Is Gold in a Bubble?

I love Economics! It’s like a puzzle where I get to put the pieces together and then get to see the big picture. It makes me understand the principles of Free Market Capitalism, the causes of economic depressions and how they could be avoided (if only governments and central bankers stopped thinking they can control everything.) It also helps me understand how fiat currency destroys wealth and brings on poverty, and the peculiarity of the fractional reserve banking system that enables central banks to create money out of thin air.

One of my favorite professors of Economics is Krassimir Petrov. His lectures are fun and he uses logic and common sense approaches. That’s quite unique for a professor of economics, but that’s why I like him. Throughout my journey of discovering the basics of macroeconomics I also learned to be a better investor. Knowing and recognizing the symptoms of the Boom/Bust economic cycles helps me put together a better investment strategy. I now know that there is a direct correlation between the economy and our investments. A successful investor is a good planner; and a good planner is an educated forecaster. I also prefer to be fully educated on ways to invest before allowing an “expert” to handle my money. Sadly I have been exposed to financial advisers that had little to no knowledge in the field of macroeconomics.

Speaking of economic bubbles I have heard all too often many saying “gold is in a bubble and is due to burst”; that “its price is inflated and is not going to last. Therefore I shouldn’t invest in gold.” Of course, if one is to look back in time at the 1970’s gold charts they’d be quick to conclude that we are now experiencing similar times. Indeed in 1971 when Nixon took the dollar off the gold standard the value of gold rose against the dollar that was plunging. Gold had a bullish decade followed by two bearish decades, when the dollar gained strength, lots of strength. The prosperity America gained during the last two decades during the past century enticed the world’s central banks to acquire dollars in reserves. Thus the whole world wanted our dollars causing its demand to rise against gold. Yet few economists at that time paid attention to Murray Rothbards’ theory of how bubbles come to life. A bubble, simply put, is a camouflaged inflation of assets. As explained in my previous article Economic Bubbles 101 it is the expansion of credit and money supply that is at the root of the bubble formation. This event is not a normal cause of a free market’s law of supply and demand but a result of a fractional reserve banking system that allows the Central Bank to lend more than they hold in reserves by creating an artificial supply of new credit and money. In conclusion the prosperity America enjoyed was an artificial one that burdened our country with excessive debt.

After the NASDAQ bubble burst – during the very early 2000’s – a few classic economists and investors that followed their advise recognized that gold was starting another phase of appreciation against the dollar. It has now been a decade since gold has been rising against the dollar and many think it’s coming to an end. But wait a minute! Before running to the conclusion that the decade of run on gold is over and it’s time for the dollar to regain its supreme position maybe we should evaluate the big picture ahead of us.

What I ask myself is why are the world’s Central Banks, including our own Federal Reserve Bank, rushing to buy gold? Why is China not selling the gold they mine? Why are most governments secretive of their gold reserves and quietly acquiring more of it? Could it be that the world knows the dollar is on its last breath but no official is willing to go out of its way to say it? Simply put the dollar has been killed by the excessive debt of a government and a people living beyond their means for way too long. And because the world reserve currency is already in its metastatic phase most countries are now realizing there’s an end altogether to the fiat currency. Running to real money such as gold is what makes sense to them.

Back in April of this year the University of Texas Investment Management Co., the second-largest U.S. academic endowment, took delivery of almost $1 billion in gold bullion. The decision to turn the fund’s investment into gold bars was influenced by Kyle Bass, a Dallas hedge fund manager and member of the endowment’s board who said “Central banks are printing more money than they ever have, so what’s the value of money in terms of purchases of goods and services? I look at gold as just another currency that they can’t print any more of.”

In Utah Governor Herbert signed into law the Utah Legal Tender Act, a bill that essentially restores the hard money options enjoyed by past generations. The bill recognizes gold and silver coins as legal tender – not just their face value, but also their value in gold and silver. The new Utah law derives its legal authority from Article I, Section 10, of the U.S. Constitution, which provides that no state shall “make anything but gold and silver coin a tender in payment of debts.”

I haven’t watched any of these events make the big headlines news on ABC, CBS, or any other media channel. They may not be important to them but I know they are very important to me and plenty of other investors. Whether you consider yourself an investor or not it should be of importance to you, as well, because I am convinced that you’d want to maintain your current standard of living. I, for one, prefer not to be distracted by news they consider worthy. What’s important for me to know – and it should be for you, too – is that the value of gold is being suppressed by the major players on Wall Street yet the main stream media considers it unfashionable to elaborate on.

So, is gold in a bubble that is soon to burst? I seriously doubt it! There is no logical explanation to prove it. Those adamant are either of the group that can’t see the forest from the trees or the group that has a lot of faith that somehow miraculously the fiat dollar will revive. I choose to follow my knowledge of the fundamentals. In the past the very few who were vested in gold during economic crises were the very few who were not negatively affected. Not to forget that during the last seventy years gold and oil moved in tandem. That tells me both gold and oil maintained their value relative to each other and it is the dollar that lost value against both. After all the price of oil and gold has really not gone up but the value of the dollar has continuously been eroded causing us to lose purchasing power. Ultimately $200, $300, or $500 for a barrel of oil should not sound as scary when assets are held in gold. That’s why for me gold is an unambiguous winner!

GoldMoney. The best way to buy gold & silver

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  1. #1 by jrfibonacci on September 14, 2013 - 10:25 pm

    Hi, Carmen. I actually never saw this blog post of yours until today.

    I give clear definitions of bubbles and booms here: http://jrfibonacci.wordpress.com/boom-or-bubble-two-stages-of-investment-market-trends/

    • #2 by carmenalexe on September 15, 2013 - 3:11 am

      Good stuff, J.R., thank you. I read it on the LI forum where you posted. I tried to read it on the link you provided but it’s password protected.

      • #3 by jrfibonacci on September 15, 2013 - 4:00 am

        Oops- you’re right. The password is currently “bubble” for anyone who sees this comment and wants to read the article on my blog (which has pictures, unlike what Carmen read).

  2. #4 by Anonymous on June 5, 2012 - 2:46 am

    ETFs are paper. If there’s a crash, they’re worthless.

    Is gold in a bubble? Yes.

  3. #5 by Steve on July 30, 2011 - 8:56 pm

    In addition to the US addiction to unsustainable deficits, there’s a huge amount of instability in the Muslim world, from Africa to the Chinese border and beyond. There are vast, incredible criminal enterprises in the former USSR, central and South America and in other areas of the world.

    If you are a ruler, investor, drug cartel, mafia or wealthy industrialist in this vast area a change of governments is likely to result the the seizure of your Swiss bank accounts and confiscation of your in country wealth (especially if it is deemed to have been gotten at the expense of the “people”) . What’s a poor dictator or other vulnerable wealthy person or organization to do?

    Gold has measurable purity, is a commodity, demand from users and investors and transportability.

    Sometimes we forget that gold is incredibly dense, almost 20 times the density of water and twice the density of silver. Visualize a 3′ x 3′ x 3′ wooden stand that supports some piece of modern art. It’s lost in the clutter of the gallery, but inside there’s a billion dollars of gold at $2,000 per ounce,

    It’s not really anchored to the floor, it weighs 31,250 pounds.

    It’s interesting to see the number of institutions that are buying gold, not etf’s but real gold.

  4. #6 by Stan Cahn on July 5, 2011 - 9:44 pm

    There are several factors that haven’t mentioned here. Over the last ten years not only gold, but just about every commodity increased in price. We’ve seen it with Oil, We’ve seen it with copper. In fact copper increased at a higher percentage than gold did since 2000.

    It was pointed out today, that while the country of India has historically been the largest purchaser of gold, mostly for the manufacture and sale of jewelry, they have been buying less over the last two years.

    So what is the real cause. In my opinion there are two factors:

    1 – since the Bush administration and continuing today, the dollar is losing value vis a vis other currencies. for example the Canadian dollar is worth about $1.04 US today.Seven or eight years ago it was worth 55 cents. The same is true of the Euro, and Argentina which linked it’s currency to the dollar lifted that a few years ago.

    2 – The ability to purchase gold as an exchange traded fund. contrary to your comment Alexe, 70% of all gold purchased today is in the form of an ETF. This is what created the demand. ETF’s are created when someone wishes to purchase it. The backing disappears when one sells it. In many ways, the economy of an ETF is contrary to the law of supply and demand, but what ever is backing it, whether it be gold, or a basket of stocks is not. Why should you bother to hold bullion, when a piece of paper will do. At some point holders will take profits in their ETF’s, and the price will decline, as the supply comes back on the market.

    One thing I’ve learned in my 30+ years as a financial professional, is “That this time it’s different” is fiction. When I see a cover like I saw in business week in 1982 about the death of equities, I knew a bull margket was about to start. I also remember the cover of Time at the time of the merger with AOL which proclaimed a merger in Heaven. finally I remember the lines in 1982 around the block which made the front page of the Washington Post of customers at Cook’s trying to buy bullion and coins when gold was $800 an ounce. they had to wait almost 30 years to get even.

    • #7 by Maximums on May 17, 2012 - 1:05 pm

      Stan, You seem to be thinking too much like a financial professional and not enough like an investor. Specifically, I am referring to your view of gold and ETFs. Gold ETFs are merely your right to a certain amount of gold against the number of dollars, euros, yen, etc that it trades for at that moment. It is a part of the supply/demand model precisely because one is trading dollars or a piece of paper representing a supply of gold that must be stocked to meet demand.

      When equities move up and down, it is the same thing. The difference is that the value of those equities is influenced by many more factors such as management actions, business strategy, product demand, changing business model, etc. As an investor, one chooses what they value more at any given time. It might be equities, dollars, gold or even sandwiches. No “backing” is required except the relief of one’s discomfort with the current investment. Having dollars in the bank may create discomfort, so the investor buys Gold ETFs, equities, whatever.

  5. #8 by Raymond Hodgdon on July 5, 2011 - 2:36 pm

    Carmen,
    You are correct that the relentless rise in the price of Gold is not a Bubble. The reason it is not a bubble is because Gold is not responding to inflation (inflation has been low and falling from 2000-2011) and it is therefore not responding to Fed monetary policy either. What it is responding to is the repeal of Glass-Steagall in 1999, which is when the current metoric rise in the price of Gold began. The repeal of Glass-Steagall removed the prophylactic shield protecting our banking system from the “Robber Barrons” (investment banking cartel), paving the way for the greatest counterfeiting scheme in the history of the world and the Financial Crisis of 2008, which is not over.

    The reason Gold is rising and the reason Gold is not a bubble is because Gold is reasserting its historical role as a reserve currency, in order to displace the USA, at least in part, as the world’s banker, because the USA has completely discredited itself as an honest and prudent banker by paving the way for and later legitimizing trillions in counterfeit credit securities. This does not mean the price of Gold will go straight up. It will have its ups and downs but it is in a long term upward secular trend.

    • #9 by carmenalexe on July 5, 2011 - 4:08 pm

      Raymond, thanks for your valuable input. Do you see gold going anytime soon at $2000/ounce?

    • #10 by Anonymous on June 5, 2012 - 2:55 am

      Gold is following the market. That means that it has become speculative for some, security (hedge) for others. Both indicate that gold is no longer tracking real value – but inflated value. (Not to be confused with inflation value.) ie it’s not the value of gold that is causing people to pay the current ridiculous price. It is the individual purchaser’s mental state…. greed or fear. Pick one.

      Another indicator that gold is off the rails price wise is the gold-silver ratio. Historically, except for brief periods of aberrant pricing due to short-term environmental factors, for at least 2000 years, the ratio has maintained between 10:1 and 25:1. At today’s close it was 57:1. Too rich for my blood!

      • #11 by Michael E Picray on June 5, 2012 - 5:05 am

        # 1 & 7 are my comments. I thought I was logged in. Sorry.

    • #12 by Michael E Picray on June 5, 2012 - 4:00 pm

      (inflation has been low and falling from 2000-2011)

      Ummmm… no. Better check your numbers there Ray. Just in the years of 2001 – 2007 GW Bush devalued the dollar against the Euro by 40%.

      Oh… wait. You’re apparently depending on the FED and the US Treasury for your numbers. (Psssst! Wanna know a secret? GOVERNMENTS LIE!) And remember too that Mr Geitner was cheating on his taxes – so he’s a PROVEN liar and crook. (I call him “TcT” which stands for “Tax cheat Timmie”.)

      Here – havealink. http://www.shadowstats.com/

      This guy runs REAL numbers. And before I found his site, I ran my own numbers on unemployment and on inflation (using real world observation and tracking). (I still do.) When I found his site, his numbers were really close to mine…

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