projections we can make”?
L: But if at some point the world really goes off the deep end and the money aspect of gold comes to the forefront—if people completely lose confidence in the US dollar, for example—at that point, the fact that gold is a commodity would not be the main driver. The monetary aspect of gold would take over?
Petrov: No, not exactly, because you will still have a commodity cycle. You will still have oil moving up. Rice will still be moving up, as will wheat, all the other commodities pushing higher and higher, and they will pull gold.
Yet another important tangent here is that in commodity bull markets, gold is usually lagging in the early stages. In the late stages of a commodity bull market, as gold becomes perceived to be an inflation hedge, it begins to accelerate relative to other commodities. This is yet another very good indicator that tells me that we are still in the middle of a secular bull market in gold. In other words, because gold is not yet rapidly outstripping other commodities like wheat, or copper, or crude oil, we’re not yet in the late stages of the gold bull market.
L: That’s very interesting. But if I remember the gold chart over the last great bull market correctly, just before the 1973-1976 correction, there was quite an acceleration, such as you’re describing—and we had one like it in 2011. Gold shot up $300 in the weeks before the $1,900 peak.
Petrov: Absolutely correct. This acceleration before the correction is exactly what tells me that the correction we’re in now is a major cyclical correction, just like in the mid-1970s. The faster the preceding acceleration, the longer the ensuing correction. This relationship is what tells me that this correction will be very long and painful. Yet another indicator. Everything fits in perfectly. All of these indicators confirm each other.
L: Could you imagine something from the political world changing or accelerating this cycle? If the politicians in Washington are stupid enough to profoundly shake the faith in the US dollar that foreigners have, could that not change the cycle?
Petrov: Yes, that’s a possibility. This is exactly what a gray swan is; a gray swan is an event that is not very likely, that is difficult to predict, but is nonetheless possible to predict and expect. One example of a gray swan would be a nuclear war. It’s possible. Another could be a major currency war, à la Jim Rickards. There are a number of gray swans that could come at any time, any place, accelerating the cycle. It’s perfectly possible, but not likely.
Now, going back to your question about monetizing or remonetizing gold—the monetary aspect of gold taking over that you mentioned. The remonetization of gold wouldn’t short-circuit the commodity cycle; the commodity cycle would continue. Actually, you’d expect the remonetization of gold to go hand in hand with a commodity bull market.
You also need to understand that the remonetization of gold would not be a single event, not a point in time. Remonetization of gold is a process that could easily last five to ten years. No one is going to declare gold to be the monetary currency of the world tomorrow.
What will happen is that countries like China will accumulate gold over time. Over time, gold will be revalued significantly higher, and there will be global arrangements. The yuan will become a global currency, used in international transactions. Many institutional arrangements need to be in place around the world, including storage, payments, settlements, and some rebalancing between central banks, as some central banks have way too little monetary gold at the moment.
L: I agree, and see some of those things happening already. But I don’t expect any government to lead the way to a new gold standard. I simply expect more and more people to start using gold as money, until what governments are left bow to the reality. I believe the market will choose whatever works best for money.
Petrov: Indeed, and that’s a process that will take many years. Getting back to gold in a portfolio context, relative to currencies, gold is extremely cheap. Historically, gold will constitute about 10-15% of the global investment portfolio relative to the sum of real estate, stocks, bonds, and currencies. Estimates suggest that right now gold is valued at roughly about one percent of the global investment portfolio.
L: That implies… an enormous price for gold if it reverts to the mean. Mine production is such a tiny amount of supply; the only way for what you say to come true is for gold to go to something on the order of $20,000 an ounce.
Petrov: Correct. $15,000 to $20,000. That’s exactly what I’m saying.
In a portfolio context, gold is undervalued easily 10 to 15 times. On a fundamental basis, gold is undervalued relative to stocks 10 to 15 times, and relative to real estate about 10 times. When we use the different types of analyses, each one of them separately and independently tells us that we still have a lot longer to go: about six to 10 more years; maybe even 12 years. And we still have a lot higher to rise; maybe 10-15 times.
Not relative to oil, nor wheat, but gold can easily rise 10 to 15 times in fiat-dollar terms. It can rise 10 times in, let’s say, stock market terms. And yes, it can go 10 to 15 times relative to long-term bonds. (We have to differentiate short-term bonds and long-term bonds, as bond yields rise to 10 or 15 percent.)
So, portfolio analysis and fundamental analysis tell me that we still have a long way to go, and cyclical analysis tells me we are roughly mid-cycle. It tells me that from the beginning of the cycle (2000) to the correction (2011) we were up almost eight times, from the bottom of the current correction (2013-2014) to the peak in another six to ten years, we are still going to rise another 10 times.
Whether it’s eight years or 12, it’s impossible to predict; whether it’s eight times or 12, again, impossible to predict; but the order of magnitude will be around 10 times current levels.
L: You’ve touched on technical analysis: do you rely on it much?
Petrov: Well, yes, but in this particular case, technical subsumes or incorporates a great deal of cyclical analysis. It’s very difficult to use technical analysis for secular cycles. We usually use technical analysis for daily (short-term) cycles, or weekly (intermediate) cycles, or monthly (long-term) cycles. We use them as described in the classic book Technical Analysis of Stock Market Trends by Edwards, Magee, and Bassetti.
If we apply technical analysis to our current correction, it doesn’t appear to be quite over yet. It could still run another three to six months, possibly nine months. But when we talk about the secular cycle, we need to switch from technical to long-term cyclical analysis.
L: Okay. Let’s change topic to the flip side of this. Can you summarize your view of the global economy now? Do you believe that the efforts of the governments of the world to reflate the economy are succeeding? Or how does the big picture look to you?
Petrov: The big picture is an austere picture. Reflation will always succeed until it eventually fails. The way I see it, the US is going down, down, and down from here—the US is a very easy forecast. The UK is also going down, down, and down from here—another easy forecast. The European Union is going to be going mostly down. However, most of Asia is in bubble mode. Australia is in a major bubble that’s in the process of bursting or is about to do so; it’s going to go through a major depression. China is a huge bubble, so China will get its own Great Depression, which could last five to ten years. This five- to ten-year China bust would fit within my overall 10-year forecast for the remainder of the secular bull market in gold.
I see a lot of very inflated and overheating Asian economies. I was in Hong Kong in January, and the Hong Kong economy is booming to the point of overheating. It’s crazy. I was in Singapore just three months ago, and the Singapore economy is clearly overheating. Last year I was teaching in Macao for a few months, and the economy is overheating there as well—real estate is crazy; rents are obscene; five-star hotels are full and casinos crowded.
Right now I’m teaching in Thailand. It’s easy here to see that people are still crazy about real estate—everyone’s talking about real estate; we still have a peaking real estate bubble here. Consumption is going crazy in the whole society, and most things are bought on installment credit.
Another easy forecast is Japan; it too will be going down, down, and down from here. Japan has nowhere to go but down. It’s been reflating and reflating, and it hasn’t done them any good. Add all this up and what I actually see is a repeat of the 1997 Asian Crisis, involving most Asian countries.
L: So your overall view is that reflation works until it doesn’t, and you believe that on the global scale we’re at the point where it won’t work anymore?
Petrov: Not exactly. We’re at the point where reflation doesn’t work anymore for the US, no matter how hard it tries. It doesn’t work for the UK; not for most of Europe; not for Japan—no matter how hard they try. But reflation is still working in China. Reflation is still working for most of Asia and Australia. As I see it, Asia is overheating significantly, based on that global reflation.
Even the Philippines was overheating when I was there two years ago. Malaysia is overheating big time—consumerism at its finest—and I’m hearing stories about Indonesia overheating until recently as well. Maybe we have the first sounds of that bubble bursting in countries like India, Malaysia, and Indonesia. The Indian currency is weakening significantly; so is the Malaysian currency. If I remember correctly, the Indonesian currency is weakening significantly, and I know well that their money market rates are skyrocketing in the last few months.
So we may have now the beginning of the next Asian Financial Crisis. Asia is still going to be able to reflate a little longer, another year or two, maybe three. It’s very hard to say how long a bubble will last as it is inflating. The same thing for Australia; it will continue to reflate for a few more years. So for Asia and Australia, we are not yet at the point when reflation will no longer work. Very difficult to say when that will change, but we’re there for the US, UK, Europe, and Japan.
L: Why won’t reflation work for the US and its pals?
Petrov: Reflation doesn’t work because of the enormous accumulated economic distortions of the real sector and the labor market. All the dislocations, all the malinvestments have accumulated to the point where reflation has diminishing returns.
Like everything else, inflation and reflation have diminishing returns. The US now needs maybe three, four, or five trillion annually to reflate, in order to work. With each round, the need rises exponentially. The US is on the steep end of this exponential curve, so the amount needed to reflate the economy is probably way more than the tolerance of anyone around the world—confidence in the US dollar won’t take it. The US is at the point where it is just not going to work.
L: I understand; if they’re running trillion-dollar deficits now and the economy is still sluggish, what would they have to do to get it hopping again, and is that even possible?
Petrov: Correct. The Fed has tripled its balance sheet in a matter of three to four years—and it still doesn’t work. So what can they do? Increase it 10 times? Or 20 times? Maybe if they increased it 10 or 20 times, they could breathe another one or two or three years of extra life into the economy. But increasing the Fed’s balance sheet 10 or 20 times would be an extraordinarily risky enterprise. I don’t think that they will dare accelerate that much that fast!
L: If they did, it would trash the dollar and boost gold and other commodities.
Petrov: Yes, that’s clear—the bond and the currency markets would surely revolt. That’s a straight shot there. The detailed ramifications for commodities, if they decide to go exponential from here, are a huge subject for another day. For now, we can say that they have been going exponential over the last three to four years, and it hasn’t worked.
Also, we know well from the hyperinflation of the Weimar Republic that they went exponential early on, and it stopped working in 1921. For two more years, they went insanely exponential, and it still didn’t work. I think the US is at or near the equivalent of 1921 for Weimar.
L: An alarming thought. So what happens when Europeans can no longer afford to pay the Russians for gas to heat their homes? Large chunks of Europe might soon need to learn Russian.
Petrov: Not necessarily, but Europe is going to become Russia’s best friend and geopolitical ally. The six countries in the Shanghai Co-op are already close allies of Russia. So is Iran. So Russia has seven or eight very strong, close allies. European countries will, one by one, be joining Russia. Think about it from the point of view of Germany: why should Germans be geopolitical allies of the US or the UK? Historically, it doesn’t make any sense. It makes a lot more sense for them to join the Russians and the Chinese and to let the Americans and British collapse. So that’s what I expect, and Russia will use all its energy to dictate geopolitics to them.
L: Food for thought. Anything else on your mind that you think investors should be thinking about?
Petrov: Well, it’s fairly straightforward. First, I do expect that the stock market is going to lose significant value over the next five to ten years. Second, I believe that real estate is still grossly overvalued; as interest rates eventually rise, real estate will fall hard—overall, it will not hold value well. Third, I also believe that bonds are extremely overvalued and that yields are extremely low. I expect interest rates to begin to rise and bond prices to fall, so I strongly discourage investors from staying in bonds. Finally, I expect that governments will continue to inflate, even though it doesn’t work, and that currencies will devalue.
I strongly encourage investors to stay out of all four of these asset classes. Investors should be staying well diversified in commodities. They shouldn’t ignore food—agriculture. They shouldn’t ignore energy. But their portfolios should be dominated by precious metals.
L: That’s what Doug Casey says, and that the reason to own gold is for prudence. To speculate for profit, we want the leverage only the mining stocks can give us.
Thank you very much, Krassimir; it’s been a very interesting conversation. We shouldn’t let this go another seven years before we talk again.
Petrov: [Laughs] Okay. Hopefully a lot sooner.