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A brief look at cycles

Steve Saville
February 21, 2004

Below is an extract from commentary posted at www.speculative-investor.com on 19th February 2004

Market prices tend to move in cycles; from very long-term cycles lasting 50 years or more to short-term cycles lasting a few weeks or months. These cycles are often very clear in hindsight -- particularly the longer-term ones lasting a few years or more -- but putting a lot of emphasis on cycles in One's market analyses can create problems because in real time things regularly don't play out the way that a purely cycle-based view of the world would suggest they should.

A good current example of cycle-based analysis leading to a monumental error is provided by those followers of the Long Wave, or Kondratyev Wave, who have anticipated falling US$-denominated commodity prices over the past few years based on their belief that we are in the "Kondratyev Winter," a period in which commodity prices are supposed to fall. Clearly, commodity prices have risen sharply, not fallen, so either the K-Wave winter ended in 2001, or hasn't yet begun, or is never going to occur because there is no such thing. Or, perhaps we are currently immersed in a K-Wave winter but it is demonstrating different characteristics to previous K-Wave winters because this is the first time in the recorded history of the world that this part of the Long Wave is occurring while none of the national currencies are officially tied to gold. In other words, even if we assume that the K-Wave winter is presently upon us does it make sense to conclude that the fiat currencies of the world are going to increase in value relative to useful and scare resources given that central banks now have the power to create currency in unlimited quantities? We don't think so. There is, however, some logic in the argument that commodity prices will fall relative to hard money (gold). In fact, although we are long-term bullish on commodity prices we expect that the CRB Index will be substantially lower, relative to gold, at the end of this decade than it was at the start of the decade.

Our belief is that cycles, including the K-Wave, are real and deserve to have a place in our overall market analysis. However, it is important not to defer to any interpretation of cycles just as it is important not to be married to any preconceived ideas of what the markets are going to do in the future. Instead, speculators such as ourselves should be continually developing a thesis (the thesis is always a work-in-progress because there are no start and finish points in the markets) by assessing the fundamentals and the price action and, in general, by paying attention to what is happening in the world. And a review of cycles could, and probably should, form part of our thesis.

Now that we've explained how we think cycle analysis should fit into the overall scheme of things, let's revisit gold's 8-year cycle (it was previously discussed in the 18th August 2003 Weekly Update).

Since the mid 1970s gold has made a cycle low every 8 years (+/- a couple of months) beginning in 1977 and a cycle high every 8 years beginning in 1980 (a chart showing these cycles is included below). So, if this cyclical pattern continues then the next major low will occur in 2009 and an important high will occur during the first half of this year.

We expect that an important high will occur during the first half of this year, but it is not likely that this year's high will turn out to be the ultimate high of the bull market because the way things are currently progressing it will be many years before we get a major low in the US$. In particular, the US hasn't even begun to address its massive current account deficit and, as explained in previous commentaries, a long-term bottom for the US$ is probably not going to occur until the US's quarterly current account deficit has been eliminated.

Furthermore, instead of a cycle low for gold in 2009 it would actually make more sense to us, based on the way things currently stand, if 2009 turned out to be a cycle high. This would, for example, allow the gold cycle to mesh with the US$ cycle illustrated on the below chart. The chart, by the way, shows the number of US Dollars per Swiss Franc and uses an inverted scale in order to highlight the Dollar's long-term downward trend. We've also attempted to illustrate that the US$ has, since the beginning of the 1970s, experienced two declines of 8-10 years and two counter-trend moves lasting 5-6 years. A continuation of this pattern would, therefore, result in a major dollar low near the channel bottom during 2008-2010.

In our opinion, the top in the gold price that is likely to occur during the first half of this year will be akin to the 1974 peak. In other words, we expect a peak that will be followed by a lengthy counter-trend move. This view happens to be consistent with the cycles, which adds to our confidence, although it is not based on cycles. It is, instead, based on our assessment of what is going to happen in the currency, bond and stock markets over the remainder of this year.

Steve Saville
Hong Kong

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