Gold is a bubble?

[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…

[sjk]

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

Now you have 🙂

Regards,

[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

[Author]

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