Financial Sense Newshour On The Gold Bubble

This week's Financial Sense Newshour podcast returned to the gold-bubble theme, in large part because more public sources are claiming that there is one. The gold-bubble meme has acquired a lot of traction lately in the financial press, and it shows in this week's podcast. The first of the two parts of an entire segment of the show [.MP3 file] is entitled, "Gold - Bubble Trouble or Ready to Double?" Essentially, the same rebuttal points used in recent weeks were re-used. Gold hasn't been mainstreamed; smart professional investors are plowing into gold right now; the Federal Reserve has expanded the monetary base hugely; the U.S. deficit, as a percentage of GDP, has reached a high-inflation tipping point; the Fed is likely to monetize more Treasury debt and jack up the monetary base to do so; the pressure to do so will be upped considerably once Treasury-security interest rates rise across the board.


There's another point that can be used to rebut the claim that gold is currently in an all-out bubble: too many people are aware of the possibility, implying that they're still skeptical of gold. This point may merely be naive contrarianism, but contrary-opinion theory has a solid kernel of truth in it. People are publicly bullish about investments they have already bought. They want company; their bullish expectations amount to, "I'll make money with this thing and so will others once they get on board too." In contradistinction, people who are bearish don't own it and don't plan to. When everyone is bullish, therefore, everyone who's likely to buy has already bought. The only way for the price to keep plowing up is if new demand comes in from somewhere else - new money. If the investment is widely-talked about, there aren't that many sources for new-money demand.

The current level of skepticism comes from people who already know something of gold. Should gold confound them, they might well switch their opinion to bullish.

At the climax of a real bubble, there is almost no skepticism. The few that are, are hesitant and often placatory. They know full well that they'll look like idiots if the investment keeps rocketing up. In addition, too may of the ordinarily prudent have already had their disbelief-screen utterly confounded at an earlier stage of the bubble. Common sense is no longer useful, and suspension of prudency-based disbelief is well-nigh universal. The jump-the-shark moment near the top of the bubble, such as bullish profiles of the investment in the non-business media, is the last of several; the others seem to be jump-the-shark moments but aren't. Hence the near-universal silence of the skeptical, and the perception among bears that top-calling is just too risky at that point.

Historically, the pros tend to exit at the beginning of the blow-off stage. Client and/or performance pressure tempts them back in. That's why they tend to get caught along with the general investor.

We're far from this stage yet. Gold may get flattened down to three digits and stay there; if so, it won't occur because of a popped gold bubble. It'll take place because a real bubble never got rolling. The recent "bubble" talk is reminiscent of U.S. residential real estate around 2003.


While I'm on the subject, gold skeptic Andrew Butler has written a Seeking Alpha article entitied "Is Gold Bubble Popping?" A catchy title, but he's really discussing whether or not gold is overvalued at current prices. He compares gold to crude oil, claiming that there's a 74% correlation between the two since 1971. By his lights, gold should be in a range centered around US$750/oz. If he's right, then gold is about 49% overvalued - or oil's about 33% undervalued.