-- Posted Sunday, 4 January 2009 | Digg This Article | | Source: GoldSeek.com

There are some important similarities between the present and the 1930s. For example, in TSI commentaries over the past 6 months we've discussed the similarities between 1937-1938 and 2007-2008, both with regard to the economic situation and the performance of the US stock market. It is therefore apropos to review how the gold sector of the stock market performed during the 1930s.

Unfortunately, we don't have much information on how gold stocks performed during the Great Depression of the 1930s. In fact, all we have to go on is the following long-term chart of Homestake Mining (HM) from the excellent sharelynx.com web site. If we make the assumption that HM's performance was representative of the entire gold sector then this chart's message is that the gold sector trended upward in relentless fashion until 1939. In other words, there was nothing resembling the huge correction of 2008, or, for that matter, the huge corrections of 2002 and 2004-2005.

According to the HM chart, the largest correction of 1930-1939 occurred during 1935-1937. This was a peak-to-trough decline of about 30% and coincided with the final 1-2 years of the Roosevelt boom. The 1935-1937 correction was followed by a rally that peaked in mid-1939.

Interestingly, but not surprisingly for the reason mentioned below, a large (60-70%) decline in HM's share price occurred during 1939-1942 -- in parallel with acceleration in the rates of government spending and monetary inflation as the Roosevelt Administration provided arms/supplies to its allies and prepared for America's entry into the Second World War.

When the gold price was fixed, as it was during the 1930s, gold-related investments naturally performed well during periods of deflation or periods when the fear of deflation was rising, and performed poorly during periods when the fear of inflation was rising. The reason is that under the monetary system of that era the purchasing power of gold would rise and fall with the purchasing power of the US$. In other words, gold and the US$ were effectively at the same end of the seesaw -- if investors expected the dollar to lose purchasing power then they would expect gold to lose the same amount of purchasing power provided that they also expected the gold-US$ link to remain in place. This, we think, explains why the stock price of HM was relentlessly strong during much of the 1930s, with the only significant correction occurring during the inflation-fueled boom of 1935-1937, and why it then tanked as war-related inflation fears began to build.

Under today's (post-1971) monetary system gold and the dollar are effectively at opposite ends of the seesaw, meaning that gold will tend to do well when the general fear of US$ inflation is rising and poorly when the general fear of US$ inflation is falling. It will also tend to do well during times of financial panic, although panics are always short-lived and in most cases such gains will be quickly given back. As a result, we would currently NOT be intermediate-term or long-term bullish on gold if we thought that a lengthy period of genuine deflation lay in store.

Due to the large differences between today's monetary system and the one that was in operation during the 1930s we don't think HM's performance during the late 1930s can be directly applied to the present. In particular, whereas the acceleration in monetary inflation during 1938-1942 proved to be a major negative for HM, we think the acceleration in monetary inflation that has recently begun will prove to be a major positive for gold stocks over the years ahead.

Also, we no longer think that the 1970s are a useful model as far as the gold sector's likely performance is concerned because the differences between the current situation and the 1970s are now far greater than the similarities. There was a 60-70% decline in the gold sector in the middle of the 1970s bull market, but this decline occurred in parallel with a rebound in the broad stock market.

To use a hackneyed phrase: we are in uncharted waters.

-- Posted Sunday, 4 January 2009 | Digg This Article | Source: GoldSeek.com

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