When it becomes difficult to find reporting about the gold price like this commentary($) by Mark Williams in the Financial Times (alternatively, here), you’ll know that we’re near the end of the secular bull market that is now just ten years old, but, until that time, the prevalence of this type of thinking toward the metal – the fundamental misunderstanding of the historical nature of money and hubris on a grand scale regarding the monetary system that is now in place (which, in itself, is both remarkable and naive given what’s happened over the last few years) – then, you know that gold prices have much higher yet to go.
Few silver linings when gold bubble bursts
Beware of bubbles. Tulips, the dotcom boom and pre-credit crunch real estatehave a lot in common; they are assets that were in vogue, became overbought and eventually fell to earth. And now it’s gold.
Historically, two-thirds of gold demand comes from the jewellery industry and from countries like India and China. The remaining demand is generated by investors, manufacturing and the dental industry. But over the last four years, gold has staged a spectacular price rise and won many new investors. Everyone from hedge funds to individuals has jumped in, seeing gold as a way to improve portfolio diversification.Today portfolios often allocate 5 per cent or more to gold. A decade ago such an allocation in sound investment circles would have been heresy.
Well, tick off “List of prior asset bubbles” for this anti-gold rant, but, for some reason, this piece is missing the most important argument against the metal that is now an industry standard – gold earns no interest and pays no dividend.
For that reason alone, this is a sub-par anti-gold op-ed…
As for investing in gold over the last decade, this is a case of conventional wisdom often being wrong because there is clearly an inverse correlation between investment soundnessand investment returns, a reality that still hasn’t penetrated the thick skulls of some.
The 2010 gold bubble is fuelled by a combination of five main factors: historically cheap cost of borrowing, a prolonged bull market, early profiteers, marketing hype and the risk being ignored. Investors claim that the current market high of $1,380 an ounce is not overpriced, but a reflection of global economic uncertainty, high unemployment and a decline in currency values. Gold is acting, as it should, as a hedge.
What about the 2006 gold bubble and the 2008 gold bubble and the mini-bubble in 2004?
See this chart for more on this subject but, really, how can you keep calling something a bubble if it keeps popping and re-inflating. That’s more like a balloon, isn’t it?
Investors also point to the 1980 bubble, when gold peaked at $850 an ounce and plummeted by 60 per cent in one year, as an aberration. Inflation was then over 13 per cent and short-term interest rates were above 16 per cent. Today none of this exists.Gold enthusiasts note the 1980 pre-bust price in today’s dollars and say gold must climb to $2,100 before hitting such dangerous levels. But such logic is flawed in that it assumes that 1980 is a good benchmark for the future.Ignored is the 20-year period from 1980 to 2000 when money invested in gold was dead money.
Partial credit is awarded for calling gold “dead money” for twenty years, however, that would have been a perfect opportunity to stress the “no yield” Achilles heel of the metal. Up until just recently, that would almost always deter a new gold investor.
Now, I don’t know about others, but the 1980s gold move sure looks like it was a bubble to me – from $400 an ounce in December 1979 to $850 by the middle of the next month and then back down to the $400s by March. But, we’ve not seen anything like that over the past ten years.
(Note to Self: When gold doubles in just over a month, SELL!)
Despite their human origins, most bubbles are not easily spotted until it is too late. The dotcom bubble took four years to burst; the real estate bubble six. The last speculative gold bubble, in 1980, took four years to implode, while this latest reincarnation is seven years in the making. This bubble will likely be pricked only when economic outlooks improve and unemployment figures in countries like the US drop below 8 per cent. This might come in 2011, but it could take much longer.
What is so funny about reading gold commentaries like this is that some are so eager to call gold a “bubble” after first stocks and then housing, but, this is the third or fourth time in the last eight years that they’ve been calling gold a bubble, only to then see prices correct and move higher. Shouldn’t they be catching on by now?
It was a bubble when it crossed $500 an ounce, then again at $700 an ounce, then at $1,000 an ounce, and now again at almost $1,400 an ounce. Of course, gold bubble spotters will eventually be right … someday.
As for the conditions of the gold bubble bursting, there is a fundamental misunderstanding here about what is likely to happen in the years ahead. What we are seeing right now is likely just a warm-up to what is to come because, if the central banks of the world are successful in creating a sustainable economic recovery, it is likely to be one where inflation runs out of control for some period of time.
If there is a silver lining to this bubble, when it does go bust, and gold prices plummet, it will be a sign that the global economy has snapped back from economic chaos to prosperity. This will signal job growth, stable currencies, a stop to US Federal Reserve quantitative easing. Then there will be little reason to own gold. In the end, speculators will relearn an age-old lesson: gold in times of financial stability is hazardous to investor health. Like tulips, it is pretty to the eye but does not provide lasting sustenance.
There will surely be another 1980s style gold bubble some day, but that will likely only come after we’ve let the inflation genie out of the bottle again (something that the Fed would desperately like to see now) and, as was the case for the late-1970s gold bubble, the late-1990s stock market bubble, and the mid-2000s housing bubble, investors are emboldened by higher interest rates when they first begin to rise.
Unfortunately, once that happens, interest rates will have to rise even further and faster and we’ll come to the sad realization that some economies in the world can’t handle the kind of tough love that Fed Chief Paul Volcker dispensed in 1980s.
It may get a little ugly after that…
