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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 YRC Worldwide (Nasdaq: YRCW  ) , Ambac Financial (NYSE: ABK  ) , and South Financial Group (Nasdaq: TSFG  ) to their knees, there's yet another bubble forming. And I believe it will burst this year.

Don’t just take my word for it -- even the world-renowned investor George Soros agrees.

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 has spent billions of dollars in stimulus funds to jump-start the economy. This influx of dollars was 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, a 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 (other than as an investment) dropped 20% in 2009.

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 the bubble is becoming a uniquely American problem.

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.

Truth be told, the only way to get the price of gold to 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, that can't last forever.

No wonder the vice-governor of the Chinese central bank recently announced that the bank'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:


Market Cap

Dividend Yield

5-Year Compounded Annual Growth Rate
of Dividends

Liabilities-to-Asset Ratio

Dividends Paid Since

Raytheon (NYSE: RTN  )

$21.2 billion





DuPont (NYSE: DD  )

$30.4 billion





Boeing (NYSE: BA  )

$47.6 billion





Home Depot (NYSE: HD  )

$51.5 billion





Data from Capital IQ and

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. Home Depot is an Inside Value recommendation. The Fool's disclosure policy is outlined here.

Read/Post Comments (4) | Recommend This Article (25)

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 February 19, 2010, at 6:49 PM, jennyhewitty wrote:

    Highest dividend yielding stocks top 250:

  • Report this Comment On February 20, 2010, at 1:43 AM, goalie37 wrote:

    The people who make and pop bubbles for fun and profit will get to gold soon. First they have to finish the game they are playing with treasury bonds.

  • Report this Comment On February 20, 2010, at 5:31 PM, masterN17 wrote:

    "from 1833 through 2005, gold and inflation had nearly perfect correlation"

    1) I don't know anyone who that advice would apply to, since no one has lived through all those years. there have also been significant monetary policy changes throughout those years, introducing several confounding variables

    2) From my understanding of the word correlation, it means the two correlated variables move together in the same direction, at a fixed polynomial (e.g. linear - y=ax+b) ratio. so if gold/inflation had nearly perfect correlation, that doesn't mean investing in gold would have you lose overall. Difficult to explain in this comment space; will try to clarify further if requested.

    I am not a gold bug but that statement just rubs me wrong. Would like to hear Barker's (Sinch's) response to that and the rest of your points.

  • Report this Comment On February 22, 2010, at 3:16 PM, MyDonkey wrote:

    Two suggestions for TMF:

    1. Put the notification "This article was originally published on <date>... " at the top of the article instead of the bottom.

    2. Include a link to the original article in the notification mentioned above.

    In this case, the original article (along with its 70 comments) is here:

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