I wanted so badly to respond to this one that I went ahead and went through the approval process I have to do for investing related posts.
My strongly held opinion is that gold is absolutely NOT in a bubble. (This is coming from a guy who, as the existence of this site would imply, doesn’t have qualms about identifying financial bubbles as such.)
A bubble takes place when irrationally euphoric sentiment drive prices far in excess to their fundamentals. Let’s start with the sentiment part first. Think back to the height of the real estate bubble here in SD. Everyone was constantly talking about how much they’d made in real estate. People who weren’t in yet were panicking to get in, getting in bidding wars on low quality and horrendously overpriced properties. The vast majority of people thought it was crazy to suggest that real estate prices could ever stop going up. (I know because I started this site in spring 2004 at the height of the speculative blowoff/panic buying phase).
And let me emphasize here that the huge majority of people thought it was crazy to suggest that prices would stop going up. To suggest that prices would flatten out or, heaven forbid, actually decline either made people angry or, more often, just made them shake their heads in pity at your total inability to "get it."
Now, let’s look at the sentiment surrounding gold. Of course you have some dyed-in-the-wool gold bugs, who are permanently bullish on gold. But among the more general populace, the sentiment for gold is absolutely nothing like what you saw for RE during the bubble. Nothing like it at all. If you’d asked a random sampling of people about real estate back in the day, the vast majority would have insisted it’s the road to riches. Ask a random sample about gold. Sure, some people will probably be bullish (up from NO people who would have been bullish a couple years ago), but the majority will tell you it’s a terrible investment, it has no yield, and ask you whether you shouldn’t be out stocking up your fallout shelter with ammo and canned goods.
And incidentally, every time gold goes up a little bit, everyone comes out of the woodwork to declare it a bubble! People also constantly point out that if you’d bought gold in 1980, you would have had terrible returns. Of course you would have — you bought at the tippy-top of a huge bubble! Nobody seems to think about the people who bought at the beginning or even middle of the 70s bull market and sold near the peak of the bubble — they just say that if you’d bought at the peak of the bubble your returns would have been poor, and therefore, gold will always have poor returns. This type of reasoning is not the kind of thing that’s widespread anywhere near bubble peaks. Let me ask you this: in spring of 2004, how many people were saying that if you’d bought a San Diego house in 1990, you would have been underwater 7 years later, and therefore homes were an inherently bad investment? Not many.
So in short, there is nowhere near enough widespread positive sentiment to qualify this as a bubble. Now let’s look at fundamentals. In my opinion, gold’s biggest fundamental driver is confidence in the global monetary system. Specifically, gold moves in the opposite direction of confidence in the monetary system and in paper money as a store of value.
Unfortunately, that confidence or lack thereof is hard to measure. But just to take a stab at how expensive gold is compared to other stuff, let’s compare it to CPI (a dubious measure of purchasing power loss, per my latest article, but better than nothing). Compared to CPI, gold is less than 1/3 as expensive as it was at its 1980 bubble peak. (And yes, THAT was a legitimate bubble). The CPI’s understatment of true purchasing power loss means that the 1/3 figure above actually overstates the current valuation of gold. You can compare gold to other things as well — stocks, the amount of currency outstanding, etc. — and see that from a raw valuation perspective you just can’t make the case that it’s in bubble territory.
Gold was in a bubble that ended in 1980, and then it was in a horrific 20-year secular bear market. Stocks began 1980 at ridiculously low valuations and rose for the next 20 years, culminating in a bubble of their own. The fact is that many investors have just become accustomed to the idea that stocks go up and gold goes down, and that’s the way of the world. They view any rise in gold as an aberration and try to explain it away. But the conditions that were in place at the beginning of that long trend are no longer in place — far from it.
Whether you are bullish or not on gold at this point should really come down to whether you think confidence in the monetary system will rise or fall in the years ahead. My opinion is that it will fall and maybe fall by a lot. Whichever camp you are in, however, and whether you are bullish or bearish, there’s really no credible case to be made that gold is in a traditional speculative bubble.
I had to get this reviewed (as discussed previously) but I thought it was worthwhile because this is a question I hear a lot. Unfortunately I can’t really get into a back-and-forth discussion due to the review process, but if you have further questions feel free to email me at [email protected].
