Thursday, March 12, 2009

Ready to Ride the Golden Bubble

First the chart, then my explanation…

People seem to forget this, but all bubbles start with a seemingly strong premise. In the case of gold it's that the printing press is going wild, thus gold should strengthen relative to the dollar. This makes sense to a degree. The Internet DID change the world, but didn't become a worldwide leader in pet accessories; oil SHOULD have increased in price due to a global economic boom, but at $145 / gallon businesses failed and people stopped driving; financial innovation DID allow many first time buyers the access to finance a new home, but someone making $20,000 a year should not be buying a $1,000,000 house.

In other words, a great story can explain why the boom begins, but it doesn't justify the price if it becomes outlandish. As money pours in and the bubble gets larger, investors pour in more money. Gold has been a similar story as the shiny metal formerly used in jewelry vs. 401k's has become exceptionally self-feeding as gold has been one of the few asset classes that has shown strength, attracting new capital.

The following are a few reasons why I believe gold may be entering the next bubble:

  1. The same people that argued gold is a BUY BUY BUY because of inflation are now coming up with well-articulated reasons why gold is a BUY BUY BUY because of deflation. I personally don’t have a clue how deflation or a decrease in credit can possibly be good for gold.
  2. Pre-house bubble pop, everywhere you looked there was housing TV show this (i.e. Flip that House), housing seminar that, become a realtor this. Now there are "gold guys" preying on frightened investors' 401k’s, infomercials about gold coins, and the Internet sensation CASH4GOLD.
  3. Gold serves no useful purpose, to my knowledge, outside of a minor uses in electronics / dentistry and major uses (at lower prices) in jewelry. I say "at lower prices" because gold is already to being replaced by cheaper metals in jewelry (the demand for gold jewelry was down 35% in the fourth quarter) and the existence of CASH4GOLD means people may be net sellers of gold in jewelry (I personally like to picture a frightened investor selling all their prized jewelry out of fear, only to take that cash and invest it in gold out of fear of inflation).
  4. The wildest thing to me is that in most cases this investment is not in bars you can actually see (the value in gold is supposedly its beauty), but in an ETF where you see its value in your account statement. (In addition: if you think the financial system is melting... don't put your money into an ETF).

After all that you’d think I’m shorting gold? Well, I actually am in the short-run (The Financial Ninja read my mind with his post regarding that opportunity), but I am ready and waiting for gold to make new highs to reverse my positioning with expectations that this bubble train is far from over. I've learned my lesson with the Internet Bubble (and recent housing bubble) that most people are illogical and invest based on fear (sometimes fearing loss, sometimes fearing they will miss out on the next big thing) and money can be made even if the premise makes absolutely no sense in the long run. As long as fear reigns supreme and equity markets remain volatile, there will be plenty of people convinced gold is the only "safe" investment.

My expectation is that eventually the golden bubble will run its course and come crashing back down to earth. If the economy gets worse, people will realize you can't eat the stuff and investors will sell their stakes to pay for necessities. On the other hand, if the economy recovers, investors will have much better opportunities with their capital… as I mentioned Tuesday, asset inflation, especially in precious metals, serves no economic purpose in the long run.


  1. Another great post. And you are putting your money where you mouth is.

    Based upon this chart you would expect gold to at least double in the next 4-10 months (not sure how arbitrary the start date for the current gold price was since we do not yet know the 'peak')

    All I can say if gold increases by more than 30% in that time frame even I may have to make a bet...

  2. i will be buying as soon as we make a new high

  3. I'll stick with this being The Last Bubble™.

    On the other hand, it's possible
    at some point that gold will stop
    being traded for fiat at all.

  4. Actually gold performed quite well during the Great Depression and has held up very well during times of deflation vis a vis shares and real estate which collapse. Ditto 2008.

    For those that remember Homestake Mining went from a peak of $90 in 1929 and fell to only $70 a share. And then rose to over $500 by the end of the Depression!

    It has not performed well during disinflation which is a different matter.

    The whole point about investing is to buy early in the trend and wait for the mania, remembering that at some price, every asset should be sold!

    I want the parabolic blow off, as should everyone that owns gold.

    Silver also offers better upside than gold as a current speculation.

  5. Eastern Europe is going down the drain and trying to drag the rest of Europe with it.

    Assuming you're looking at Gold denominated in US$, check it out as Euros. I imagine that bubble looks a little bigger in Euros.

    Do any of these struggling European countries have substantial gold reserves?

    Could or would these countries start paring down their Gold reserves to fund their budget shortfalls and/or stimulus packages?

  6. Look at the price of gold when FDR is elected and 8 years later and then you will understand that gold can have a big price increase during a delfationary period.

  7. As far as the intrinsic value of gold- besides for consumption, the primary reason people are hoarding it is because it's historically a relatively portable store of wealth- not as good as paper money obviously, but the ultimate fear is the fiat currencies will collapse- so in this sense it's an insurance play more than a normal commodity play.

    Not sure if you remember or care, but in your last blog about gold storing value vs stocks, I mentioned testing the divergent limits on the stock market against real GDP growth. There was an interesting article on Reuters along those lines today:

    Not sure if you care, but some of the data in there might make for some interesting analysis.

  8. irrational... i have something ready to post on just that tomorrow.

  9. Oh, come on! Does the chart prove anything, or just that four asset classes had similar 60 month run-ups and 24 month declines.

    Not much to support a bearish Gold theory there. What do you say about March 2008 Gold and Silver prices, and whether both metals ought to recover to those levels?

    Look at inflation-adjusted Gold prices if you are going to make a point about Gold's value as a store of value and alternate currency.

    Not sure I expect or want a huge run-up, but Gold and Silver should quietly appreciate here as the Dollar and much of Europe fall away. Since the Gold/Silver ratio is currently above 70, and should be close to 60, we can expect Silver to push ahead. Silver is underpriced at anything under $20.

  10. I am a bit confused by what you are suggesting: the Financial Ninja says that he will be in gold only if the price breaks 1000; you seem to be a believer in gold short and have not waited for the break above 1000.

  11. i won't be buying gold until it makes new highs (i.e. comfortably breaks $1000). it was EXTREMELY overbought, thus my short in the short-run

  12. "i wont be buying gold until it hits a new high"

    LOL. I'm going to wait until summer to have a pool installed so i can pay the highest price.

    Gee, i think i will wait until the sale is over before i buy the steak at the supermarket.

    Better yet, i could kick myself for not buying real estate in 2006 when prices were so much higher. why did i have to buy in 1993. darn! Drat! #$%%^$!!

  13. as the dude says in the big lebowski "obviously you're not a golfer".

    while i am far from an elite trader, i do know a thing or too about resistance levels. if gold doesn't break well through $1000, it may never.

    what's better?
    * to miss out on 10% of the upside, when my hypothesis is that if it breaks $1050 it will run to $2500+ or
    * to buy now and see gold break down to $500?

    as i said in the post, not only am i not long yet, i am actually short the stuff for that reason

    finally, how can you possibly compare trading to the installation of a pool (i.e. entertainment) or the purchase of a steak (i.e. eating)? that really doesn't make sense.

    a better analogy would be trying to time the bottom of the market... an impossibility, so why try?

  14. In 12mo at 3,000 or 4,000 it will be justified as deterministic. It's only after it returns to 1000 or 750 that sadly it will be seen as a bubble

  15. Given the lack of "STORE OF VALUE"
    utility in every other kind of "exchange medium = currency" it is comforting that they cannot PRINT or produce DIGITAL GOLD.

    Golds utility [ which I think is High] ASIDE, it is good at holding the M1,M2,M3 ad naseum, ACCOUNTABLE.

    I use GOLD'd DERIVATIVES to Deal the advances and declines. Nothing is as bad as its made out, nor as good as you hoped, but I do love markets that go to extremes.

    Gold Money, like the Canadian Maple Leaf, seem like a good bit of insurance, bought right.

    Gold stocks, upon which you can sell options or collect dividends, probably are very useful for many people's portfolio.

    HERE is the THOUGHT -> GOLD sets the VALUE for CURRENCIES, not the other way round.

    Market Thoughts and TA activity, read it at:

    Good Luck All,