The ‘gold bubble’ meme

Some folks just don’t get it. According to The Intelligent Investor at the SMH today, gold is approaching its top because:

“a German company, already with operations in Europe and the United States, was brining a ‘gold-to-go’ self-service machine to shopping centres, hotels and airports.

Everyday shoppers and travellers worried that modern economies were on the brink of collapse could readily assuage their fears as they head out for a juice and croissant.

Surely gold vending machines are a classic sign of a market top?

Secondly, miners are starting to announce bonanza profits. Newcrest Mining, Australia’s largest gold miner, recently posted a record full-year profit, as did OZ Minerals. When oil hit its peak in 2008, energy firms announced similar sized results.

Thirdly, more money is now going into gold exploration than any other commodity. Combine points two and three and there is a high risk prices could fall, certainly higher than most imagine.

That doesn’t mean the bull market is over. In the prior bull market, gold prices fell by 40 per cent and 50 per cent before ultimately reaching an peak and popping.

I have no doubt this run will end in a similarly spectacular pop. But who’s to say whether gold at $US2000 an ounce is closer to the beginning or the end of the cycle?

There is no rational analysis to make either case, which means investors are acting more from instinct and emotion than anything else. And that rarely ends well.

No rational analysis? It’s really quite straight forward and rational. In modern markets, gold is the only alternative when the tools of macro-economic management behind the world’s reserve currency cease to function. When the relative pricing mechanism for all commodities reaches the zero bound, the printing press is all that remains. When fiscal policy ceases to function as well, then that only places more emphasis on failed monetary endeavours. And the entire structure of currency management appears broken.

The cause of the dysfunction is debt. Until there’s some resolution to the debt weighing down the economy behind the world’s reserve currency – either a grand bargain with creditors or a write down at the point of a gun – then the problems will continue and gold will flourish.

That is not a reiteration of the old gold bug love song  that the yellow metal is some plateau of perfect value. It is a common sense recognition that that’s how markets see things. What is irrational about that?

Houses and Holes
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Comments

  1. Until the current mess is dealt with (they have no fixes) any pull backs are just healthy corrections before the next leg up IMO

  2. I find this article contradictory. Over many months you have presented us with excellent facts and figures proving housing is overpriced. Yet when it comes to gold you provide no facts and figures just your own personal opinion.

    In the last decade Gold has gone up more than 500%(?) which is a hell of a lot more than property. Surely if the gold bugs are correct in money becoming worthless and inflation exploding then houses are undervalued, and in fact much better value than gold?

    • Think about the gold price this way: it’s just the opposite of the USD.

      The more of something that is produced, the lower its value, right?

      USD production is in a bubble. So gold keep rising, because it’s the flipside f USD.

      The AUD price of gold is not as clear-cut as the USD price, because we have the additional factor of the AUD/USD exchange rate to consider.

      AUD gold = USD gold divided by AUD/USD exchange rate.

      (So, if you think the AUD will fall against the USD, and if you like gold, you should buy AUD gold rather than USD gold).

      • If money becomes worthless then the price of gold will reach infinity. But, before money becomes worthless a new system will be introduced. It will be a system where gold partially backs currencies.

    • Fair point. But the fact there is no way to intrinsically value gold does not mean its a bubble. Gold is a hedge against an unstable $US. That’s all. My point is that so long as it remains unstable, gold will go up.

      As GG says, gold is a way of measuring monetary chaos. That’s not easy to value but my point is it’s obviously going to get worse before it gets better.

      • “obviously”

        dont be so sure, Mr Market has a way of upsetting ‘sure-things’

        some measures of ratio between Dow/S&P and gold provide some valuation

    • “Surely if the gold bugs are correct in money becoming worthless and inflation exploding then houses are undervalued”.

      I often think about this. The gold price seems to have already factored in significant inflation. What about the deflation scenario? When it comes to house prices the commentary here seems to favour debt deflation. When it comes to gold, general inflation.

      As far as I know, the gold to house price ratio is not that far from historical averages so an article explaining the two seemingly contradictory points of view would be useful to a novice like me.

      • Don’t fall for the mainstream trap that gold only rises because people expect inflation. Gold is rising because of an international loss of faith in fiat currencies, which are not backed by anything except faith.

        It is very likely that we have deflation in house prices in Australia (due to households cutting debts and credit growth slowing) and inflation in consumer goods prices (due to increasing commodity prices, which are caused by the deluge of USD printing).

        I don’t know what value there is in looking at a gold to house price ratio. House prices are a function of credit growth. Gold prices are a function of loss of faith in fiat currency. So, the drivers are different.

          • Given your expertise, I’m sure you have figures for Australia on the current value of the housing stock and maybe the amount of debt associated with it.

            Not sure if there are any figures for the amount of gold held for investment/safe haven purposes by Australians, but international estimates are that gold is about 1% to 1.5% of total financial assets.

            Let’s guess that Australians hold 50x to 100x more in real estate than they do in gold. If that’s right, then even if it was leveraged at 10:1, that’s not much debt supporting gold compared to the amount that supports houses.

          • Of course the other factor is the fact that a lot of people are expecting deflation in what you own and inflation in things that you need. i.e a reverse of the great moderation. Their words not mine.

            Inflation and deflation are not mutually exclusive. Deflation occurs on assets that were bid up by debt, inflation occurs on prices that were suppressed or received no credit in comparison.

            In other words it could mean another scenario – that prices are equaling out between assets again and the imbalance that is debt to the prices of goods and assets will slowly be addressed.

          • GG

            but atleast a house is useful, i get the gold = store of value but its practically useless, it only has value in that enough people perceive it as value

    • Hi Freddy, the issue with comparing houses and gold is that gold is a transferrable/transportable store of wealth, where as housing is not transferrable/transportable. Sadly housing has been converted over the last 30-40 years into an area of speculation rather than a store of wealth. With the modernization of our financial markets, the same is happening with gold. Personally I believe gold is a great store of wealth, but is progressively being turned into just another speculative asset.

  3. I’m still finding gold as an asset class quite an interesting study.

    I think analysing the price of gold in terms of mining profits and the amount of exploration/new mining supply coming online in particular misses the real point – which H&H highlights.

    Gold is currently an ‘Armageddon’ investment. Forget any supply/demand fundamentals – as long as global governments keep running unsustainable deficits, and as long as central banks turn to monetary policy and quantitative easing in an attempt to inflate away the debt and provide some economic stimulus, gold will continue to go up. Once policymakers stop trying to bandaid these problems and attmept to find real, sustainable long-term solutions, that’s when the ‘gold bubble’ will burst. Actually another question just popped into my head – is it a gold bubble, or a fiscal/monetary idiotic policy bubble that we’re in the midst of?

    • When do you expect politicians to start trying to find sustainable, long-term solutions? If you can pin-point that timing, then you’ve found the time to sell your gold.

      Your last sentence/question hits the nail on the head.

      • the large expectation of the public for politicians to ‘fix’ things is part of the problem. Blaming policymakers for the mess we are in but not taking any responsibility ourselves is almost a systemic belief in society.

        While we grant policymakers to solve our fiscal/monetary woes the current trend of cheap dollars, bubble-nomics will continue and gold may well keep going up. If concentrated power in economic matters cause the problem how will it fix them?

        People seem to forget economies arent created by the manipulation and brainpower by politicians/academics..

    • I agree that gold is an ‘Armageddon’ investment. Its always been a safe haven, but in these days of a looming Eurozone crisis and endless money-printing in the US, the risks of financial Armageddon seem much more likely.

      What I find weird is that gold often rallies on “risk on” days as well as “risk off” days. I suspect that’s because most risk on days are due to news of more money printing than positive economic news.

      Regardless, I think gold is driven completely by sentiment — fear and greed — I don’t think current prices can be justified by gold’s intrinsic value to humanity. Sure its rare, but you can’t do a whole lot with it, except stick in a vault somewhere. You can’t burn gold, and you can’t eat gold, so why do we treasure it so?

      Lets face it, if aliens landed tomorrow, they’d have a hard time figuring out why humans had all this gold locked up in vaults all over the place!

      • “Lets face it, if aliens landed tomorrow, they’d have a hard time figuring out why humans had all this gold locked up in vaults all over the place!”

        NO! They would not! They would have a hard time figuring out why it isn’t freely tradable as gold money and why the merchants of debt money are not locked up in vaults (gaols, jails) for crimes against humanity.

        • Actually, they probably wouldn’t find much at all if the fractional bullion banking of 100:1 is really in operation 🙂 You have to wonder why Ron Paul has been unable to audit the Treasury’s gold all these years.

          Even Ben say gold is a financial asset so you can convert it to money, and that has been done in the Greek bailout. Lots of examples of gold being used for money, and you can buy food with it.

          Even the IMF have gold in the proposed SDR basket for the next reserve currency, and the G20 have discussed it quite a lot lately.

          I don’t know all the details on gold, but it does have a monetary use or if you prefer a financial asset use, and it’s used by many Central Banks. They just don’t want you to know about it and that is a problem. It’s being traded in many ways by countries that don’t trust USD’s, the BIS acquires it and uses it.

          At 1% of global financial assets it gets a lot of press for something that many claim is worthless. It’s clearly worth something. If it’s worthless then why does the US Treasury have 8133.5 Tonnes? And total CB stock of 30,562.5 Tonnes and growing. Why do many Investment Banks hold gold? etc.

      • “if aliens landed tomorrow”

        They wouldn’t have time to go sight seeing gold vaults. Julia has already budgeted their time in, and they will be working on the clean energy australia innitiatives.

      • “Lets face it, if aliens landed tomorrow, they’d have a hard time figuring out why humans had all this gold locked up in vaults all over the place!”

        I have to agree, its just a rock. If someone can tell me why it has any value expect that we say its value then feel free.. its scarcity seems to be its only quality/inability to counterfeit

    • You can’t eat it. You can’t drink it. You can’t screw it. You can’t wipe your behind with it. It won’t make you better if you’re sick. It won’t keep you warm or move your car. Someone else can physically take it away from you during a period of civil unrest. Gold is certainly not an armageddon asset.

  4. Gold is tricky for a lot of people because of the ‘intrinsic value’ argument. yeah, just like paper money there is little ‘intrinsic’ value in holding gold. However, there is a history of gold being valued by humans for whatever reason which goes back as far as anyone can remember.

    This is obvious when you realise that the amount of gold in circulation/storage is many multiples of the annual production and most of the gold that has been mined in human history is still being stored by humans. This is unlike any other commodity, which is simply mined to be used.

    So for whatever reason, without applying any logic, gold is seen as having ‘value’ purely because it is a shiny sun-like metal. Hence, in our collective conscious, it is seen as a safe-haven.

    Equating gold prices to property or oil bubbles ignores these fundamental issues. Gold isnt a bubble because people are trying to profit in the future, gold prices are rocketing because people are trying to protect their wealth and historically gold is the way to do it.

    So its a bubble based on a lack of trust of everything that isnt gold, and in trying to protect capital. a lot of economists need to take their data blinders off to understand this.

    • +1

      Loss of faith/trust and debasement in current the system inversely drives the relative price of gold up.

      Conversely, the proper valuation and treatment of the current system and wooing of faith/trust inversely drives the relative price of gold down.

      People are simply not used to the system being in the state that it is: living-dead; zombie-like.

      Consequently, they do not understand that the vast majority of their valuations are largely irrelevent, as they were/are mostly developed and calibrated in the context of “Faith in system = TRUE”; whereas now, “Faith in system = << TRUE" (and even "FALSE"), such that the most significant parameter – the Philosophical Faith/Trust parameter – is far from what it used to be.

      Hence, it's a whole new ball game, and the "old rules" (of the last century or two) don't apply nearly as validly anymore; the Philosophical context has changed, rendering the nearly invalid.

      My 2c

  5. H&H, it’s a good point. Unfortunately most gold bugs don’t accept that gold is not money (it’s a store of wealth). I think a lot of bubble-scepticism is a reaction to the Ron Paul/ Austrian crowd who would have us go back to the gold standard. But yes, so long as reserves around the world recognise it as valuable and more of the paper stuff fills their balance sheets it will go up.

    See Barry Eichengreen’s awesome debunking of gold as sound money:
    http://nationalinterest.org/article/critique-pure-gold-5741

    • Ron Paul actually wants competitive currency (ie the abolition of a state’s monopoly to print currency, abolition of counterfeiting laws etc), not necessarily a gold standard. He states, however, that historically gold and silver have been the two commodities that have best satisfied the requirements as a store of wealth. They arent necessary, though, to back sound money. Anything that the market deems valuable could be used.

      There’s a small but important distinction there.

  6. Depends how you measure gold. If you measure it in paper $ then you could consider it to be in a bubble. However if you consider it in terms of the energy surplus that it holds, then it could be fair value.

    http://www.economist.com/node/11436159

    All metal extraction requires energy. The more pure the resource, the more likely it will be extracted first. If future metal resources are the smaller, harder to extract and lower quality, then the amount of energy to extract is going to be more.

    If you wanted to store ‘energy’ for the future, its probably easier/legal to store bars of gold in your backyard, rather than barrels of oil! This assumes of course that someone will still want your gold in the future…

  7. The point made in the Intelligent Investor article was that there was rational way to tell if gold had reached a top, as people had been calling the top of gold for a long time and at many different price points.

    Far from ‘not getting it’ the article, in full, was quite sensible. My understanding of the arrticle’s argument was that, for an asset class that produces no income, it is difficult to provide any rational analysis of what the price of gold should be. Therefore, it is difficult to call a top because the price is set purely be demand (rather than having an earning capacity, which may serve to anchor valuations).

    All we can do in these circumstances is look to markers or events that might suggest there is/isn’t a top. It sounds to me that you’ve written off the article without appearing to understand the argument.

    • No, I got it. But the article also clearly suggested a top was in the offing and it had no conception of what drives the value of gold.

      Also, the point you highlight about the difficulty in finding a value with no income stream, was made last week here by The Prince so that doesn’t predispose me to the piece either.

      Actually, the more I think about it the more obvious it becomes that this is a bald piece of plagiarism.

    • Cash as an asset class in most western economies is not producing any income (Zero or negative interest rates). That I think is the main cause for the price of Gold what it is today.

    • It is true that it is difficult to provide a rational analysis of Gold. But I think it would be a lot easier than trying to do so with fiat money which is too only got value due to desire/demand for it.

      It is the nature of all money – it has no use of its own and can’t/should not be consumable. i.e it’s only use is a way of keeping account (i.e I worked so this is my credit for working). The only reason why it is valuable is because people still have faith that it is a system that properly “keeps account” and other people see it as this too. In other words it isn’t the money that’s valuable – its the work required to gain that unit/credit. Easy counterfeiting by any player destroys the value of my work. Once I lose faith in it as a store of my labour and work I will no longer want to work for it and it will lose value.

  8. +1 H&H “And the entire structure of currency management appears broken.” So true.

    And

    “The cause of the dysfunction is debt. Until there’s some resolution to the debt weighing down the economy behind the world’s reserve currency – either a grand bargain with creditors or a write down at the point of a gun – then the problems will continue and gold will flourish.”

    There is a lack of faith in the USD, and gold isn’t going up as such, but the USD is going down. There is fear that the US is one way or another won’t honour it’s debt. The FED is hoping to inflate the debt away, but even if that did work, and it’s currently not working, it’s going to take a long time, and given NO fiscal solutions just how will the US pay it’s debt the greater debt/GDP increases?

    Ok the market is rushing into US T’s as well, but it’s out of necessity not because it’s makes good sense economically.

    Gold lives off fear, and we have an abundance of fear right now with not much political, and fiscal honesty from any major government.

    The people of the world are going to get slimed because the politicians/bureaucrats we trust to manage our nations and economies are not up to the job.

    Again gold is 1% of global financial assets so even at USD 1822 gold can’t rescue the debt. Total Central Bank Holdings (alleged) 30562 Tonnes = USD 1,790,239,442,600. I think total private gold is about 40,000 Tonnes.

    I don’t know the answer, but there have been lots of stories like re-value the reserves in some sort of reset so ??

    The US has about (alleged) 261492025 oz so for a national debt of 14 Trillion they need gold at about 54,000/oz.

    Interesting info of the Chavez story..could be gold bug spin however:
    http://www.goldmoney.com/gold-research/gold-politics-and-venezuela.html?gmrefcode=gata

  9. Gold is an alterative currency – people need to stop seeing it purely as “another commodity”…and even more so, gold (precious metals generally) is a “non-current-system” call; it is taking your ball and going home because you are no longer happy with the game. It is not necessarily “anti-system”, but is it is an “opt-out” to a large degree.

    ie. people go to gold (precious metals) when they are losing faith in their current non-gold system.

    Therefore, the price of gold reflects the level of faith relative to the faith in the USD-based system (ie. the current status quo).

    Hence, it is easy to pick when a gold bubble forms: when the rational “exodus” from the current system becomes a mass flight to safety.

    And, hence, it is “easy”, so to speak, when the gold bubble pops: when it is both good and safe for the masses to re-enter the system, so they do. And that will not occur until the system gets its act together (which I personally think is quite some time away).

    My 2c

  10. Top is easy to pick, just wait until the last gold mining co declares “unhedged and completely exposed to gold price upside” then watch the price crash.

  11. Until we see debt problems resolved in the developed world, I think we will see corrections in gold, but not the top. As others have posted here, once debt issues are addressed seriously, then I would think we would see a top. I’ve seen some stats from Casey research that show the us govt could cut 100% of all non interest expenditure , but by 2020, they will not be able to meet their interest payments, let alone their social commitments. what we will see as we get closer to a resolution I don’t know, but some sort of financial/debt reset would not be out of the question. Isn’t this the final design of fractional reserve banking, eventually the interest compounds until it can’t be paid off? What then? A debt jubilee ? It seems the run to hard assets is as a place to hide out while all this is settled.

  12. I understand that some US States accept gold as legal tender.

    Another issue – the CME and Shanghai raised the margin requirements for gold & a bunch of other things last week. Remember when silver did its’ big crash about the end of June? – partly precipitated by an increase in margin requirements.

    However, while the World’s financial system is this fragile, I don’t think gold is going anywhere but up.

    • May I add, a banknote was a promissary note of gold or Silver as an alternative (note the term ‘pound’) and silver coins were just that.

      Fifteen oz of Silver SHOULD equal One oz of gold.

      Challenge: find Silver bullion to buy. Its almost out

      “There is some uncertainty as to the origin of the term “pound sterling”. Some sources say it dates back to Anglo-Saxon times, when coins called sterlings were minted from silver; 240 of these sterlings weighed one pound, and large payments came to be made in “pounds of sterlings”.[9] Other references, including the Oxford English Dictionary, say a sterling was a silver penny used in England by the Normans, and date the term to around 1300.”

  13. “Gold is an alternative currency…”

    This is stretching it a bit. People buy gold because they think it is going to rise in value (that is, value as expressed in terms of USD, Euro, AUD….or some other real currencies, which you can actually use to buy things, employ people, pay taxes and use to enjoy yourself with).

    The opportunity cost of holding gold is extremely low at the moment, and will remain so for a considerable time, so it is not a big deal to put some cash into a speculative “asset”.

    Once the opportunity costs of such holdings begin to normalize – and they eventually will normalize – then the appeal of gold will diminish.

    Holding any currency entails forming a view and taking a bet about the future. In the case of legislated currencies, the bet is that governments, central banks, households, businesses, the financial markets..the whole apparatus and set of market processes…will continue to produce goods and services and satisfy the wants and needs of the population.

    When you buy gold, you are basically applying a discount to the future productive potential of the real economy. This is a short-term and highly speculative bet, and one that gold-buyers should be prepared to lose.

  14. The dollar ‘price’ of gold is not understood by the masses because few people care to undertake the vast and far reaching study that is required by the normal individual to come to terms with the factors influencing gold. If you don’t have the time of day to inform yourself….just buy the dips and sit tight.

    • “just buy the dips and sit tight”

      probably the worst advice, seems like your married to your bias

    • The recent run down is already shaking out some of the weak hands.

      Don’t ever forget somebody was selling into this boom in prices. They had gold and don’t presently want it. That includes me.

      An interest rate rise in the US will kill the gold price. This would make the bullion banks and other shorters happy. Some of them are notorious for having the ear of government.

      A decent fall now is required to make this a good investment IMO. Not these little BTFD dips either.