The Coming Bubble of 2010 and How to Avoid It

Even though it has been barely two years since the latest investing bubble burst, sending the stocks of companies like Sirius XM Radio (Nasdaq: SIRI  ) , Cell Therapeutics (Nasdaq: CTIC  ) , and Keryx Biopharmaceuticals (Nasdaq: KERX  ) to their knees, there's yet another bubble forming. And I believe it will burst this year.

Just ahead, I'll tell you how to completely avoid it -- and present an alternative investment strategy you can adopt instead of following the crowd into this bubble.

But first, let's take a look at this bubble and how it formed.

All that glitters
Congress is spending billions of dollars in stimulus funds to jump-start the economy. This influx of dollars is funded almost entirely with debt. As the national debt level rises, the dollar becomes weaker, because currency investors shy away from high-debt countries. This causes higher inflation, which most everyone agrees is coming.

But the consensus right now is that the best way to counteract inflation is by investing in gold.

And the consensus is dead wrong!
Alas, gold is a luxury commodity. It has no coupon rate or growth prospects, and it can rise in price only as much as demand for it grows.

It's also difficult to value. Some believe the price of gold per ounce should match the Dow Jones Industrial Average. Others believe it must reflect the price of a top-tier man's suit. Still others believe it must account for global supply and demand.

In spite of this inherent confusion, many prominent investors -- John Hathaway of the Tocqueville Gold Fund, Jim Rogers of Quantum Fund fame, and even top hedge fund managers like David Einhorn and John Paulson, to name a few -- believe gold can do well right now.

Even more shockingly, the recent Value Investors Congress was full of lectures on how to profit in precious metals.

Even the best can be fooled
The average investor is blindly following these noteworthy financial wizards. That's why more than $12 billion of new money was invested in the SPDR Gold Trust in 2009 alone. I'm the first to admit that falling prey to other investors' moves is an easy pitfall, but it can also set you up for disaster.

So what exactly are all these investors -- and their followers -- overlooking? These three facts:

1. When gold demand rises, supply does, too, which brings gold prices back down.
Fortune magazine reports that gold miners invested more than $40 billion into new projects since 2001, and they "are now bearing fruit." Bullion dealer Kitco "predicts that these new mining projects will add 450 tons annually -- or 5% -- "to the gold supply through 2014, enough to move prices lower." The demand also brings out sellers of scrap gold, which adds even more to the supply.

All this while demand for gold has dropped 20% in the past year.

2. Gold is not just dollar-denominated.
Unlike oil, gold is bought and sold in local currencies throughout the world. The Wall Street Journal reports that "gold remains well below last winter's peaks when priced in pounds, euros, yen, or Swiss francs." This indicates that only Americans are speculating on gold's rise.

3. Gold is historically a poor investment.
Perhaps the most damning fact is that, from 1833 through 2005, gold and inflation had nearly perfect correlation, according to Forbes. This means that, after taxes, you would have actually lost money in gold.

Warren Buffett once quipped, "It gets dug out of the ground ... Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

In fact, the only way to make gold rise is to get other investors to buy into the idea -- like a giant Ponzi scheme. And as we know from watching the unraveling of Bernie Madoff's empire, this can't last forever.

No wonder the vice-governor of the Chinese central bank recently announced that it's holding off on purchasing gold.

All of this explains why buying gold today is a horrible decision -- and why investors would be better off looking elsewhere.

The absolute best place to look
The best way to invest for inflation is to invest in high-yield dividend companies. Unlike gold, which has no coupon rate and no growth potential, you should be sending your investing dollars to companies that pay a dividend (which often rises) and also have both stable growth potential (which also often rises) and strong assets (in inflationary periods, assets are more valuable since they cost more to replace).

Here are four solid candidates that fit that bill, all of which have a long history of dividends -- through periods of inflation and deflation alike:

Company

Market Cap

Dividend Yield

5-Year Compounded Annual Growth Rate
of Revenue

Liabilities-to-Asset Ratio

Dividends Paid Since

Caterpillar (NYSE: CAT  )

$37.2 billion

2.8%

5.8%

86.9%

1914

United Technologies (NYSE: UTX  )

$66.1 billion

2.2%

7.8%

67.9%

1936

Chevron (NYSE: CVX  )

$159.2 billion

3.4%

3.1%

44.2%

1912

ExxonMobil (NYSE: XOM  )

$330.3 billion

2.4%

1.4%

53.2%

1882

Data from Capital IQ and DividendInvestor.com.

These are exactly the sorts of dividend-paying stocks that former hedge fund analyst and current Motley Fool Income Investor advisor James Early looks for in his market-beating service.

In his newsletter, James has put together a "core portfolio" of top dividend stocks, consisting of six dividend stocks he believes every investor should use as a platform to profitable dividend investing. You can see his portfolio completely free, with a 30-day trial to his newsletter as my guest today. Click here for more information.

This article was originally published Nov. 6, 2009. It has been updated.

Adam J. Wiederman owns shares of no companies mentioned above. The Fool's disclosure policy is outlined here.


Read/Post Comments (20) | Recommend This Article (47)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 09, 2010, at 9:52 AM, Fool wrote:

    I can't connect how your Gold Bubble is related to the high growth stocks such as siri, ctic, etc. Your article is starting as if these stocks will be in Coming Bubble. And then your story is all about Gold Bubble. You are giving an impression that the stocks listed in the beginning of the article have been moved up without real value; therefore, they will Bubble. How do you responsible for bringing down the stock prices if these stocks have real value backed up for their growth?

  • Report this Comment On January 09, 2010, at 10:24 AM, Fool wrote:

    I believe the MF trying to bash SIRI so people won't will be prosperous near the future when it climbs back up to $3.00. Instead of discussing about Crude Oil price bubbling along with Gold, the MF loves to talk about SIRI! It has NO connection whatsoever with commody price bubbling! I never want to read ANY MF's articles again!

  • Report this Comment On January 09, 2010, at 10:25 AM, Fool wrote:

    tgg

  • Report this Comment On January 09, 2010, at 12:17 PM, BigVincent wrote:

    ^^^ The author mentions one sentence on siri and a couple other comapnies and you dodo heads start an unnecessary rebudle.

    You make the siri stock look bad, knock it off and let the writer write his piece.

    The article was about inflation, and currency and what not to invest in and you numb nuts rebudle as if your point had some merit when it doesn't.

    'm a siri shareholder and you make the group of us look bad, knock it off..

  • Report this Comment On January 09, 2010, at 12:29 PM, cnight80 wrote:

    More siri bashing for no good reason... How about going back to journalism school, learn how to include FACTS about siri in your article instead of so many OPINIONS. You mention that siri will be part of a bursting bubble in your opening paragraph and then you talk about gold the rest of the article? At least tell me why you think siri will fall. More MF stupidity and hostility towards a stock (siri) they swore would go under back in March of 2009....GUESS WHAT MF? SIRI HAS DONE NOTHING BUT IMPROVE AND GROW IN EVERY POSSIBLE WAY WHILE REDUCING DEBT, SO NEXT TIME TELL US WHY SIRI IS GOING UNDER, WITH ACTUAL FACTS. SIRI LONG!!!!

  • Report this Comment On January 09, 2010, at 1:23 PM, buynholdisdead wrote:

    This really isnt that hard to understand. I remember when everyone was saying how great Siri was and how they were all going to get rich. Then they hung on to long. I think the author is trying to warn everyone, especially the siri people, to not get taken in. Now might be a good time to get out of gold. I understand the concept behind holding gold but like I have always told my friends, if the world was to blow up what would you want? Gold or bullets? You take the gold and I will take the bullets.

  • Report this Comment On January 09, 2010, at 2:15 PM, k2sherpas wrote:

    Much ado about nothing! Maybe the writer shouldn't mention any stocks by name, but I believe the article is written to discuss how to avoid the next stock bubble burst, which is coming. He tells you why it is coming and then gives you a way to avoid it or lessen the crash. He also states why the way to avoid the crash this time isn't gold investing. Not that complicated of a concept or article.

    Paranoia will destroy ya! Reading way too much into the article that just isn't there.

    Quick without looking name the other two stocks he mentions in the first sentence. UHHHHHH!

    Big Vincent has it right!

  • Report this Comment On January 09, 2010, at 3:16 PM, yahoomania wrote:

    As usual.....another "Motley Fool's" horrible description of the current environment, and complete irrelevance to Sirius! Where do they get these guys???????

  • Report this Comment On January 09, 2010, at 3:38 PM, goalie37 wrote:

    Bubbles occur when hedge funds decide they will occur.

  • Report this Comment On January 09, 2010, at 4:09 PM, Redliner4stocks wrote:

    I get the point of the Gold perspective but I'm disappointed in Adam for using stocks like CTICm AGAIN, in negative articles that have nothing to do (not even as an example) of what he's trying to get across!!!

    The more he bashes these stocks, you know the better they will become in the long run. He's just trying to keep prices down, intentionally!

  • Report this Comment On January 09, 2010, at 7:30 PM, RuthBaba23 wrote:

    Top list of the highest dividend yielding S&P 500 Dividend Aristocrats 2010:

    http://www.TopYields.nl/Top-dividend-yields-of-Dividend-Aris...

  • Report this Comment On January 09, 2010, at 8:24 PM, lennysims wrote:

    and what does gold actually do? we use it here and there for some wires and some jewelry(78% for jewelry), wow that gold sure is special. It's a metal that is valued as much as religion, yet both serve next to no real purpose in society. Somebody got some people really hooked on the stuff along time ago, and it's going to take along time to unhook them.

  • Report this Comment On January 10, 2010, at 4:57 AM, rslogic wrote:

    The article focused on supply and demand & fundamentals of gold it overlooks although there is leverage Options & futures contratracts involved in gold this makes it speculative.However what about stocks,bonds corporate and even treasuries you could make the same argument have options and futures involve so they are also speculative.also stocks are much more sensative to the demand component of the economic argument where gold has supply and demand component to drive it higher.Most of the above groung gold has been found and although there will be more players invovled in mining gold it will be increaingly harder to to dig and find gold than in the past just like oil where most of the easy finds have been made it is going to cost more to get the gold out of the ground as time move forward.also most of the major finds are in very volitile areas of the world politically unstale,subject to litigation,nationalization,natual disasters or just plain captol upgrade and will cost more in input cost to get the gold out of the ground and a cut off in supply would make prices spike.Also a company and governement can theortically issue virually an infinant amount of shares print virually an infinant amount of dollars and ultimatle companies can go defunked i.e.

    enron Lehman poloriod gold can not go to zero like stocks!As for a poor investment in 1930 gold was 13 dollar in the 40s 20 dollars and in the 60s 39 dollars

    and on the 70 150 dollar in the 80s peaked 2 850 dollars and dropped to 259 dollars in late 90s and now almost 1200 dollars.so that would mean since the 30s 70 years gold has a return of 9000 percent.

    the dow was 480 now its 10500 which corresponds to a rerund from 70 years since the 30s of about 2100 percent and since 9000 is about 4.5 times greater than 2100 gold has actually outperforment the major equity index by 450 percent !!!!!

  • Report this Comment On January 10, 2010, at 10:44 PM, spr0949 wrote:

    I don't see The MotleyFool or TheStreet jumping up with any commentary or analysis of the "SatWaves" interview of Liberty Media CEO Greg Maffei. It is well worth reading and reporting on.

    http://satwaves.com/blog/2010/01/07/liberty-ceo-sirius-xm-to...

  • Report this Comment On January 12, 2010, at 6:57 AM, Bioswatch wrote:

    Adam, your lack of knowledge about the history of Keryx Biopharmaceuticals ( KERX ) surprises me. As you fully know, KERX had a setback with one of their lead drugs in the pipeline back in March of 2008. The rise and setback was not due to any bubble whatsoever as it was with a stock like Sirius.

    As of late, KERX has new 2 SPAs, Orphan Drug Status and Fast Track Designation from the FDA for a multi cancer drug, Perifosine. There is a new CEO and they have initiated a successfully new business plan with plenty insider buying as well as exercising of shares by the CEO and CFO. For all these reasons, KERX has become a top riser on the Nasdaq and helping to lead other bios into this new bubble. However, all one needs to do is look at the KERX chart and see that their successful rise is not a bubble whatsoever. It is a gradual and steady rise brought on by a successful chain of events.

    With that being said, I do a agree a bubble overall in the markets is being formed. This especially holds true for the bios and many are suggesting that a bio-bubble much like dot com bubble of the the late 90s and early 2000 is coming. I agree with this in theory and especially since the bio-bubble had already began to grow bigger than the dot com bubble in March 2000. Then President Clinton along with Tony Blair made a totally ridiculous speech pertaining to the patent rights of US bio companies. They crashed the bio bubble of 2000 within seconds and smack in the middle of the trading day. The chain of events took the the dot com bubble down with it and eventually all the markets leading into 9/11 2001. This is exactly what the hedge fund managers and Alan Greenspan had been wanting so one always has to be skeptical about who motivated Bill Clinton and Tony Blair to make that speech.

    Now we are in a new era and the bio-bubble is recovering from the damage done by Bill Clinton and Tony Blair. Many bio companies are moving closer to fruition and bringing products to market. So the bio-bubble that is beginning in 2010 is with good reason.

    Fundamentally attractive companies such as KERX and a few others should have a much longer run than you anticipate when this bubble begins and taking all the bios with them. It may not be what some of your friends who are hedge fund managers want to hear but it could serve to be a healthy move for the markets and the economy as a whole.

    Unlike the dot com bubble and the early bio-bubble of 2000, this new bubble is being built on rational exuberance as opposed to "irrational exuberance", which as we all know now, was a term trademarked by Alan Greenspan which the hedgies very much appreciated.

    So I hate to burst your bubble but we have a long and healthy bubble in the making.

    Good luck.

  • Report this Comment On January 15, 2010, at 12:44 AM, streetflame wrote:

    "Unlike oil, gold is bought and sold in local currencies throughout the world."

    What color is the sky on your planet?

  • Report this Comment On January 15, 2010, at 10:32 AM, sofpan wrote:

    OK. Don't buy Gold and keep your fiat worthless Money.

    Sure... you can buy stocks... in these levels...

    OK.... let's talk again at December 2010.

    ;-)

  • Report this Comment On January 15, 2010, at 2:20 PM, fug57fug wrote:

    This is an investment advise website. Why the shock and outrage? You act like this article appeared on ESPN.

  • Report this Comment On January 16, 2010, at 10:34 AM, belihe wrote:

    Goodness, so serious! I remember when the last bubble burst I was sitting here thinking "where do I put my money? what do we do to survive a downfall of depression degree?" I emailed some friends who said invest in gold and I thought about it for a while but my thinking was more like Warren only I got down to basic survival. If it came down to that, survival basics, you can not eat gold. It would trade for nothing because it will not feed you. You could have a mountain of it beside a group of starving people and they wouldn't care a lick (pun intended) but a sack of dried beans they would kill for. :)

  • Report this Comment On January 25, 2010, at 4:23 PM, FuerteFunds wrote:

    Take this scenario if you will, you are a well protected country of farmers will an enormous crop of food (USA). Right in the relatively stable now, you accept negotiable paper. Perhaps in the future, physical gold will enter into the transaction. Less futures contracts and derivatives and more physical delivery will help the gold price improve as well edible commodities. The United States holds an unaudited 7500 metric tonnes (most of any country) hence it is the fiat currency of the world. If we sell gold, what do think will happen to our dollar?

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