Gold Makes One Of Four Assets Classes In Fortune Bubble List

Fortune magazine has webbed a list of four asset classes which the author of it considers to be in bubbles. The entire list makes for a real grab bag. Two on it are financial assets: U.S. stocks and U.S. Treasury bonds. The other two are commodities: gold and oil. Some may wonder if the list is self-contradictory, but the liquidity sloshing around explains how T-bonds and gold could both be considered in bubble territory right now; excess liquidity is fungible. Suffice it to say that both being in bubbles implies that bulls in each market expect different inflation outcomes.

The author, Shawn Tully, uses historical norms for each: in the case of gold and oil, he points to high prices calling forth a lot of additional supply. Here's what he has to say about gold:

Investors are rushing to gold, because they rightly fear far higher inflation in the next couple of years and want to hedge against both rising prices and a declining dollar with a commodity that, they claim, has a fixed supply.

Since early 2009, the price has jumped to $1,100 an ounce from $875, triple its average price between 1990 and 2004. Yet the supply of gold is far more fluid than the gold bugs admit, partly because mining companies are investing heavily to increase production.

The real threat: Prices are so high all over the world that people who once treasured their gold jewelry are now rushing to sell it. Swiss refiners are offering irresistible prices for bracelets and brooches, "cash-for-gold" stores are in Chicago malls, and suburbanites are hosting Tupperware-style parties where neighbors show up to hock their gold teeth.

When this happened in the early 1980s with silver, prices plummeted from $50 to $15 in less than a year. Look for gold to end up below $500 an ounce within two years.

There it is - a real mirror of any excited goldbug who's calling for $2,000-$2,500/oz within two years.


As I pointed out in the Enter Stage Right article that's "Entry Zero" of this blog, bubbles get rolling when historical measures imply that an asset is overvalued but subsequent price action mimics undervaluation. The explanatory gap is filled by a New Era story that explains the mysterious rise in terms of a fundamental value-shift to the asset's benefit. As the bubble progresses, the New Era story spreads and grows in the telling, to the point where it becomes an all-out New Era delusion.

Thanks to the popping of the August-November parabolic rise, gold's still on the cusp of an all-out bubble. The price movement of the metal doesn't defy sanity as of yet, although it briefly seemed to as of November last year. Remember the report about third-quarter world demand for gold falling 34%, which the gold market ignored back then?

Tully's argument is fundamentalist in nature, and is more gut-level than the deflationists' warnings. It applies even if inflation stays at today's mild but positive levels. Furthermore, it makes economic sense: when new supply is called forth by high prices, prices fall. That's the way markets work.

Given the supply increase he points to, his argument will be confounded even if gold stays where it is. The supply ramp-up will have been met by a corresponding ramp-up in demand, most likely investment demand. If gold stays flat this year, as I suspect it will, then we'll be watching an incubating bubble. The off-to-the-races moment will be amplified when the general public shifts from being net suppliers to net demanders, when the "Cash for Gold" companies' revenues slump while bullion sellers' soar.

Should the gold bull market turn into a bear market, the likes of Mr. Tully will say that the gold bubble has popped. Myself, I would say that an incipient bubble never got off the ground. Gold as an investment has not been mainstreamed enough for it to have engendered all-out bubble fever; nor has there been the general euphoric bliss that characterizes a full-scale bubble. In fact, the mainstreaming process hasn't proceeded all that far, and it can be argued that the process is in its early stages.

It's still cusp time...