Gold run a reason to be wary of the stock market

Commentary: 10 years ago, everyone had lost interest in yellow metal

By Brett Arends, WSJ.com

BOSTON (MarketWatch) -- The booming gold price is making me very nervous. About Wall Street.

Why? Because gold's rocketing boom -- it's risen from around $260 an ounce about a decade ago to just under $1,200 now -- is a vivid daily example of what a real bull market looks like.

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History says that such massive bull markets -- like equities from 1982 to 1999, or commodities in the '70s or real estate from the mid-'90s to 2005 -- usually start only after a big bear market ends.
Sounds like common sense, yes? Maybe even a banality.
But here's the problem: Those holding a lot of stocks right now are taking a gamble that the big bear market on Wall Street, which began in 2000, ended earlier this year. They're betting that the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (INDU 10,345, +35.30, +0.34%) , now 10,309, won't tumble again toward, or even below, the intraday low of 6,440 seen on March 9.
Are they right?
No one yet knows for certain. Looking back to early March, there certainly was a lot of panic and capitulation, which you usually see at a market bottom. People talked of a new "Great Depression." One thing I noted at the time was that investors were shying away even from rock-solid defensive stocks with big, well-protected dividend yields. People weren't just scared; they were petrified.
Is that really how a massive bear market usually ends?
The last example before our eyes was gold, whose big bear market ended a decade ago. It looked very different.
Like shares in the 1930s and the early 1980s, gold ended its secular bear market in 1999-2001 with a whimper, not a bang. People didn't panic; they simply lost interest.
I remember calling around gold analysts in London in 2000, when gold was near its lows. There weren't many left; most of them had been laid off years earlier, as investor demand had dried up. The few who remained generally earned their keep by advising gold-mining companies on how to use the futures market to sell their output. It was dull work in a dull market.
Key fact: Almost none of the analysts was bullish on gold! A number of them gave me reason upon reason why gold was going to fall even lower.
Everyone now pretends they were buying gold back then. But of course if they had been, gold wouldn't have fallen as low as it did.
I actually know two investors who really were buying. Everybody else rolled their eyes or laughed at them.
Gordon Brown, Britain's hapless and accident-prone prime minister, was the chancellor of the exchequer, or Treasury secretary, at the time. He chose to sell more than half of Britain's entire gold reserves near the lows. According to Her Majesty's Treasury, the government sold about 395 tonnes in 17 auctions between 1999 and 2001, raising around $3.5 billion.
The average sale price worked out at around $275 per troy ounce. At today's price of $1,178, those same 395 tonnes would sell for $15 billion. Put it another way, the move cost Her Majesty's government, or the British taxpayer, a stunning $11.5 billion in lost profits.

Britain sold about 395 tonnes of gold in 17 auctions between 1999 and 2001, raising around $3.5 billion. At today's price of $1,178, those same 395 tonnes would sell for $15 billion.

Hindsight is 20-20. (The Treasury also made back a small amount of those losses by moving some of the money in currencies like the euro, which have risen.) What is important here is that Brown's move was not especially controversial at the time.
Yes, some people warned it was a bad move, but they were a small minority. Some in the City of London criticized the way the government handled the sale. Yet the overall direction of the move -- cutting Britain's holdings of the "barbarous relic" of gold for more "productive" assets -- enjoyed broad support among the financial community.
Indeed, around the same time other European central banks (notably the Swiss, Dutch and Belgian governments) quietly sold even more gold than Britain did -- more than 2,000 tonnes in all.
(An aside: The U.S. Treasury kept its 8,134 tonnes. These show up in the national accounts as an asset of just $11 billion, because for historic reasons the gold is booked at just $42 an ounce. But at today's prices, the gold is really worth $308 billion, and account for the bulk of the U.S. government's entire foreign-currency reserves.)
Ten years ago, pension funds and institutional investors around the world held little gold, if any. Merrill Lynch's monthly survey of institutional fund managers, probably the best barometer of their collective sentiment, didn't even include a question about gold until I (as it happens) asked them to start about five or six years ago.
Gold was such a nonissue that neither Merrill Lynch nor the fund managers had noted the absence.
This is how, on the financial markets, a big bear market tends to die. Not in a dramatic hail of gunfire, like Wall Street last March, but quietly, unnoticed, in the night of old age.
No, this doesn't mean we necessarily have to see new lows in stocks. Financial markets don't function like clockwork. It is notable that even fund legend Jeremy Grantham, a long-standing bear, thinks we probably did see the lows last March. (My own preference, as an investor, is to buy good-quality companies when they look cheap, regardless of what I think of the market or the economy.)
But history says a generational bull market, like Wall Street from 1982 to 1999, is usually followed by a generational bear market. I'd feel a lot more comfortable about stocks if everyone had lost interest completely, like they did in gold 10 years ago.