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If a picture says a thousand words, then the image below speaks volumes against accusations of a bloated asset bubble in gold.
I'm sure you've seen the invariably confident claims that gold must represent a bubble, backed by deeply unscientific litmus tests. It must be a bubble, because "my mother recently asked me if she should buy some." (Psst! Hey, Mom ... Yes!) Others may feel compelled to sound the panic alarm because -- gasp! -- commercials have appeared on television to sell the yellow metal.
Of course, those anecdotal arguments against gold exposure have proven incorrect time and time again. With each successive breakout to fresh all-time highs, gold continues to confound perennial bubble callers with the sheer strength and continuity of its secular bull-market run.
Concealed amid the cavernous disconnect between the equally entrenched outlooks of gold bulls and bears, however, lies a basic and crucial consideration that bubble callers have persistently overlooked. It's all too easy to presume that a bubble exists when an asset gains value and attention quite rapidly. But one careful look at the relative historical context offers enormously compelling evidence that gold's historic resurgence retains ample room to run. At the core of gold's momentum is not a fear-driven speculative frenzy, as many have argued, but rather a protracted revaluation event for a global currency that had been all but tossed into the world's collective wastebasket.
I know we are all busy Fools, but I need you to take a moment to fully absorb the implications of the following chart:
Hedge fund manager Eric Sprott presented this data to the Casey Research Gold & Resource Summit last fall, and it remains the most powerful visual tool I have encountered to help dissuade Fools from rushing to careless presumptions of gold's bubblehood.
As you can see, a very significant portion of the world's wealth was routinely held in gold throughout the twentieth century; that is, until the currency encountered wholesale cultural abandonment in favor of the almighty dollar and its worldwide fiat counterparts, and the global economy embraced obscene degrees of fiat-based leverage that we now know set the stage for our ongoing financial crisis.
Gold ownership through the ages
Although many continue to misperceive gold as a commodity to trade fluidly in response to panic or fear, many fail to recognize just how significantly that notion differs from historical attitudes toward gold. Prior to 1933, gold was effectively indistinguishable from U.S. currency, and the dollar's official peg at $20.67 per ounce of gold meant that gold coins and paper bills that were promises for gold could circulate in tandem.
Then along came a historic bait-and-switch that Bernie Madoff himself would tip a hat to: In 1933, President Roosevelt ordered the confiscation of all gold from the public, outlawed the possession thereof, and then devalued the U.S. dollar by nearly 70% overnight, with a revaluation of gold to $35 per ounce. By the time American citizens would once again be permitted legally to own and trade gold in 1975, the gold price had appreciated a further fivefold to some $175 per ounce. President Nixon, of course, had finally severed all ties between gold and the dollar in 1971, which itself set the stage for that decade's inflationary battle and subsequent spike in gold to $850 per ounce in 1980.
After then-Fed Chairman Paul Volcker courageously hiked the federal funds rate to 20% in 1980 to slay an inflationary beast, the gold market snapped back, fell out of favor with most investors, and quickly became the all-but forgotten currency of the late twentieth century. Asset allocation models, which had typically advocated for 5% to 10% gold exposure after 1975, were gradually adjusted to remove gold from the picture entirely. Unbacked fiat currency, and in particular the U.S. dollar, grasped the financial reigns as though gold were now some wholly irrelevant vestige of a quaintly fiscally constrained past. As private investment demand tanked, and sales from central banks boosted supply, gold struck rock bottom as the century came to a close.
Enter the true asset bubbles
To be clear, the above chart does not speak directly to those trends within gold investment allocations, nor reveal the shifting boundaries between public and private ownership of gold. The preceding discussion, rather, provides context for the historically anomalous abandonment of gold that happened to coincide with an equally anomalous and highly leveraged explosion in the combined notional value of competing asset classes worldwide.
Every last Fool who has ventured to ascertain the root causes of our ongoing financial crisis will no doubt recognize the factors that precipitated the massive decline in gold's value as a proportion of global assets between 1981 and 2009. Following incremental moves to undermine the reach of Glass-Steagall -- as in 1987, when the Fed bowed to pressure from the predecessors of Citigroup (NYSE: C ) and JPMorgan Chase (NYSE: JPM ) to permit banks to deal in commercial paper and mortgage-backed securities -- the eventual repeal of Glass-Steagall fomented arguably the largest asset bubble ever formed. I'm talking about the toxic mountain of global financial distress that Warren Buffett labeled "financial weapons of mass destruction": derivatives. And thanks to Helicopter Ben and his seemingly limitless appetite for monetary intervention, this asset bubble has yet to truly unwind!
During 2009, gold reached the $1,000 mark for the second time in as many years. Fortune Magazine boldly proclaimed gold a bubble at the time, drawing a sharp rebuke from this very Fool. The SPDR Gold Trust (NYSE: GLD ) , which I do not recommend as a suitable proxy for gold, has climbed another 34% since that time. A secular bull market, of the strength and longevity we have witnessed from gold thus far, underscores the fundamental return of this globally recognized currency into the fabric of our global financial system, Alan Greenspan himself has marveled: "What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment."
If gold is not fundamentally irrelevant, as the world's financial markets saw fit to pretend for many years, but rather the foremost barometer of distress in unbacked currencies (Greenspan has called gold "the canary in the coal mine"), then a Fool can reasonably expect gold to retake some meaningful portion of its value relative to global assets before any secular bull market reverses course. I have no way to know whether gold will ever make up as big a proportion of global assets as it did historically, but I am extremely confident that its proportion beneath 1% as of 2009 was only the beginning.
Something has to give with respect to the chart above. Wholesale accumulation of gold by central banks and investors the world over will likely continue to support gold's multiyear revaluation event relative to the U.S. dollar. Meanwhile, global asset values, tainted by toxic derivatives and other leveraged assets, remain highly susceptible to a significant downward correction. Along with those derivatives, I consider U.S. Treasuries another potential bubble of fairly epic proportions; bond fund manager PIMCO's remarkable decision to remove all Treasury bond exposure only seems to confirm my suspicions there.
If any of this strikes a chord of truth for you as an investor, consider some form of investment exposure to gold (or silver). Central Fund of Canada (AMEX: CEF ) provides reliably sound exposure to unencumbered gold and silver bullion, while the Market Vectors Junior Gold Mining ETF (NYSE: GDXJ ) offers some very simple one-stop exposure to promising gold and silver miners, including my top gold pick for 2011: Gammon Gold (NYSE: GRS ) . Those seeking larger-cap plays, meanwhile, should remember that Goldcorp (NYSE: GG ) is the hands-down king of the major low-cost producers.
I believe that gold will keep rising well beyond my conservative long-term price target of $2,000. As I stated last year: "Gold's legitimacy was never lost; it was merely forgotten, ignored, and then grossly misunderstood." Restoring what is truly the ultimate currency from the brink of supposed irrelevance to its rightful place within the sum of global asset values requires a monster move, and 0.8% of the total by 2009 does not even begin to convey a bubble.
Give me a shout when gold reaches even 5% of global assets. Perhaps then, it'll be time to evaluate whether gold's really a bubble. For now, however, I view some manner of gold (or silver) exposure as a basic financial imperative. Whatever your view on this inescapably controversial topic, I look forward to reading your thoughts in the comments section below.