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Having locked ourselves into a big position in gold shares, we needed to have some idea of how the gold price might perform and how high it might rise. We ran into the conundrum that has confounded fundamental analysts since 1971. How do you value something that has no utility value, no earnings or net asset value, does not spoil or corrode and is not used up?
Other commodities such as copper, soya beans and corn etc., are priced using a combination of demand, supply and stocks. If demand exceeds supply, stocks diminish, shortages develop, prices rise and new production comes on stream. Eventually supply exceeds demand, stocks build up, prices decline and marginal producers go out of business. The cycle then repeats itself. Other commodities are produced for consumption while gold is accumulated.
Consequently large stocks of gold exist in official hands as central bank reserves. There are also large stocks of gold in private ownership, in vaults around the world, in homes, buried in gardens, in coins and gold jewelry. New mine production of gold is tiny compared to available stocks. In 1971 official holdings of gold were about 37,000t. Cumulative world gold production throughout history up to 1971 was estimated to be about 90,000t, so investors/hoarders must have owned at least as much as the official holdings. In 1971 world gold production was a mere 1,450t, or less than 2% of the estimated amount of gold held in the world at that time.
The fundamental conclusion was that the owners of the large stocks of gold would determine the future of the gold price. If they became net sellers, the gold price would decline. If they became net buyers, the gold price would rise. There were reasons to believe that they would be net buyers. The world had been launched into an untried experiment where all countries were subject to Government fiat currencies and, in addition, there was a latent group of buyers in the wings. Americans had been prevented by law from holding gold since 1933. With the collapse of the gold exchange standard on 15 August 1971, there was no reason for this prohibition to continue. On 31 December 1974 (another Moses generation period from 1933) the largest and wealthiest nation on Earth allowed its citizens to buy and own gold.
The obvious conclusion was that it was necessary to resort to technical analysis to find a way to predict movements in the gold price. I experimented with a variety of technical systems and then got lucky. I discovered that the Elliott Wave Theory (EW) gave superb results in predicting the gold price. I couldn’t get the same great results using EW in other commodities or markets. EW is a complicated system with many difficult rules, but I will try and explain it in simple terms.
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