Gold's new rise compared, contrasted with that of '70s


That '70s Show: Gold Prices' Surge

While Parallels Exist, New Factors Could Make High Prices More Sustainable Now and Limit Falls When They Come

By Devon Maylie
The Wall Street Journal
Monday, December 7, 2009

LONDON -- As gold prices continue their bull run despite a pullback at the end of last week, market participants wonder if they are going to see a repeat of the 1970s.

During that decade, the price of gold soared by a factor of 24 times, peaking at $850 per troy ounce in 1980, then crashed, losing 65% of its value in two years.

Gold rose to a record $1,226.30 an ounce Thursday, putting the price at about four times its average level at the start of this decade. Gold fell sharply Friday, closing at $1,168.80 on the Comex division of the New York Mercantile Exchange.

Some of the factors that have determined gold prices were present in the late 1970s. But others, such as a sharp slowdown in selling of gold by central banks and the risks to global economic recovery, weren't. These new factors could make high prices more sustainable and limit falls when they come, analysts said.

In percentage terms, the current rally can't compare with the 1970s. The degree of that rise was due partly to the end of the Bretton Woods fixed exchange system in 1971, which unlinked the dollar from its peg to gold, freeing the metal from a fixed price of $35 an ounce. A selloff of gold came when interest rates rose and monetary policy tightened in the early 1980s. After the price of gold dropped by two-thirds, it languished around $300 an ounce until the next bull run began in 2000.

In uncertain times, gold is seen as a hedge against currency weakness and inflation. Currently near-zero interest rates, a weakening dollar, growing government budget deficits and inflation fears have pushed investors into gold.

Jeffrey Frankel, a Harvard University economics professor, says lax monetary policy and low interest rates are common to both the 1970s and the past nine years.

Those two factors, then and now, resulted in U.S. dollar weakness. But when interest rates rise and governments rein in spending, the current rally may end in much the same way as the 1970s spike. "I imagine tighter policies will do the same this time around -- it will be the death knell of the rally," says HSBC analyst James Steel. But "there is no sign of this on the horizon yet."

Few analysts say gold will see the same kind of trough-to-peak percentage increase as the bull run culminating in 1980, which would take gold to near $7,000 an ounce. Predictions fall between $1,300 and $2,000 an ounce for where gold will peak in this cycle.

Nevertheless, the two periods have key differences that give cause for more optimism over the sustainability of the current rally.

Gold's rise in the 1970s was very event-driven, says Andy Smith, a metal strategist at Bache Commodities. The invasion of Afghanistan by the Soviet Union played a large role, along with inflation and the weak dollar, he says.

While currently inflation barely exists, loose monetary policy, intended to kick-start stalled economies, could fuel inflation down the road, a worry that provides a lot of impetus to gold's rise.

"Unlike the 1970s ... there aren't the strongly inflationary, supply-side 'shocks' from oil prices which were a hallmark of that decade," says Linda Yueh, an economist at Oxford University. "Instead, most of the inflationary concerns are due to the stimulative policies and bailouts of banks."

Many investors think governments may not be able to avoid inflation and, in the face of growing deficits, want gold to hedge that risk, according to Michael Lewis, a commodity analyst at Deutsche.

Another factor driving prices is the greater ease with which people can invest in gold today. In 2003, the first physical gold-backed exchange traded fund was launched. Holdings in the major gold exchange-traded funds stand at 1,738 tons as of Oct. 30, according to World Gold Council data. That's larger than most individual central bank gold reserves.

But it is the behavior of central banks that has attracted traders' and analysts' attention. While over the late 1970s-early 1980s boom-bust period central bank holdings of gold remained relatively stable, at around 35,000 metric tons globally, a selloff beginning in the 1990s resulted in total holdings falling below 30,000 tons in 2007.

This year analysts predict central banks will be net buyers of gold for the first time in more than 20 years.

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