The Shocking Truth Behind the Gold Bubble

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This isn't the first time I've warned investors like you about the gold bubble and what I believe will be its looming collapse. Admittedly, the spot price of gold has risen nearly 25% since I first called it a bubble, so it's possible it might still rise after you read this.

Be that as it may, I'm more convinced than ever that gold is a bubble that's set to burst.

You're right to ask why. Keep reading -- the answer will be clear in a few moments. First, let's look at why gold is still rising...

People are still scared about loose fiscal policy and the massive amount of debt governments incurred while saving the world from economic destruction. Legitimate concerns, yes, but they're not what's really pushing gold higher.

A recent story in Bloomberg Markets lays out the real history behind this unprecedented gold spike, which I want to share with you. Once you know the facts, I'm certain you'll be as convinced as I am that gold is an unsustainable bubble, and it's just a matter of time before it bursts.

You'll want some better alternatives for where to invest, which I'll also share at the end.

A desperate solution and its frightening consequences
Historically, panicked investors seeking gold had to buy it in the form of bullion bars or gold coins -- not an easy strategy. It meant high commissions when buying and selling, needing a storage facility and insurance plan, and knowing the right people to deal with.

With a few exceptions, this kept gold as a slow-moving market. Rightly so, since however you look at it, gold is just a shiny metal with no coupon rate or growth prospects.

That all changed in 2004.

Two years earlier, Christopher Thompson -- then-chairman of major South African Gold Fields (NYSE: GFI  ) -- took over as the chairman of the World Gold Council's executive committee.

At the time, the WGC was in a heated debate about whether jewelry was the best way to keep the price of gold moving higher.

But Thompson had another solution. He realized that a huge catalyst for the price of gold would involve the creation of an ETF backed by physical gold reserves, which could be traded by anyone with a brokerage account on the NYSE.

So in 2004, the SPDR Gold Trust (NYSE: GLD  ) went live. According to Financial Research Corp., it "attracted more investment for the month than all but two other funds offered on the NYSE, including mutual funds -- even though it traded for only eight days."

Thompson's solution was a success. In the year and half following the ETF's launch, the price of gold shot up nearly 60%.

Which brings us to today...
At the end of 2010, this ETF owned more than 41.4 million ounces of gold, giving it a market value of more than $58 billion. It's become the fastest-growing ETF in history.

But as we know, trees don't grow to the sky -- and prices don't go up forever.

This means the still-nascent interest in the fund will gradually come to a screeching halt, especially as the world economy continues smoothing out and the level of fear subsides.

And who will be left out to dry?

Some hedge fund stars like John Paulson and George Soros could feel some pain if the ETF heads south. Paulson & Co. owns more than $4 billion worth of the fund, and Soros Fund Management owns some $625 million (he also owns shares of competing ETF iShares Gold Trust (NYSE: IAU  ) .) However, both have shown the exceedingly rare ability to effectively time the market.

On the other hand, according to BlackRock, "individual investors may hold as much as half of the gold in ETFs that specialize in the metal." According to Capital IQ, the asset management branches of both JPMorgan Chase (NYSE: JPM  ) and Bank of America (NYSE: BAC  ) own more than $1 billion and $2 billion worth of this ETF, respectively.

So it's individual investors who will get demolished when gold prices come back down to earth.

That is, if you don't act quickly -- or smartly
If you are one of the many who own shares of the SPDR Gold Trust, my personal suggestion is to sell shares.

There's a better way to mitigate risk -- with a commodity that is completely overlooked right now.

And that's with natural gas. Even as credit concerns faded and every asset class has risen, natural gas has been stuck around $4 per thousand cubic feet since late 2008.

One way to play what I believe will be the commodity's inevitable rise is via the United States Natural Gas Fund (NYSE: UNG  ) , which seeks to mirror the move of natural gas.

But I think the smartest way to play this commodity would be by investing in Ultra Petroleum (NYSE: UPL  ) . This exploration and production company owns first-rate natural gas assets with huge potential, has a returns-obsessed management team, and keeps its balance sheet conservatively leveraged. Even better -- its stock has been as flat as the price of natural gas since late 2008.

The company was pointed out to me by Tom Jacobs, the advisor of Motley Fool Special Ops, a focused portfolio service that seeks out underfollowed stocks, turnarounds, deep-value plays, or other special situations. Tom and his team of expert equity analysts believe Ultra Petroleum could be worth nearly double what it is today.

If you want to see three more of Tom's favorite special opportunities today, just enter your email address in the box below for special access to his video analysis as well as the opportunity to join Special Ops when the high-demand service reopens for a limited time this month.

Adam J. Wiederman owns no shares of the companies mentioned above. BlackRock is a Motley Fool Inside Value recommendation. The Fool owns shares of JPMorgan & Chase and Ultra Petroleum. Through a separate Rising Stars portfolio, the Fool is also short Bank of America. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (18) | Recommend This Article (22)

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 18, 2011, at 4:19 PM, dbtuner wrote:

    Value of outstanding derivatives: Hundreds of Trillions of dollars

    Value of Gold ETF: $50Billion or so.

    I still like my chances

  • Report this Comment On February 18, 2011, at 4:48 PM, c5then wrote:

    And what would be the catalyst for gold prices to drop? The simple realization that gold is higher now that it used to be? So are car prices. The ETFs would all have to disband and return their gold bullion back to the market. The previous peak for gold prices was in 1980 at $615 per ounce. If you adjust for inflation to 2010 dollars that equates to over $2000 per ounce.

    Meanwhile what happens when (not if) the world decides to move to something other than the US dollar as the reserve currency? What happens in the next couple of years as the $3 trillion dollars that were dumped into the banks and the financial institutions by the Federal Reserve starts to make it's way into the money flow? What happens when the above two events occur at the same time?

    You can't use Natural gas as money to buy your food.

  • Report this Comment On February 18, 2011, at 4:50 PM, jk511111 wrote:

    I don't understand this article. It acknowledges that Gold has gone up because of fiscal debt. That has been the driving force for Gold's 10 year run. Has the issue subsided? No, it is accelerating and there is no one who claims to have a solution. That is because there is none. Gold has a steady and healthy 10 year chart. Bubbles do not. The day will come to sell your Gold (probably at $6k an ounce or more), but it is not here yet. Neither the technicals nor the fundamentals indicate this run is over.

  • Report this Comment On February 18, 2011, at 5:18 PM, GameTheSystem wrote:

    I would avoid buying leveraged ETFs such as Ultra Natural Gas and Ultra Petroleum, as they suffer from contango (where rebalancing their futures in order to achieve proper leverage costs them some of their equity), which can destroy one's stake even if the underlying commodity does not perform poorly.

  • Report this Comment On February 18, 2011, at 6:41 PM, bodi5 wrote:

    Natural gas is priced low becuase of horrible fundamentals: over supply and over production. With summer coming on there's also a seasonal lull. Go ahead, speculate on low priced natural gas, see where it gets you.

    Gold on the other hand, while high, is facing a tail wind of inflation that is now becoming manifest. Real estate will probably out perform natural gas too.

  • Report this Comment On February 18, 2011, at 7:20 PM, xflyzipperx wrote:

    RE: "I'm more convinced than ever that gold is a bubble that's set to burst ... the answer will be clear in a few moments".

    To say the answer isn't clear from your article is being generous ... the answer isn't even blurry.

  • Report this Comment On February 18, 2011, at 8:02 PM, renecohrt wrote:

    Goldbubble! Rubbish talk. The fiat money system has ended.

  • Report this Comment On February 18, 2011, at 8:08 PM, selfdestruct2 wrote:

    I agree with all of the other comments. The reasoning is far from clear. As soon as I read UNG, I said "no way". I've lost 80% of my original investment in this ETF. Lastly, the US economy is on the verge of collapsing. Gold will continue to rise in value.

  • Report this Comment On February 18, 2011, at 8:12 PM, scooter186 wrote:

    "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"

    -Warren Buffett 10-19-2010

    Could not have said it better myself, Mr. Buffett. Remember this when you all finally realize you just paid $1,350 for a (very small) piece of metal.

  • Report this Comment On February 19, 2011, at 11:22 PM, highgravity wrote:

    Your best argument that gold is in a bubble is "trees don't grow to the sky -- and prices don't go up forever"...really?

    I own real money. I don't own GLD, I too like my chances.

    Oh...and "If you are one of the many who own shares of the SPDR Gold Trust, my personal suggestion is to sell shares." Let's talk in 6 months Adam.

  • Report this Comment On February 20, 2011, at 5:05 PM, mavos wrote:

    Gold is rising because of fear. People, and rightly so, are skeptical and dubious about the future of the dollar (a fiat currency).

    While inflation is preferable to depression we have devalued the dollar, via the printing presses, roughly by one third since the end of 2008.

    Since then gold has almost doubled in price, so there may be merit to the argument that it is overpriced and it may fall. That might hold some ground if the devaluation of the dollar would have ended but it has not. In fact inflation is now in the house, regardless of what you hear. Just look at the rising prices of food and fuel.

    So, it's not that gold is rising in value. It is maintaining its value against world currencies that are being devalued by their governments.


  • Report this Comment On February 20, 2011, at 5:18 PM, FlorisHJ wrote:

    UNG may attempt to mirror the price of natural gas but it has failed HORRIBLY to do so over the last two years (see above comments on leverage and contango). Alternative to GLD? You must be kidding. UPL should have been moving up (not remaining flat relative to gas) if their "returns obsessed management" actually knew what they were doing.

    Gold can pay "coupons" - write calls against your shares of GLD and you will get paid even if it doesn't go up.

    Gold has great liquidity - it belongs in a diversified portfolio (add stops if you worry about a bubble, but don't sell just yet!)

    In all - not one of the most insightful articles I have read on TMF, lately.

  • Report this Comment On March 05, 2011, at 10:02 AM, joemama43 wrote:

    I believe that natural gas will continue to rise in price, as it is energy. I believe all commodities are rising in value, and they won't drop unless America makes a mass effort to grow their own food, or some of it, and stops buying so much useless crap from China. Make that useless crap here, and things will change swiftly. Ha Ha, I said "change". Gold may rise or fall, but I wonder if silver could be the new gold. It has the dual use of industry and money.

  • Report this Comment On April 19, 2011, at 3:48 PM, druidmechanics wrote:

    I may be the only one, but I AGREE with this article. It appears to me that too many people have switched o rational thought and jumped on a bandwagon, and that's exactly how real estate bubbled. A bunch of gold tulip bulbs. Anyway, if it's true, it may come tumbling down this year. I may very well be wrong, but I won't be buying any gold any time soon. From available minerals, I'm with uranium.

  • Report this Comment On May 18, 2011, at 3:40 AM, stefaith wrote:

    I agree that Gold is over-priced. Bubbles always look like sound investments until they don't. In spite of the huge amount of money created since the economic crisis, inflation has been moderate. As long as industrial utilization remains low, and unemployment high, I see no danger of inflation becoming rampant. Of course if the economy improves, which it will eventually, interest rates will have to rise, and then gold will get sick.

    Discosure. Short GLD, and long a number of companies that will benefit from higher natural gas. (EXC, RRC). I am also long Canadian Oil Sands, which is a bet on continuing high crude oil prices; ie coninuing and spreading turmoil in the Middle East.

  • Report this Comment On June 06, 2011, at 10:32 AM, fuzzywzhe wrote:

    When there is an actual bubble, the media will be constantly challenging anybody's assertion that it's a bubble. This is what was done in the bubble (Nasdaq) and the Housing Bubble.

    If everybody put 10% of their wealth into gold, gold would be in the 10's of thousands of dollars. Nobody owns it. If every American owned just 17.68 troy ounces of gold, that would be all the world's gold ever mined that is known to exist today.

    At this moment's price of gold at 1,551 dollars per troy ounce, that works out to be $27,421.

    At this same moment, every American owes $46,215 as their share of the national debt. All the gold ever mined doesn't even cover the national debt.

    That's the bubble, the dollar bill. The media is constantly telling you it's a not a bubble. Deflation is here, move your money out of risky assets and into the dollar, that's safe. They're doing the same routine, but nobody realizes that a dollar is an investment, and a terrible one at that.

    You're better off buying anything than the dollar because that's the mother of all bubbles right now. Currently we're skiing down the slop of hope for the dollar, and it's not about to bottom any time soon, maybe 2017 to 2020.

  • Report this Comment On August 10, 2011, at 5:09 PM, davidf95 wrote:

    I completely disagree with this article for many reasons. But I'll just state one. Gold doesn't change in value at all. it doesn't up in value at all. The supply today is the same as it was 5 billion years ago and 5 billion years from now. Since humans are incapable of create a massive super nova. So his statement about gold going up forever is not sustainable is a misleading statment. it's the DOLLAR that is what is important here. The dollar is going down in value. Now the real question who should be asking, is the vlue of the dollar dropping sustainable forever? Every country around the world compares their currence to gold. it's the currency that the numbers represent, not the gold.

  • Report this Comment On August 15, 2011, at 2:28 AM, mvelloso wrote:

    How's your bubble bursting doing so far?

    If the horse wins the race once, lucky horse

    If the horse wins the race twice, start considering betting on it

    At some point you should accept you're in denial or misunderstanding the fundamentals. Either that or keep repeating yourself until in some decade you can prove you're right

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