Look for Gold to Start Leading

2004-MAR-01

Last week many commodity prices reached new multi-year highs. Soybeans and corn, copper and the PGMs, crude oil and gasoline - all of these commodities are moving higher.

In fact, the CRB Index of commodity prices last week reached levels not seen in twenty years. To repeat my observation from my January 6th Alert, it's "a commodity bull market".

In that Alert I presented a monthly chart of the CRB Index through December 2003. I present it here again, but have now updated it through the end of February. This chart is very bullish:

While commodity prices across the board are moving higher, gold appears to have been left at the starting gate. For example, on December 31st gold closed at $415.70 and the CRB was 255.29. In contrast, gold closed February at $396.40, down -4.6% over this two-month period. In contrast, the CRB Index closed February at 274.73, rising +7.6% above its year-end level. Gold's lackluster performance is made all the more apparent by silver - gold's precious metal cousin - which has risen +12.5% over the past two months.

As if that comparison were not enough, take a close look at the following chart, which really makes gold's underperformance obvious.

The above chart presents both the price of gold and the CRB Index in order to easily compare their relative performance since 1982. Note the following:

1. In the 1980's, gold (the red dotted line) led and the CRB Index (the blue line) followed, which is their normal relationship. Gold is sensitive to inflationary pressures. That's an important element of its historical role - gold is a barometer of inflation. Note points A, B and C. Gold led commodity prices, both on the upside and the downside.



2. This relationship between gold and the CRB began to break down in the 1990's. The reason is that hedging by gold mining companies and the use of gold in carry trades considerably expanded the quantity of gold liabilities, which 'cheapened' gold. In other words, all the paper gold being created back then began to distort gold's historical relationship to commodity prices in general and the CRB Index in particular. Note points D, E and F. Clearly, gold was no longer leading as it had done previously.



3. Now look at point G. Even though the CRB Index climbed, gold went nowhere. The reason for this result in my view is that the gold price was being managed, which I think is well documented by all of the material published by www.GATA.org.



4. At point H, the CRB Index fell back to retest its previous low, and it successfully held this support above 180. The CRB Index also did something else - it picked up gold and started dragging it upward along with it. Despite the ongoing efforts to keep gold subdued so that its rising price would not signal rising inflationary pressures, the surge in commodity prices was so broad-based and so persistent, gold could no longer be contained. All the managers of the gold price could do was to be satisfied that gold was only following, and not leading.



5. Finally, we get to point I, the current situation. Again, in contrast to what gold did in the 1980's at points A, B and C, gold is following the CRB Index. Gold is not leading. Again, I believe the reason for this result is the ongoing management of gold's exchange rate to the US dollar, which is so well documented by GATA.

Based on historical relationships between gold and the CRB, it is clear from the above chart that gold should be closer to $500 ($16.10/gg) than $400 ($12.85/gg). But this observation is not reason for despair. To the contrary. It makes buying gold here at $400 per ounce an easy decision because we can clearly see from the above chart how undervalued gold presently is, which is the point of this analysis.

If you believe as I do that we are in a commodity bull market, which commodity do you buy today? The commodities that have already moved higher? Or the one still in the starting gate that looks to be the best relative value? If you are a value investor, you should be buying gold.