There Is No Gold Bubble

Gold has certainly received a lot more attention from investors since the beginning of 2009. Last Wednesday, with gold near its high for 2010, precious metals consultancy GFMS said in its annual report that the market "has moved out of kilter with its underlying fundamentals." George Soros, the wildly successful speculator, went as far as to call gold "the ultimate bubble" at Davos in January. But talk of a gold bubble is nonsense, and here's why.

When a master investor flops
In February, the Wall Street Journal reported that hedge fund manager John Paulson had only raised $90 million for a dedicated gold fund that he launched at the beginning of the year -- much less than the $250 million of his own wealth he's allocated to the fund. Paulson famously made cumulative gains of $20 billion in 2007 and 2008 with a macro-themed bet against subprime and financials. When an investor with Paulson's stature and recent track record can't quickly crack $100 million for a new gold-oriented fund, investors clearly aren't falling over themselves to own gold.

Paulson already had a significant allocation to gold-related investments prior to the new fund, including positions in the SPDR Gold Trust ETF (NYSE: GLD  ) and gold miners Anglogold Ashanti (NYSE: AU  ) , Gold Fields (NYSE: GFI  ) , and Kinross Gold (NYSE: KGC  ) .

But there's more ...
The tepid reception for Paulson's new fund is anecdotal evidence against a gold bubble, but there is more evidence against the bubble hypothesis. Here are some elements that "bubble-spotters" may be overlooking:

Gold isn't even halfway to its all-time high price: Although gold achieved a nominal all-time high price of $1,226 per ounce in December 2009, it is still well below its 1980 price in real terms. Adjusted for inflation, the 1980 high of $873 per ounce is equivalent to over $2,200 today.

Investors likely remain underweight gold: The total value of all mined gold represented about 3% of the stock of global financial assets ($178 trillion) at the end of 2008. That "market weighting" for gold is probably higher than its weighting in the portfolios of institutional investors.

Consider the Teacher Retirement System of Texas (TRS): In October 2009, it launched a $250 million internal fund that invests in precious metals mining stocks and ETFs. Although the initiative suggests that TRS is one of the more pro-active pension funds with respect to gold investing, the $250 million allocation represents approximately a quarter of a percent of the $95 billion in assets TRS oversees. In fact, TRS's total allocation to commodities -- all commodities -- was less than 2% at the end of August 2009.

(If readers have any aggregate data on gold holdings at institutional investors, I'd be grateful for an email with the reference.)

The Greek canary in the sovereign coalmine: The current sovereign debt crisis in Greece is a foretaste of the reckoning that many advanced economies will face (including the U.S. and the U.K.). As maverick Societe Generale strategist Dylan Grice wrote in a note to clients at the end of March:

Eventually, there will be a crisis of such magnitude that the political winds change direction, and become blustering gales forcing us onto the course of fiscal sustainability. Until it does, the temptation to inflate will remain... Until it does, the outlook will remain favorable for gold.

Overweight gold, underweight U.S. stocks
I have no idea where gold will trade next week, next month or even next year. However, I'm pretty confident that while the precious metal may no longer be a contrarian play, neither is it in bubble territory. Investors need not fear owning the yellow metal: With gold and the S&P 500 both trading near 1,200, I'd rather to be overweight the SPDR Gold Trust than the SPDR S&P 500 ETF (NYSE: SPY  ) . (Let me be clear: "Overweight" and "underweight" are defined against benchmark weights -- I'm not implying that one's allocation to gold should exceed one's allocation to stocks.)

The Fed is creating a new set of risks for investors, but gold isn't the only way to hedge these risks. Tim Hanson highlights the top markets right now.

Fool contributor Alex Dumortier loves macro-themed investing. Alex has no beneficial interest in any of the shares mentioned in this article. The Fool owns shares of SPDRs. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy


Read/Post Comments (15) | Recommend This Article (32)

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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 April 19, 2010, at 5:44 PM, fockewulf wrote:

    When I first saw Soros´s comment I took his use of the word "ultimate" as meaning the "biggest" or "greatest". I gained another view of what Soros really ment by another investor. Below is his post explaining to me what Soros really ment. It explains why Soros has made a major investment in gold.

    "There's a hell of a debate raging as to his meaning of the word "ultimate" here's the gist of it..........

    Everyone seems to be misunderstanding Soros. But his actions are 100% consistent with his words.

    He said that gold is the "ultimate" bubble. That is exactly what he meant. Ultimate means "last." Think about the literal meaning of this. He is saying that when the value of all other asset classes collapses, gold will be the last asset standing. When all other bubbles have burst, the money will go to gold. The "ultimate" bubble.

    You can disagree if you wish (and it's certainly a doomsday scenario). But you can't accuse him of inconsistency. He is acting in exact accordance with his words and he is putting his money into what he believes will be the last store of value."

  • Report this Comment On April 19, 2010, at 5:45 PM, fockewulf wrote:

    When I first saw Soros´s comment I took his use of the word "ultimate" as meaning the "biggest" or "greatest". I gained another view of what Soros really ment by another investor. Below is his post explaining to me what Soros really ment. It explains why Soros has made a major investment in gold.

    "There's a hell of a debate raging as to his meaning of the word "ultimate" here's the gist of it..........

    Everyone seems to be misunderstanding Soros. But his actions are 100% consistent with his words.

    He said that gold is the "ultimate" bubble. That is exactly what he meant. Ultimate means "last." Think about the literal meaning of this. He is saying that when the value of all other asset classes collapses, gold will be the last asset standing. When all other bubbles have burst, the money will go to gold. The "ultimate" bubble.

    You can disagree if you wish (and it's certainly a doomsday scenario). But you can't accuse him of inconsistency. He is acting in exact accordance with his words and he is putting his money into what he believes will be the last store of value."

  • Report this Comment On April 19, 2010, at 5:58 PM, plange01 wrote:

    gold is simply extremely over priced and could easily drop a $1,000 and still be to high...

  • Report this Comment On April 20, 2010, at 12:48 AM, ET69 wrote:

    plange01. If gold drops $1000 and is still too high then it really is the end of civilization.Do you always exaggerate?

  • Report this Comment On April 20, 2010, at 12:52 AM, ET69 wrote:

    Plange01,

    If gold drops a $1000 and is still too high then it really is the end of civilization.Do you always exaggerate?

  • Report this Comment On April 20, 2010, at 2:29 AM, SnapDave wrote:

    focke,

    I don't discount a potential doomsday but given Soros is a manipulative POS I'd speculate he was trying to encourage a price drop in anticipation of his recent large purchases.

  • Report this Comment On April 20, 2010, at 10:11 AM, skepticbill wrote:

    There is a gold bubble going on. It's dirt simple to spot: what is the ratio of the price of gold per ounce to its relative scarcity versus the price of platinum, palladium, and silver to their relative scarcities? Also, the other metals are actually used in industry, so they have intrinsic value besides impressing girls. Gold could be used in industry, except industry thinks gold is too expensive. Only the investors with agendas are telling you to buy gold now. Gold is trading almost at parity with Platinum, a much rarer precious metal with more industrial uses. If Gold hits as high as the pundits want you to think it might, it will be worth more than platinum per ounce, and that is patently absurd based on fundamentals. Silver has incredible potential for nanotech and antibacterial applications, and mining hasn't matched demand for refining in years. If you want to hedge against externalities, skip gold - its already too hot. Any further purchases of gold are completely speculative and not based on reality. Buy some silver, platinum, or palladium instead. Not only do these hedge the same things as gold, but they are the only place the gold dollars can flock to once that bubble bursts. Also, I am shocked that the author would even bother mentioning the 1980 very temporary spike in gold. Just because the bubble isn't as big as it was in 1980 doesn't mean we aren't in one now, nor does it guarantee that this bubble will grow as big as the last one. The Fool sounds like those jerks trying to sell silver based on the fact that it's "below historical highs" from that time those other jerks tried to corner the market and failed - that's not a historical high, that's a speculator's joke. Read a book on statistics and throw out the obvious outlier in the data before you stake your reputations on illogic and speculation.

  • Report this Comment On April 20, 2010, at 10:12 AM, BMFPitt wrote:

    Gold: The world's shiniest fiat currency.

  • Report this Comment On April 20, 2010, at 12:24 PM, Canuck2010 wrote:

    Isn't there a case to be made that the 1980 high for gold was simply a bubble itself that was very rapidly deflated to the great annoyance and financial ruin of many gold bugs?

  • Report this Comment On April 21, 2010, at 8:57 PM, extremist wrote:

    The derogatory and ho-hum commentary above offers more evidence that gold hasn't yet reached the bubble phase; otherwise people would brag about their outlandish golden profits and exhort everyone to jump on the train before it's moving too fast to catch up. I follow the adage of buying when they're crying and selling when they're yelling -- and no one's being particularly loud yet, just a bit miffed about not having joined the bandwagon earlier.

  • Report this Comment On May 14, 2010, at 9:19 PM, rscarawa wrote:

    FIrst of all, I have to say I cannot see the point of investing in gold. I had a telemarketer call me yesterday (on my cell phone too) telling me not to miss the boat. Instead, I kept him on the phone for 15 minutes and gave him several reasons not to invest in gold. Here are a few of my worries:

    How do you properly value it since it has no industrial use other than plating of certian items?

    How do you value something that someone wants and they do not even know why they want it or what they will use it for.

    Considering the bulk of the worlds gold is held by a few owners, (US, China, India, Russia), does that not concern you that any one of the above mentioned parties could blow open the market if they wanted to get out? That is much different than a company where the largest inventory may hold less than 10% of the holdings.

    Does it not concern you when they try to sell it on TV or through high pressure marketing? If it were so valuable, would it not sell itself? So why not just get others to buy who are not sure why they want it. They will be the last out of the market if it should fall hard. I worry about anything trendy investors buy as they seem to be the last to arrive at the party and magnify a bubble. I had a friend in this party say to me "Buy high, sell higher" during the Dot-com era.

    I see so much more use in anything with utility other than gold. Gold does not earn dividends. It has to be maintained if it is not in your possession. If it is in your possession, then it has risk of being stolen.

    To quote Randy Jackson on AI, "I just don't get it dawg."

  • Report this Comment On May 21, 2010, at 10:03 PM, MattCohn wrote:

    Gold drops to $300/ounce by the end of the year.

  • Report this Comment On October 11, 2010, at 7:29 AM, ServusDei7 wrote:

    Gold is a huge bubble. Just because it has not yet reached its 1980 price in real terms does NOT mean that it is going to. Nasdaq reached an all time high of 5132.52 on March 10th, 2000, and it is now at 2401, which is not even half the nominal all time high. If you want to be bullish, why not be bullish about the Nasdaq? Judging by the price from the all time high alone, Nasdaq is much cheaper than gold, so your argument makes no sense.

    Also, there is a huge difference between the gold bubble now and the gold bubble then. In the 1970s leading to gold's high in 1980, there was massive inflation with interest rate in the double digits. People piled into gold as an inflation hedge as stocks and bonds did not keep up with inflation. Today, however, interest rate is low and there is no hyperinflation, despite what the gold bulls say. For the past 100 years, gold has only appreciated at the rate of inflation, which makes complete sense as it is a commodity and is behaving as a commodity. However, for the past 10 years, gold has gained more than 500%, way way above inflation. The principle of reversion to the mean tells me that gold must drop from here, probably to $600/oz for a fair price. I would strongly advise all to avoid this bubble now.

    In sum, when something is at an all time high, and everyone is bullish about it and saying buy, buy, buy, that is a bubble which must end badly.

  • Report this Comment On October 11, 2010, at 8:32 AM, nickolassc wrote:

    Once the hedge funds start profit taking in GLD for year end earnings watch out! I wouldn't jump into gold until next year at the earliest for several reasons.

    1. We are overdue for a short term correction at the minimum, and if the correction is over-done it will pop the bubble (I think this scenario is unlikely but possible)

    2. Bubbles typically follow a set pattern. Looking at the 10 year gold chart makes me think gold still has room to rise, I'm looking at gold to hit 2,000 an ounce at it's peak and expect it will hit it within the next 6 months. Bubbles typically fall to 25-33% of the peak, so gold will fall back to 500-660 per ounce before it's all said and done.

  • Report this Comment On November 06, 2010, at 5:49 AM, MFreader001 wrote:

    Gold is a smoking deal. By dividing the debt money to the gold reserve the price of gold per 1 g should be USD 1682.93 (if viewing the currency as backed up by gold reserve) - according to calculations 5 min ago - and that figure is growing.

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