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Wednesday, July 18th, 2018 - Buy Gold - Bringing you trusted gold news and gold investing information since 2006

Is Gold in a Bubble?

As a commodities investor, I own gold. I know from history that gold goes up during a commodities bull market, but I have often had difficulty understanding its value. I can empathize with gold bears on this one point: Gold is not a necessity, like food or energy; hence, the intrinsic value gold seems difficult to determine. Oil has always been my focus. It is easy to understand the functionality and utility of oil and this gives you a better sense of its value. So perhaps it is best to explore the function of gold.

What Is the Function of Gold?

I think almost anyone can agree with me that gold has historically been used by people as a medium of exchange and as a long-term store of wealth. Bears might be quick to point out that gold has not always been so effective as a long term store of wealth. I concede this point but its intended function (as an asset) can be simply put as a store of wealth. Bears will say that other investments have served better as a store of wealth. Hence, gold has always had to compete with substitute investments throughout history.

What Are the Substitutes for Gold?

Substitutes for gold are basically the mainstream investments we know today: real estate, stocks, bonds, and savings account interest. During the 1980’s and 1990’s, these financial instruments performed far better than gold as a store of wealth.

Here are some of the numbers:

To say that gold underperformed from 1980 to 2000 is an understatement. Gold lost 54.8% of its nominal value at this time. Why? Because better substitutes – stocks, bonds, real estate – existed. These assets served as good stores of wealth due to the following conditions:

  1. Falling commodities prices
  2. Falling interest rates
  3. Economic growth with decreasing inflation
  4. Stable currencies
  5. Increasing investor interest

In a nutshell, gold’s competitors – financial assets – started to perform well again (other than real estate, which performed well in the 1970’s and continued on in the 1980s and 1990s). Year by year success of these assets drew interest from more investors and appreciation continued. The final fundamental was increasing investor interest. As the trend continued, more people put their money into financial assets and real estate and abandoned gold. From 2001, however, the conditions listed above started to change one by one.

The Bull Market in Gold

Gold is thriving now for the following reasons:

  1. Rising commodities prices
  2. Bottoming interest rates (in most developed countries, interest rates are at historical lows)
  3. Lack of economic growth in developed economies
  4. Economic growth in developing economies accompanied by rising inflation
  5. Unstable (western) currencies
  6. Increasing investor interest in gold

As conditions changed, gold gained and then outpaced its competitors. Here is the data:

2000 to 2005

Gold

59.1%

Real Estate

66.8%

S&P500

-14.9%

30 Year Bond

47.7%

2005 to 2010

Gold

175.0%

Real Estate

8.5%

S&P500

-6.4%

30 Year Bond

30.6%

At some point, of course, the fundamentals which cause an asset class to appreciate can change. If underlying long term fundamentals behind an asset’s appreciation have changed while investor interest keeps increasing (along with the price), then we have a situation that people call a “bubble.” A “bubble” is where the underlying long term fundamentals do not support the current price level. And if long term fundamentals have changed it means that prices can drop severely – more than 50% – and steadily. This is what happened with gold in 1980 and is happening in real estate currently.

Today gold bears claim that gold is a “bubble” and it should pop soon. Consider the following questions:

  • How have fundamental forces which pushed up the price of gold changed?
  • What is a good substitute for gold today?

So I ask the bears: Why is gold overvalued? What fundamentals indicate that other assets are going to serve as a better store of value? Finally, I might add that the investor participation in gold is still very small. GLD, the primary ETF for gold, is currently valued at $59 billion; Apple (AAPL) – one stock – is valued at $312 billion; the US stock market is valued at over $11 trillion.

One day the price of gold will peak and decline from its highs. I am not sure what this will look like. There may be no 400% spike in one year followed by a 50% drop, as there was from 1979 to 1980. History does not exactly repeat itself but it might rhyme. This gold market will come to an end when the fundamental forces behind it have changed and other assets –substitutes for gold – start to serve as better stores of wealth.

Disclosure: I am long GLD.

The original article is published at http://www.c2ads.net/full-text-rss/makefulltextfeed.php?url=http://seekingalpha.com/sector/gold-precious.xml&format=rss&submit=Create+Feed


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