by Louis Golino for Coin Week

Many people say gold is a bubble about to burst, but is that really the case? One of the problems with identifying bubbles is that one is not certain one exists until it has already begun to burst. I do not think that is the case with gold today, at least not yet.

gold bubble 2 The Coin Analyst: Ten Reasons Why Gold is Not Yet a Bubble1.) The average American is selling gold, not buying, because they need the money and believe the mainstream press, which keeps telling them prices will collapse soon because they are too high. In the late 1970′s there were huge lines winding around coin and jewelry shops as everyone rushed to get in on gold. Today if you go to those establishments and wish to sell, you had better plan on being there a while because so many people want to cash in on high prices. Not nearly as many people are buying, at least at the retail level, in the U.S.

People at cocktail parties may be talking about gold’s meteoric rise, as Dennis Gartman, a longtime commodity trader and author of the Gartman Letter said recently, but they are mainly doing just that – talking about it. If you ask people if they actually own gold, relatively few people outside of the very wealthy and people outside of America in fact do.

2.) Only 1%-2% of the world’s wealth is in gold. During the last bull run in the late 1970′s, 5% of the world’s wealth was in gold. Much is being made of the fact that the exchange-traded fund (ETF) that tracks the price of gold (GLD) has surpassed the total value of the ETF that tracks the S&P 500. But what is not mentioned is that one company’s total stock shares, Apple, have a value that is four times that of GLD. The gold market is only a fraction of the equity market, and the bond market is much larger still.

3.) Most demand for gold comes from India and China, which are expanding economies likely to continue growing. As the size of the middle class in Asian countries increases, more and more people seek to protect their assets from rising inflation. Emerging markets are the major growth area in the world economy in the coming years, so this trend is likely to continue.

4.) There is a remarkable degree of skepticism about the current gold rally, especially in the mainstream financial media. Hardly a day passes without commentators on CNBC proclaiming that gold is a bubble and that wise investors should sell. The same is true of magazines and newspapers like Barron’s, Money, and Kiplinger’s, which regularly feature articles warning about the dangers of investing in gold.

5.) Gold’s status as an asset class is changing. Some people now call it an alternative currency rather than just a safe haven or a hedge against inflation and uncertainty.

6.) Central banks all over the world have been purchasing gold in order to diversify their balance sheets. With not just a declining dollar, but literally a race to the bottom among the world’s leading currencies, further debasement of fiat currencies is virtually guaranteed. This is being done to make exports cheaper to prop up growth and to reduce the value of outstanding debt. Moreover, it was recently reported that the U.S. money supply just hit an all-time high. It can take time for increased money supply to translate into inflation, especially in a basically recessionary environment, but that will be the eventual impact of the various rounds of quantitative easing.

A member of German Chancellor Angela Merkel’s government called on August 23 for European Union countries to pledge gold reserves as collateral towards future bailouts of eurozone countries. European central banks now have another reason to own gold.

There is lot of speculation about whether Federal Reserve chief Ben Bernanke will either announce a new round of monetary easing on Friday at the annual Jackson Hole, Wyoming meeting of financial experts and officials, or an extension of maturities on existing asset purchases. Gold may decline significantly if Bernanke disappoints in this regard, but it is likely to be a relatively short-lived decline.

7.) In the past few weeks, as gold continued to hit one new high after another, margin requirements were increased 22% earlier this month on the Chicago Mercantile Exchange, and a small increase was made by the Shanghai, China exchange effective later this week. Brief corrections in the price of gold have generally brought out enough buyers to push prices at least part of the way back up. For example, early on August 23, gold hit another new nominal high of $1917, and over the course of the day it retreated to below $1830, but a few hours later it was back up around $1850, which is where it ended last week.

However, additional margin requirements in the near future are likely to knock prices down, as is increased profit taking, which is always a possibility when an asset rises as quickly as gold has recently.

8.) If gold were in the final stages of its current rally, it would be hitting what is called a “blow-off top.” That would mean prices going up something on the order of $100 or more a day. It would also probably not be the case until gold surpasses its inflation-adjusted 1980 high. That would mean a price of about $2500 per ounce. Until we see prices in the range of $2500 or more, I doubt the rally is over. And when it does end, I am not so sure prices will collapse to the levels many financial analysts predict such as $1,000 or less, especially in the absence of a liquidity crisis as we faced in late 2008.

9.) Corrections within bull runs are healthy because they help build support for prices at higher levels. If gold had not corrected this week, I would be more concerned, but that is not what has happened. I would tend to agree with those who are predicting prices of $2,000 by the end of the year, depending on how the overall economic situation develops.

10.) Finally, mainstream analysts always say gold is a fear trade, or an end of the world trade. But it is really a hedge against uncertainty rather than economic collapse. There is a huge amount of economic and financial uncertainty in the world today. As long as Europe and the U.S. remain mired in what is a recession by any other name, and plagued by debt problems and dysfunctional political systems, I think gold will perform well. None of those conditions are likely to change in the near future.

None of this should be taken as a suggestion that gold is an investment without risks, or that it is not currently a crowded trade at the investor level. Going out and buying a lot of bullion or relatively low premium collectible gold coins right now does entail risks. And if you need the money, or feel you need to reduce your risk and take some profits, selling makes sense. But when you hear someone saying gold is all the rage these days, ask them if they own any. When lots of people respond that they do, then you may want to consider selling more of your position.

golino portrait thumb The Coin Analyst: Ten Reasons Why Gold is Not Yet a BubbleLouis Golinois a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, and a number of different coin web sites. He collects U.S. and European coins and is a member of the ANA, PCGS, NGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.

 

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3 Comments

  1. Alicia says:

    I enjoyed the article! You make some good points.

  2. Louis says:

    Thanks, Angela. Today’s move back towards $1800 follows the usual pattern, as buyers come in after a correction and push prices back up.

  3. joe says:

    Louis,

    I totally agree…very few people I know own gold.

    It is in the best interest of the central banks that gold prices be kept low as they add to their positions. Over the past few years, it seems that mainstream media is basically a voice for our government (like Pravda was in the old Soviet Union). I often wonder if the MSM is a mechanism to steer us the way the administration/wall street wants us to go (e.g., sell gold, gold is on a bubble, etc.).

    I think the correct view is that gold is not really going up, but it’s the dollar that’s going down. Even if by some miraculous intervention fiscal sanity abounds around the world (never gonna happen by the way), it’s probably too late for conventional fiat currencies. The proverbial “house of cards” is just too unstable. Gold may not be the solution or even a good substitute as a currency, but it’s a heck of a lot better than getting stuck holding Ben Bernanke’s toilet paper (i.e., the USD).

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