Gold moves to next bubble phase?

Investing and speculating in gold is almost as emotive a subject as residential property, so I’ll try to keep this short and sweet.

I treat physical gold as a “Type Zero” security asset, a small insurance hedge against financial instability – a “Minsky Metal”. (I will publish an article regarding my research into the “Minsky Metal” and how I treat capital assets differently in the future)

Physical gold may have a place in a future reserve currency or SDR (most likely alongside a basket of other currencies and goods) if the modern monetary system changes, and if so, the intrinsic value of gold should increase, but this is nothing more than speculation.

When it comes to the derivative of the shiny physical stuff, I throw out all these notions and see gold for what it is: a speculative commodity/currency. I trade gold futures from time to time (only because its behaviour is very similar to my equities based trading system) and have studied its long and medium term price behaviour, correlated against other risk assets.

Most of the time, in a flight to safety during a dip or correction in a secular trend (or the current bear market rally), it is dumped alongside other risk assets as speculators move back to the USD. Interestingly, this hasn’t happened as harshly in recent “safety” events, which may show an internal resilience to the gold “bubble”.

There are (worrying?) signs that gold may be moving into the “Media Phase” of the classic bubble chart by Dr Jean-Paul Rodriguez, as seen below, which may go someway to explaining this slightly different behaviour.

If the GFC was the Bear Trap....

Mad Jim Cramer, the notorious CNBC shock stock jock, has proclaimed that everyone should have gold in their portfolio. This is usually a deathknell for stocks and other assets (although to give Cramer a break, he has been right most of the time during this crack-up boom in US stocks – but then everyone thinks they’re a stock-picking genius when everything is going up.)

Rotten Apple (Macro’s man in Manhattan) has reported before about the bombardment in the US media for retail investors to pile into gold. The Bullion Baron (my favourite Australian gold blogger) has also talked about gold’s rise in the Australian/Asian media.

The definitive main in Australian “mainstream” media, NineMSN has recently published an online article (h/t to Burbwatcher) claiming that “gold could hit $US1600 an ounce”, although the story is made up of a series of quotes from a very bullish gold investor.

The Bullion Baron (my favourite Australian gold blog) has talked about this new media previously.

From Media to Public
What makes this seemingly new media phase different to the even more bullish “public enthusiasm” stage? Similar to other speculative assets like property, you need to take care of signs that the bubble has taken hold with the crowd including:

  • almost all financial planners advocating a strong gold presence in your portfolio (and never physical, always via an ETF or a structured product) – by strong I mean more than 2% which seems to be the standard for professional investor advice
  • talk at social gatherings (e.g BBQ’s, dinner parties etc) about people buying gold, shares in gold mining companies etc online and claiming “its obvious to anyone that it will replace the dollar as a currency – you’ve got to buy some!”
  • any discovery, or possible discovery or expansion of current mining operations publicised by any gold mining company results in said companies shares skyrocketing that day (intraday moves of over 100% are not out of the question – bigger companies like KCN, NCM etc could go up by more than 10% each day). Year on year tripling or more of share prices will not be uncommon.
  • mainstream media articles explaining how even if a bit expensive, gold is now a good part of your portfolio for diversification, pointing to the lack of downward price whenever markets correct or dip (thus self-justifying the “it can only go up” behaviour)
  • charts proliferating showing gold is “not in a bubble” but rising in correlation with the fundamentals. Most of these charts will be constructed to obfuscate the exponential price rise, like the current “price-to-income has been flat for 10 years” for property.
  • more ETF/trading vehicles for gold become available for the retail investor, including built-in leverage (the “Ponzi” moment when investment banks look for as many ways possible to make money out of the bubble)

Tin-foil hat conspricacy theorists aside, have you heard or seen any of the above in great quantity or broad reach yet?

From Bull to Bubble
I contend that for a bull market to transition to a bubble, the uninformed (and greedy) crowd has to move in and bid up the prices, using “fundamentals” to justify their fear of “missing out”. This clearly occurred in the NASDAQ boom and the US housing boom of the last decade, and its peak has probably occurred already with the Australian housing bubble (although I can only hear a hiss, not a pop – I’ll let others work that one out).

The DotCom NASDAQ Bubble....

TEOTWAWKI – and I feel fine…
Just to be clear (I’m beginning to sound like John Cleese in Life of Brian) I contend that physical gold is not a speculative endeavour, as only a very small minority of people actually own physical “Minsky Metal” although its price is quoted daily at the end of our nightly news as if we all have a few ounces at home.

However, like all other risk assets, gold trading in non-physical form is purely speculative and there are clear signs that this speculation is spreading. The memes of “higher inflation” and continued ZIRP by the ECB, BOE and The Fed could provide the turning points for the crowd to step in and bid up gold to new heights, thus justifying the bubble itself.

Participants and non-participants alike need to observe the careful dynamic of psychological behaviour of bubbles and manias and take defensive (and possibly profitable) actions where necessary.

Disclosure: Regular readers know I’m a full time equities trader, but I also trade gold from time to time (usually long but sometimes short). I also own physical gold, but only as a “Minsky Metal”, and only as a small part of my portfolio. My investment company does not trade in, nor invest in gold or gold mining companies.

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  1. Prince, thanks.

    Please keep you finger on this pulse – could be the next bubble after the commodities bubble bursts (after thet housing bubble, after the stock bubble, which was after the other slightly smaller housing and stock bubble…trends, anyone??)

  2. No worries Stewart. There’s plenty of good and bad analysis of the housing bubbles out there.

    I think what we are witnessing in the form of huge volatility in asset prices are not “bubbles” per se but bad gas – after the….deposit…..left by the modern monetary credit bubble of the last 20-30 years, as better explained demographically/psychologically by Houses and Holes in his “Beware the First Strike” article.

    I have no idea what’s going to happen to gold in the long term (and no one really does), but I can’t see the current monetary/currency systems sustaining for too much longer.

    Fascinating times to be sure.

    I’m preparing an article on how I trade gold which I’ll publish in the next week or so.

  3. “Tin-foil hat conspricacy theorists aside, have you heard or seen any of the above in great quantity or broad reach yet? ” answer is NO

    In regards to a risk off event and gold i think as Australians we have a huge advantage since the AUD gets destroyed in this situation. Gold keeps making new High’s in USD and still has not reached its high from 2008 in AUD of close to $1500.

    • Agreed.

      I see the Forex effect as a real mitigator of problems for USD denominated precious metals – the conditions that bring falling precious metals are likely to also bring a fall in the AUD/USD ratio, thus dampening losses.

      My 2c at least!

      • Bingo. That’s the point; the “gold play” is essentially just a short USD play that is primarily aimed at hedging against the further US dollar weakness that is likely to accompany QE2.

        The biggest asset bubbles in global financial markets (ignoring Australian housing for a second) are US Treasuries and US Dollars respectively.

    • Thats because the powers that be are protecting the 1450 line, 1450-1500 is breached then id say 1600 is on the way not to long later.

  4. @ Prince – You said /say: “as only a very small minority of people actually own physical “Minsky Metal” although its price is quoted daily at the end of our nightly news as if we all have a few ounces at home.”

    This just couldn’t be further from the truth and I’ll give you a brief overview of the Ownership of Gold.

    1. 75% of the World’s population consist of Asians of one sort another and as well as being primarily rice eaters, culturally and traditionally, all these people – let’s say 5 billion +/- or so, buy, hold, store, give, receive, etc., Gold on a daily basis. Even what you would describe as primitive tribes deep in the jungles of the Orient and / or on the deserts – steppes and grass plains of Asia Proper, Gold attracts and holds a large demand and intrinsic and cultural value.

    Recently China encouraged its not to insignificant population to buy Gold and a fair proportion of that mined in China was set aside for such purposes. The Gold shops of China are having a hard time satisfying domestic demand due to the Raw outputs being flat out pouring bars and delivering same to their wholesale demand customers – big customers.

    Asia Gold that is purchased on the street, is either x2 or x3 9 Pure and unlike the rubbish Gold sold in Western Shops and no self respecting Asian would buy Western Gold as an investment or a Gift. Mind you, Perth Mint has a large Asian customer base for its real Gold sales and depositor accounts. Different thing altogether.

    A few years ago when China was rebuilding its nation’s Power Infrastructure, Gold was being painted onto the raw copper cables so as to dramatically reduce energy losses, of course, Gold was not so attractive then to heroes and the neo-believers cum Roubini flock.

    And, even in South America and Africa, Gold holds an attraction and is a sign and symbol of wealth. Gold is the safe haven from politicians and bureaucrats; Gold is paranoia and paranoia keeps you alive.

    Ladies Hold Gold, under their arms, in their belts, hair, teeth and in holes in trees and in the ground. In the region of south West China – from Hong Kong to and through to Turkey and beyond, Gold is in demand and will always be.

    Europeans don’t understand Gold except of course for the Germans and Suisse.

    No bubble – just No Trust/confidence in “leadership” – Gold and Silver are the hedge against that which comes… and that which is going to be felt in the harshest terms


  5. As yet “they” can’t print Gold and Price wise you ain’t seen anything to date compared to what’s to come.

    In Australia 98 out of 100 couldn’t even tell you the US$ price let alone the value in A$ terms.

    The smart asses deride Gold -it is after all anti -establishment.I would encourage all to spend the time & educate
    yourselves on the precious metals.There’s some good info out there.

  6. Prince, the bottom line is that very few people actually own physical precious metals. Only 1 in 10,000 people is actually buying silver hand over fist in the USA right now. Does that sound like a mania to you? Silverbug Jason Hommel, gives some background by telling the story that when he goes to gold and silver conventions and talks in front of audiences of professional precious metal investors, who mostly have gold and silver stocks, he asks them how many actually own, for instance, bags of “junk silver” (silver coinage, now no longer used, and often seen as the cheapest way of buying the metal). Typically, only 5% of the audience will raise their hands. Now that’s in a crowd of gold and silver bugs! Even this demographic do not have physical metal. In my street, I don’t know anyone who has any precious metals. We’re a long, loooong way from a mania.

    • I agree Sceptic as that’s the thrust of my post: we are not yet in a mania phase, we have probably moved into the “media enthusiasm” stage.

      As I said, when I go to BBQ’s (if people invite me) and they start telling me to buy silver or if on the drive to the airport the taxi drivers says he’s buying gold.

      I would consider 5% of your total wealth in physical gold is a prudent allocation – I do mine via my super, the whole balance of which I consider insurance (health) anyway. Its also a good place to get life/tpd/income protection.

      Sorry, you can take the financial advisor out of the… 😀

      • Yes, true.

        George Soros said that gold is the “ultimate bubble”, by which he meant that it will be the final asset to go ballistic, when things really start falling apart, under the pressure of (inter alia) climate change and energy (oil) depletion.

        I have a 20+ year investment horizon, and I have over 50% of my money in physical gold and silver. BTW, I’ve doubled my money in the last few years (thanks mostly to my silver)!

      • “I do mine via my super, the whole balance of which I consider insurance…”.

        Prince, depending on your age of course I wonder if you honestly believe that you will ever get to see your super?

        Over the past year I’ve read that there’s at least half a dozen countries that have either directly or indirectly confiscated (“compulsorily reallocated”) citizens’ retirement savings to date since the GFC. And lots of insider talk from other govt’s hinting at similar moves. Why would one not think it prudent to consider the same happening here in Oz?

        Already we see hints of the direction things are going, with the tenor of “public” contributions to the govt’s superannuation review. Noteworthy not only for the usual super industry lobbyings for increases to the compulsory % rate. But more signally, for the little-publicised talk about legislating compulsory allocations of super funds into “safe”, “govt-approved” investments (ie, govt-inspired infrastructure projects, govt bonds etc). After all, we can’t have more retirees and near-retirees losing a bucketload of their lifetime “savings” again, in another GFC-style stock market misadventure, now can we. /sarc

        I’m early 40’s. Seeing where this is all going, I honestly do not believe I’ll ever see a cent of my not inconsiderable super. By the time I reach retirement age (?), I’ve little doubt the government will have *incrementally* taken over all super, for “safe(r)” investment in govt-approved investments (ie, to prop up their fiscal mismanagement), and at best will be offered a govt pension commensurate with the level of my super at retirement. The option of redeeming it as a lump sum on retirement, to use as I wish, will be a distant memory, I’ve little doubt

        Being self-employed, I’ve found ways to avoid paying any super for myself at all for several years now. So I can invest my money how I choose. Not how the govt and/or FIRE industry chooses.

        With greatest respect, as an avid reader of your blogs, I think you’re failing spectacularly to see the writing on the wall if you consider your super as any kind of insurance.

      • David, I agree with you completely.

        That’s why I consider my super (actually my wife and I self managed super) as insurance in the “biblical” sense only. i.e we are not going to rely upon it for our retirement. Not one cent.

        We use it whilst we can to pay for non-disposable income things like Life, TPD and income protection insurance and of course some “exotic” insurance like gold and eventually – property. Agricultural property actually….there’s also the 5% in-house assets rule that I use to my advantage, and I use my SMSF as a testbed for trading and investment strategies, instead of tieing up scarce non-super capital.

        I do not put an extra cent into super for exactly the same reasons you outline. Sod the “tax advantage” I’d rather have my money in my back pocket (minus a larger percentage, sure), but its mine and I can allocate it how I want.

        I have seen the writing on the wall as well with the “MySuper” campaign – a public/quasi private “choice” to dump your super into a select fund at low cost – I can see that morphing into a “no choice” option, particularly as revenue declines and expenses increases.

        So what I mean as “insurance” is exactly that – not for retirement or wealth building. I’m in a similar age bracket to you and have similar doubts that it will still be there in 20/25/30 (who knows when the preservation age will be lifted again?)

        The most I can hope that our super becomes is an “old age health insurance” fund – but by then I even doubt my ca. 15-25% average annual returns in super will be enough to cover healthcare!

        Thanks for reading btw.

        • Ah ha. I’m with you now. Thanks for clarifying what you meant by “insurance”.

          And a very hearty “thank you” indeed for sharing re your SMSF. You’ve got my attention with the comment about agricultural property. I simply didn’t know there were ways that you could do that with your super. This is *exactly* the sort of thing I’d like to do myself.

          Any info you can steer me towards on this? I’d actually been pondering getting into ag property with some non-super capital for some time now. If using super is an option, both I and my business partner may well be keen.

          In fact, how about an article (or series) on this topic area?

          Since we are of like mind concerning the end game, I hope you’ll agree that blogging on this could help to alert and save thousands of fellow Aussies (and others) from the caring, helping hand of the government. Most people I know have no clue at all as to what is *really* going on in the world of superannuation “reallocation”.

      • No worries David, I’ll make some notes and thoughts about a series on super.

        The subject of non-Boomer superannuation is a pet area of mine.

        You can buy property in super using a property warrant. You need an LVR of no more than 60% (last time i checked). Its usually used for business owners who buy their own business premises in super, and then their business (usually owned by the family trust) then leases it back.

        The lease payments pay down the mortgage – which is almost always positively geared (or helped with SG or SS contributions).

        Big risk there of course – but you can do the same with agricultural property, which I consider a Type Zero (plus) security asset, particularly in Australia, as we have this thing about building McMansions on prime ag land, whilst we farm the crap out of marginal land at high cost….WTF?

        We’re considering ag property in NZ, my No.1 preferred retirement spot. There’s a variety of reasons for that and I think you know why….

        • Excellent. Thank you again for this. I’d vaguely heard about buying business premises using super, but no idea how, and was never interested in commercial anyway. But if ag property is also possible, then I’m absolutely all ears.

          I’m having a “twilight zone” moment over your mentioning the (IMO criminal irresponsibility of) McMansions on prime ag land, and, NZ as your preferred retirement spot. For the past couple years I’ve increasingly been contemplating getting out of dodge and heading over the pond myself … far sooner than “retirement” age. But for now I’m also interested in WA. I’m partial to the fact that WA is the only state that can secede from the Federation. Given its natural riches, and the parlous state of every other state’s structural financial position (not to mention the dearth of IQ points in state politics), I’d not be at all surprised to see circumstances where WA invokes their option to go it alone at some point during my lifetime.

          Very much looking forward to your series on super. Rest assured I will make a point of publicising it far and wide. Forward-thinking, prudent, *contrarian* super information/advice is desperately needed by all Aussies, IMHO. And I know from personal experience that we will never get it from the super “industry”, or the govt, or the plethora of “conventional” financial advisers and TV talking heads.

          An anecdote – in early May 2007 I met my (at the time) super fund “manager”, as I wanted the lot switched to cash. To date I’d not taken much interest in my super, believing I’d never see it, but felt I should at least try to be responsible with it anyway, given I could see the crash coming. He brought along a new associate, aiming to con-vince me to switch into one of *his* portfolio of fund options. Bloke actually had the hide to get the sh!ts and have a tantrum when I insisted that I was not interested, wanted to be in cash-only, and the reason was that I was convinced the global equity markets were going to tank. Naturally he said I was a nutter. Felt wholly vindicated when US began to roll over literally a matter of weeks later (June), came back some thru Nov, then dived again into March and Bear Stearns. And we all know the story from there.

  7. Hi Peter, thanks for your insight.

    You answered your own criticism: you didn’t mention ‘Strayans in your reply.

    Apart from Jewellery (I note here that my wedding ring – size V – has doubled in value since I got married – maybe I should have done later earlier?), most Australians have no physical gold as part of their portfolio or for hedging/insurance.

    I (and Bullion Baron) are watching Chinese gold demand too – its not just because of the leadership instructing the citizens to buy it (and I believe this is the no.1 customer base of the Perth Mint).

    You are quite correct about the Non-germanic Europeans: they all see it as a barbaric relic, and that idea has been passed on and through the Anglo-Saxon/English speaking world for the last 30-40 years.

    But in barbarous times, barbaric relics should do well…

    • China is the world’s largest gold producing at the moment, and the Chinese government is buying gold in huge quantities, even importing it. Earlier this month UBS published a report saying China imported 200 metric tonnes of gold in the first two months of this year, which suggests an astonishing and bullish restructuring of the physical market.

      • The seekingalpha article is flawed at its heart. The author says:

        the rapid price increase in gold over the past few years is due to mounting fears over currency, poor investment alternatives, and the lack of stability in just about anything else – among other things.

        In fact, the underlying reason for the rise in gold and silver, and the purchase and re-purchase of gold by governments and central banks, is far more profound. Any intelligent person should be able to see that there are profound implications not only in the intemperate creation of vast amounts of fiat currency, but even more so in the looming climate and energy problems humanity is only now starting to face.

        At the moment, 19 out of 20 people will either deny climate change and peak oil, or be ignorant of these monstrous approaching calamities. Can you even begin to imagine what will happen in the decades to come as these dilemmas become plain for all to see, and as they wreak utter devastation on equity markets?

        We are living in an amazing time when people have the opportunity of investing in dirt cheap real money, the precious metals. This opportunity will disappear in the coming years, so that only the super wealthy are able to invest.

        I’m as sure of this as I am of anything in this life.

  8. More bubble talk.

    With the song & dance about the distorting effect of ‘easy credit’ on real estate on this blog, you would think that some would clue in to the fact that bubbles are a credit phenomenon.

    That is, it is not houses per se that are a bubble but mortgage credit.

    Gold is not credit, it cannot be a bubble. Gold is money, it is the $ that is the bubble, since the $ is the obligation of its bank of issue.

    • JMD, by and large bubbles are a phenomenon of easy credit, although there are some older historical examples where it was just plain greed (and happened during “sound” gold/silver standards of the day).

      Gold can be in a bubble if the market in which it is traded is used as a derivative over the real thing, regardless of the credit creation behind it.

      You are quite correct that the physical tangible of that derivative – e.g houses and physical gold – is not in a bubble, or changing (much) in intrinsic value.

      For example, almost every Australian house is 20-40% above intrinsic value, but they are no different (except for very small hedonic changes) to 5 or 10 years ago. The same applies with gold (but not silver – and you know why!)

      Look, I’m sympathetic and my inner tin-foil hat tells me you and many others are onto something – either the reality or the perception of easy money is stoking the fears that currencies around the world are being debased at an exponential rate, whilst gold production goes up at around 2-3% per annum (and world population at a slightly lower rate).

      The charts in this article: show an obvious trend and a possible “end game”, but that is still speculation.

      Gold is not (yet) money, as it has to be transformed into sovereign currency to be used in transactions.

      Until gold “becomes” money, and whilst derivative markets exist, it can be in a bubble, just like any other asset.

      • Gold and silver have been regarded as stores of value for about 5,000 years. They still are, and always will be.

        Energy is becoming scarcer and the consequences of using energy (fossil energy) are increasingly dire. But in order to get gold and silver out of the earth and into compact, concentrated form, prodigious amounts of energy are required. Cam you see where this is going?

        I don’t want to have to spoon feed, so I’ll end here.

      • Spoon away Sceptic!

        Unlike most other gold sceptics – who, using the failed MPT/EMH approach reckon that gold has no value because it has no yield, I contend that you can actually calculate an intrinsic value for gold.

        You’ve hit it on the head how that works in terms of labor, capital and refinement – this all “costs” something, and that’s the intrinsic value.

        What that exact figure is, nobody knows, because like shares, we all have different levels of required return from the speculator to the miner to the refiner to the distributor.

        Silver is quite different because of the vast industrial uses for the metal (at current or any price) that go beyond its utility as a currency, and its scarcity compared to the above ground supply of gold (which does not deplete much if at all year to year.)

        • Silver is special. There’s less silver above ground that gold, and we are past peak silver with the USGS saying we are now looking at the last decade or two of mineable silver, and there’s going to be no reclamation or recycling of silver that’s been used already.

          Silver has a special place in the future. It’s in solar panels and used in the best solar thermal reflectors for concentrated solar power, because it’s the most reflective and conductive metal on the planet.

          In 2009, scientists at the National Renewable Energy Laboratory (NREL) and SkyFuel teamed to develop large curved sheets of metal that have the potential to be 30% less expensive than today’s best collectors of concentrated solar power by replacing glass-based models with a silver polymer sheet that has the same performance as the heavy glass mirrors, but at a much lower cost and much lower weight. It also is much easier to deploy and install. The glossy film uses several layers of polymers, with an inner layer of pure silver.

          There is going to be a humongous solar renaissance in the next 30 years. See where this is going?