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 Citigroup (NYSE: C  ) , Adventrx Pharmaceuticals (AMEX: ANX  ) , and Nextwave Wireless (Nasdaq: WAVE  ) 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 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 set you up for disaster.

So what exactly are all these investors -- and their followers -- overlooking? These two key 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 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 is 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-Assets Ratio

Dividends Paid Since

3M (NYSE: MMM  )

$57.7 billion





Abbott Laboratories (NYSE: ABT  )

$82.1 billion





PepsiCo (NYSE: PEP  )

$110.0 billion





International Business Machines (NYSE: IBM  )

$167.9 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. 3M is a Motley Fool Inside Value pick. PepsiCo is an Income Investor pick. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool's disclosure policy is outlined here.

Read/Post Comments (5) | Recommend This Article (15)

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  • Report this Comment On March 30, 2010, at 10:16 AM, MyDonkey wrote:

    Two suggestions for TMF regarding recycled posts:

    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:

  • Report this Comment On March 30, 2010, at 10:29 AM, outoffocus wrote:

    Good points, and I wish I could agree with you. But it seems like the bigger bubble is the Treasury market, which tends to have a negative correlation to gold. If the treasury bubble bursts, where are investors going to fly to first? Most likely other currencies and PMs. So while I would like to agree with you with the gold "bubble" I think the bigger bubble (the 800lb gorilla in the room) happens to be whats driving the increase in gold prices in the first place, the oversupply of cheap dollars. People flock to gold as a wealth preserver and an inflation hedge. Currently the Fed is giving investors every reason to.

    The only way I see a gold "bubble burst" is if the Fed preemptively decides to raise interest rates which I dont see happening anytime soon.

  • Report this Comment On March 30, 2010, at 10:55 AM, bristle99 wrote:

    What the heck does the bubble of 2008 have to do with Adventrx? The company had a failed clinical trial in late 2007, which led to a deterioration of share price due to diminished up-side and shrinking cash. Not to mention, microcap stocks like Adventrx don't track with the large indices. That sell off would have happened even in the best of bull markets.

  • Report this Comment On March 30, 2010, at 12:29 PM, itallionstallion wrote:

    I disagree 100% with this analysis! Please explain why George Soros reported that we were entering a "gold bubble" in an effort to talk down gold and then days later went out to buy a bunch of gold? this another sign of sheisters talking something down so they can get in cheap before the real rise? Hmmm...interesting that stocks are talked up and gold talked down...trying to whipsaw investors again? I'm tired of the speculation, games, and deception. From now on when I hear a major financial institution recommend buy something I'm going to sell it; likewise if I here them poo poo something I'm going to buy it.

    On another point - this article confesses that inflation will be a problem; why then would you recommend anything including high-yield dividend stock? Isn't that like saying dollars are going to suck so make sure you buy even more of them? By the way, the recommended stocks are not high-yield dividend stock - just a few years ago REITS were paying out 12-15% in dividends!!

    I could go on and on about the problems with this article; instead I'll just say your homework folks, there's a whole litany of information out there in the alternative media that clearly explain the financial problems we're in today. Go to youtube and search Peter Schiff, Ron Paul, Max Keiser/Keiser Report, etc

  • Report this Comment On March 30, 2010, at 7:21 PM, skaut wrote:

    Well said Rocky!!

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