From the late 1990s up until the last year or so, anyone who advocated investing in gold was viewed as a “gloom and doomer” or worse.  When you mention gold to someone these days, they no longer look at you cross-eyed.  We believe this development marks the official end of phase I of the gold bull market.

Phase II is all about climbing the so-called wall of worry.  Some very sophisticated investors have accumulated positions in bullion and mining shares, but the general public still has no idea what is going on.  Gold, which is still primarily viewed as a hedge against terrorism, has yet to resurface as an inflation/U.S. Dollar hedge requirement for most mutual funds as it was during the 1980s.  That’s right, you probably don’t remember, but twenty years ago, gold was considered an essential cash-equivalent for many popular mutual funds and most of them had a few percent allocated to the yellow metal at all times.  The dollar weakness of 2001-04 and subsequent reflation has put gold back on the map which means it is ready to launch into phase II.

What we can expect to see next in terms of gold price acceleration is a repeat of phase I but with a lot more volatility.  Gold has run up quite a bit over the last few months and it likely needs to shake out the weak hands before moving higher.  But because we are in phase II, the corrections and subsequent bounces will come a lot quicker than in phase I because the smart money is learning to buy on the dips.  The very end of phase II will be when major investment banks become long-term bullish on the price of gold.  We don’t expect this to happen anytime soon as equities (and maybe energy) are still king on Wall Street.

Habits of central banks in Asia, the Middle East, Russia and parts of Latin America are another sign of phase II.  These countries are all adding to their gold reserves as they realize the value of the holding oldest currency in the world.  Phase II will morph into phase III once every central bank starts adding (instead of selling or holding) gold reserves amidst a U.S. Dollar and fiat currency crises.  Finally, you know it will be time to sell when gold and silver dominate the airwaves of CNBC.  If you ever attend a cocktail party and the topic of conversation is Latin American gold mines, its time to get out.

February 17, 2006

Todd Stein & Steven McIntyre

Texas Hedge Report

Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets