With the financial system crisis looming around the world, the gold bull market is starting to enter into its third phase. On the chart below, we have broken down the gold bull market into three phases. The first phase began in 2001 and continued for 54 months with gold gaining 100% (avg. 1.85% per month). The second phase began in 2005, lasted for 24 months with gold gaining 60% (avg. 2.5% per month).

The third phase is the most impressive yet. Its start coincided with the widespread recognition of a crisis in the western financial system, further exacerbated by the slowdown in the economy. It is difficult to predict the slope of the third phase, but the first few months have been promising. Since September, gold has gained more than 20% (avg. 4.0% per month): steep gains indeed. The length of phase three, we think, will at least rival that of phase two ? 24 months or more.

The foundation of the gold bull market is strong and there are no signs of a speculative spike. This bull market is not booming on price inflation and speculation of the 1970s, but on a crisis of the world financial system based on fiat money. There is no easy resolution to this crisis. Methods currently employed by the financial authorities do not address the core of the problem but attempt to delay the pain. The question on the minds of the well-informed is: how much longer will the US dollar remain the world reserve currency?

Gold Stocks

The bull market in gold stocks can also be broken down into three phases. The first phase began in 2001 when gold stocks made a very large advance in a short period of time. These gains were made during a severe bear market in US equities. Gold stocks acted in a truly counter-cyclical manner.

The second phase was difficult for gold shares. It coincided with a cyclical bull market on US equities. Production costs rose steadily, driven by fast growing demand for energy and base metals caused by exceptional world economic growth. Gold stock performance was choppy, with indices being pulled up by a few diversified producers with significant exposure to base metals.

The third phase started in late 2007, concurrently with the beginning of a strong advance in gold as was the case during phase one. To date, all conditions are shaping up in a similar manner as in 2001-2003. Consequently, we expect phase three to be similar to phase one in both strength and length of the advance.

It is especially important that the gold / crude oil ratio ($GOLD / $WTIC) appears to have bottomed last summer. Oil is unlikely to move much higher and the ratio will continue to trend up, taking the pressure off of the gold exploration, development and production stocks. As a result, the $HUI / GOLD ratio will begin trending up in 2008 and gold stocks will regain their leverage to the yellow metal.

This is an excerpt from an RSG Newsletter posted on January 20, 2008.