Gold is a bubble?

[babbleon]

I posted recently asking what the next bubble might be. Got some good responses here and then had a conversation with an economy professor at my alma mater.

He said gold was currently ‘bubble-like’ and to stay away from it. He said the current run-up we’ve seen since ’01 is unsustainable.

I’m confused. I thought after doing plenty of research on the subject that there was potential growth in gold but now I’m not so sure.
Thoughts?

[drunkle]

pure uneducated speculation:

gold is bubbled, but with more to go, particularly with the recent fed cut, euro banks poised to cut, more cuts looming, a skittish economy, china on a precipice and ww3 looming.

[CricketOnTheHearth]

I’m not sure what to think of gold.
For one, I’m getting deja vu to the big gold boom of the early ’80’s. Then, like now, the economy was under great stress, and people were scared– so they stampeded to gold. At one point it got up to $1000 an ounce IIRC.

In those days, too, just like today, you had shills pushing gold on the mass media. It seems that whenever it spikes up to a high price, that’s when sleek-talking salesmen and saleswomen come on the TV urging you to buy. Hm, you think they bought it in ’05 at $450 an ounce and are looking to sell….?

However, the peak of the ’80’s didn’t last long, and the price quickly dropped back down. I saw a graph on one of the econ blogs recently which showed the big ’80 spike and the rise we’ve had in the last couple of years. Compared to the prices of gold the rest of the time ($300-400 range for years on end) they both looked like short-term spikes of about equal height.

On the other hand, there is the argument that gold is the item of value of choice when dollars, stocks, etc head south. It is the one item you can be sure that people will always want and buy.

You could also say the rise in the price of gold is an illusion which reflects the fact that the dollar has actually fallen in purchasing power.

I’m inclined to agree with drunkle. Gold seems kind of “bubbled” to me– but passions are high these days, and will drive its price higher in the short term (next year or two), IMO.

>chirp<

[stockstradr]

I bought gold yesterday, 5% of my portfolio.

I see a correction coming, yes. However, I bought because I’m sick of watching myself use the “I expect a correction in gold prices” as an excuse to avoid buying gold.

I cannot hesitate any more. Way back at $450/ounce I did the research and concluded gold was headed for $1,000/ounce in five years. So far it looks like I was right, but I missed making money on my prediction.

So finally I bought and I’m going to just hold that gold, even if we see a correction back to $640/ounce levels. Instability in global markets and flight from the dollar are the primary reason money will move into GOLD.

[stansd]

I’ve been hesitant to go into Gold, but I have about 40% of my portfolio in TIPS (Treasury inflation protected securities), which seem like the next best thing. Most of the rest is in international stocks….Thoughts on TIPS vs. Gold?

[stockstradr]

one more thing.

Today I increased my SHORT position on oil. “DUG” is one way to get 2X inverse exposure to oil.

Go ahead. Laugh. Consider me crazy for shorting oil. However, understand this is not a long-term position. I see oil going below $50/bbl within 24-36 months. Beyond that time frame oil prices are headed up.

Recession is at our doorstep. Worldwide oil demand is already falling. Every damn hedge fund and foolish investor has loaded portfolios heavy with energy. I’m a Contrarian.

It is time to short oil.

When the recession takes oil prices below $50/bbl, then it will be time to close those short positions and BUY BUY BUY because of course the long-term trend is UP.

[stockstradr]

TIPS can be seen as a smart move, but I have hesitated, for the following reasons..

Many think the CPI is total bullshit, perverted more and more with each “revision” as part of a conspiracy to under-represent true inflation so our government can inflate its way out of national debt. Foreigners holding our debt must be tricked into thinking our inflation is lower than actual.

Additionally, the dollar continues its long painful decline on international currency markets.

Here is an example. You hold TIPS for five years. China decides to unlink from the dollar and let the RMB roam free. So let’s say the RMB-$$ exchange rate moves 50% against you. Many respected economists do think the RMB is 50% away from its true unrestrained floating market rate. On a fixed rate control, the commies already allowed it to move 10% in that direction in last 4 years.

Now you cash out your TIPS. Think about what will have happened over that five years to the price of every Chinese made product (pretty much 90% of what’s in our retail stores)? Effectively the value (to buy foreign made goods) of those TIPS funds will have fallen dramatically.

I have friends (Chinese) who are moving money into China, and buying CD’s from Chinese banks. The interest rate kinda sucks, but the long-term exchange rate trend is going to prove out their wisdom.

Over the last five years we have moved over half our assets into China. We own property in China not in America. We have savings accounts in the BoC. I don’t think you want your money in dollar-denominated assets.

You are investing in our government at a time when foreign nations are realizing the US is no longer a credit risk worth investing in! America is a junk bond credit risk.

[Stu949]

I agree about TIPS – government inflation data is crap, so your TIPS are modest, at best, for inflation protection.

Is gold already in a bubble? I don’t think so, but I agree that its flucuations are not for everyone. I bought $5,000 worth of bullion at $425 an ounce back in 2004 – haven’t touched it since; except for on occasionl mining stock here or there. Yeah, you here some gold ads on the radio, but I don’t think gold is in a bubble until it is a topic at cocktail parties – I don’t see the mainstream kinfe catchers jumping on gold right now. I think calling a gold top right now is like calling a real estate top in 2003/2004 (depending on the area). You would’ve missed the two best years.

Been thinking about jumping on a couple of silver/gold miners if the overall stockmarket pulls back a little in the next few weeks. Maybe jump in on some miners prior to Ben’s next rate cut. Play it short term.

Stocks will probably head lower from here on out; however, the public will see sporadic gains and think the market is remaing healthy. Long term, I think you’ll see a gradual decline in equities.

I’m looking into a mixed currency index for inflation protection as well. Silver/gold; other currencies (euro, yen, and other Scandinavian currencies); and pure commodities plays (sugar, coffe, cotton) if you can get into it – tough for the average investor though.

[stockstradr]

I ask myself this straightforward question:

“Do I think over the last five years, the average actual price inflation has been 3% on the basket of items my family typically buys?”

That’s what our government claims, based on CPI.

What a joke!!!!

http://www.bls.gov/cpi/

(At that web site click on “Inflation Calculator” link)

[Anonymous]

I think Gold is headed higher in the next two years, and just bought in myself today (10% of assets), as hedge vs inflation. It’s ‘high’ vs a few years ago, but nowhere near inflation adjusted peaks in the 80s

[desmond]

I have never heard anybody actually making money on Gold, that is, actually selling it for a profit. Most buy and hold, hold so long they Will it away. If selling for a profit starts to happen how fast would the price fall? I can see myself buying it, the prices then plunge, and I fall in love with the shine not the luster.

[sjk]

(I have never heard anybody actually making money on Gold)

Now you have 🙂

Regards,

[asragov]

You might like to read Minyanville’s article on the past, present, and future of gold.

It is excellent:

http://www.minyanville.com/articles/gold-gld-nem-asa-gss-dollar-fed-greenspan-housing-mrb-uxg/index/a/14027

[stockstradr]

You might like to read Minyanville’s article on the past, present, and future of gold.

You are right. That is a brilliant article, and one I think is worthy of deep reflection, in terms of repositioning one’s portfolio.

Thanks for posting that link!

[drunkle]

the author assumes that global economies will remain sound through the us downturn. is this a realistic assumption? europe is facing a liquidity crisis and housing boom of their own. china is facing stiff inflation due to pegging the yuan to the dollar. canada and australia… with strong regional currencies, are they to become service oriented economies like the us?

if you invest in gold, but dont get out in time for the inevitable (and historically rapid) reversal of liquidity, how will your investment fare?

for savvy investors, gold may be a good bet, but for joe 401k… seems to me the gold rush is as risky as ever. sure, it’s going up for now. sure, it’s better than blackjack. but when to cut and run? like all the re investors who knew a sure thing when they saw it…

[Eugene]

My thoughts.

On gold: yes, gold has the tendency to get bubbly. But it’s nowhere near as expensive as it might be.

http://www.itulip.com/images/goldReal.jpg

And even 1980 peak is not the limit. We have almost a billion of people living in the Western world, and all these people are conditioned to believe that their dollars and euros and pounds maintain their value well. Imagine what happens if things start going haywire, America hyperinflates, Europe follows by lowering rates, and all these people lose their trust in fiat currencies. Also, imagine what happens if some country ends up going back to gold standard. There’s surprisingly little gold in the world. Total value of all gold ever mined is somewhere around $3 trillion at current prices. For comparison, total liquid net worth of all Americans is $30 trillion.

On TIPS: they are not as bad as people think. Government has been trying to keep some price increases from showing up in CPI, but it’s been mostly successful in delaying the effects. For example, they hid the housing bubble from CPI by using rent figures and excluding house prices. Guess what, now we’re looking at accelerated increases in rents nationwide as house prices are going down and former “homeowners” end up back in the rental market.

Overall, TIPS and gold are on two opposite ends of risk/reward specturm. TIPS are low risk (guaranteed not to lose any money) but low reward. Foreign currencies are in the middle. Gold is high risk (what if it falls back to $200?) but very high profit potential if you time the bubble and sell at the peak.

[stockstradr]

Total value of all gold ever mined is somewhere around $3 trillion at current prices. For comparison, total liquid net worth of all Americans is $30 trillion.

Yes, and the part I love is China’s $1 trillion in Forex reserves (represents a large sum relative to total mined gold)

If China ever decides a significant portion of its Forex reserves should be held in gold, we better hope we are holding gold in our portfolios and not holding dollar-denominated securities!

[drunkle]

if china didn’t drop their dollar peg prior to making such a change, they would surely be killing themselves as well due to inflation.

if they did, if china’s currency were to float… wouldn’t they also be in a mess with deflation, loss of exports, economic mayhem?

i think they’re stuck… economic mutual destruction… or fisticuffs to collect debts…

come the day that china demands the us govt accept an IMF style strict monetary policy…

[Rich Toscano]

No bubble in gold

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].

[stockstradr]

Rich,

great post. Thanks for sharing your valuable opinion!

[want a good deal]

One thing to keep in mind is the low cost of mining gold. The higher it goes the more they can spend on mining more and more and more. Unlike oil, most gold is not used up, instead it just becomes more common. I am no expert and would like to hear opinions about this.

[HereWeGo]

Just to inject a little data into the argument, here is a link detailing the demand statistics of gold.

[bob007]

look for middle class indians to buy lots of gold skewing gold prices

[HereWeGo]

That’s the key question, Bob. Forget the dollar, forget oil … if the Asian consumers balk at current gold prices, gold will tumble. On the other hand, if they find the prices acceptable, gold will remain high or rise.

Jewelry dominates gold demand.

[SDbear]

Have you seen how Indian rupee has fared against dollar? $ has lost nearly 20% against the indian currency within around a year. Gold has increased close to 15% during the same period. So demand for gold from the jewellery industry (majority of it coming from the sub-continent) from a price point of view has actually increased from mid 2006.
Much of the Rupee appreciation against $ happened during mid-late 2006. Although $ depreciated against other currencies in 2005-2006. That is the reason why gold did’nt breach the 2005 high of 720 in 2006. We have to look at the loss in monetory value of fiat currency along with the demand to understand its price moves. Currently investment demand (due to people buying gold to hedge against $) is low compared to jewelry demand (around 70% last time I checked). But this might change very soon as Rich noted. This will need central banks, individuals start putting portions of their assets in gold. Last I checked the european banks are still selling their gold reserves. But if $ keeps depreciating against rupee I think the jewellery industry can easily prop up the prices until people realise and push up the investment demand

[CardiffBaseball]

Since outsourcing development or maintenance work (Software) to India is akin to an import of services, I assume the weak dollar makes Indian Labor more expensive?

[HereWeGo]

Well, the dollar has barely moved against the rupee since July, so Indian consumers observed a rather massive runup in gold prices recently. The wedding season is underway, we shall soon see how well the Indian demand holds up.

If those economies start to slow, though, I really wouldn’t want to hold much in the way of gold. There’s no way investment demand can possibly make up for the massive jewelry demand.

[Rich Toscano]

HWG, I do not agree with the idea that jewelry demand drives the gold price.

The site you linked to details the usage of new gold supply, but this ignores the usage of the gold supply that already exists above ground. Just to put it in perspective with some numbers, the gold.org site lists jewelry demand at 2279 tons in 2006. Per the website of the LBMA, where much of the world’s bullion gets sold, the volume of gold exchanges id 562 tons PER DAY — http://www.lbma.org.uk/clearing_table.htm. The 2279 tons PER YEAR cited by gold.org is absolutely swamped by this.

Also from gold.org, we see that they listed jewelry demand in 2004 at 2614 tons, vs. 2279 tons in 2006. That’s a decline of almost 13% in jewelry demand. The gold price averaged $410 in 2004 and $603 in 2006 — a price increase of 47% despite the 13% decrease in jewelry demand. Something else is clearly driving the gold price.

To cite one other particularly glaring example, I know that gold medallions were popular in the 1970s, but do you really think that’s what drove the 20-fold increase in the gold price? 🙂

Gold’s supply and demand can’t be analyzed like other commodities becuase unlike other commodities, gold commands a monetary premium. IMHO that monetary premium is the primary driver of the gold price. Also IMHO what drives the monetary premium is falling confidence in the global monetary system and especially in its reserve currency, the dollar.

As always, feel free to email with any questions because I can’t do a whole lot of back-and-forth per my last post.

Thanks,

Rich

[babbleon]

From the Market Oracle…

Despite its higher prices of late, gold’s global supply-and-demand fundamentals remain dazzlingly bullish. Worldwide investment demand far exceeds the ability of miners to ramp up their production. And if you adjust gold’s early 1980 high by CPI inflation, it works out to about $2300 in today’s dollars. So most of gold’s bull probably remains ahead of us , not behind us.”

Market Oracle

[babbleon]

From the Market Oracle…

Despite its higher prices of late, gold’s global supply-and-demand fundamentals remain dazzlingly bullish. Worldwide investment demand far exceeds the ability of miners to ramp up their production. And if you adjust gold’s early 1980 high by CPI inflation, it works out to about $2300 in today’s dollars. So most of gold’s bull probably remains ahead of us , not behind us.”

Market Oracle

[babbleon]

From the Market Oracle…

Despite its higher prices of late, gold’s global supply-and-demand fundamentals remain dazzlingly bullish. Worldwide investment demand far exceeds the ability of miners to ramp up their production. And if you adjust gold’s early 1980 high by CPI inflation, it works out to about $2300 in today’s dollars. So most of gold’s bull probably remains ahead of us , not behind us.”

Market Oracle

[babbleon]

From the Market Oracle…

Despite its higher prices of late, gold’s global supply-and-demand fundamentals remain dazzlingly bullish. Worldwide investment demand far exceeds the ability of miners to ramp up their production. And if you adjust gold’s early 1980 high by CPI inflation, it works out to about $2300 in today’s dollars. So most of gold’s bull probably remains ahead of us , not behind us.”

Market Oracle

[Author]

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