No Gold Bubble

Are we in a gold bubble? Well, since gold is moving virtually unstoppably towards its previous nominal high at $ 1,030 – the question is valid. But the answer is: NO. If an asset class is in the stage of a bubble it has completely different characteristics:

1. Everybody from the taxi driver to the mutual fund manager owns gold and gold stocks and tells you that gold can only go up in price (poised to rise)
2. The price has reached a new high in real terms and shows some kind of a vertical chart

As for gold: most people have no interest in gold or gold stocks and gold has not even closely reached a new high in real terms. Gold in real price terms would mark a new high at approx. $2,400 per ounce (based on the official CPI numbers). Taking the real inflation into account $2,400 is far too low. So, are we near a top? No, not at all. Most bull markets end if an asset class reaches a new high in real terms.

The talk regarding bubble is completely wrong. But I hope that most of the bubble speakers are more thinking about the short term outlook for gold rather a fundamentally based top. I got asked some days ago if gold will hit $1,000 per ounce again. My answer was yes and it is likely that once reached, gold will see some profit taking back to $ 900. But if not, than prepare yourself for a very strong move.

click to enlarge

For the short term, any forecast is very difficult and doesn’t really matter for me. Interestingly, the NY session was positive – no manipulation and not enough COMEX selling from commercials to hold gold back. The leading indicator of net short positions from commercials, as stated in the closely watched commitments of traders, indicates a declining gold price in the near to medium-term. But the indicator has pointed for some weeks toward a declining gold price, but instead gold has steadily risen towards $ 1000 per ounce and finally hit this mark last Friday.

What does this mean? I’d say that gold has been rediscovered as an asset class by a broad base of investors. That is not a guess, that is reality. Let me tell you some observations I made (which are real and not speculation):

1. Some very well known banks based in Switzerland have huge inflows into gold ETFs and physically held gold in vaults by clients – some are having trouble to locate additional space to store gold and inflows are getting stronger
2. Some hedge funds are pushing heavily into physically gold and are trading ‘gold tickets’ in the $ 50 million range. Not just once but continuously
3. Most investors already holding physical gold are not thinking of taking profit, they are rather buying more gold – this is different from last March when gold hit its past nominal intermediate high of $ 1,030
4. There is serious pressure from the public that central banks stop selling gold – selling gold against a bubble currency (that is inflated greatly) is the worst thing to do and truly a disservice for the generations to come

So what does this tell us about the future? Obviously, the main driver of an appreciating gold price is investment demand. Did you know that during the last bull market in gold in the 1980’s – a lot of portfolio managers advised to hold approx. 10% in gold of the overall assets. So where are the gold holdings now as a percentage of the overall assets? 1% or 2% at maximum.

I talked to a number of fund managers and financial advisers and found out that some very deep pocket players (family office managers with assets in the multi billion $ range) are holding 0% (zero!) in gold. I’m asking myself if they have any idea about basic economics and any idea about how inflation does work. Just have a look at the quantity equation and you will find out that inflation is inevitable (in practice) once the velocity of money accelerates. All the money that is been shoveled into the system is not yet working (spent) but just sitting in some ‘accounts’. But once the spending cycle starts, and that’s what all the stimulus packages are intending, than inflation will come back furiously.

These big players with 0% in gold will soon buy gold or gold shares. There is a lot of money entering a very small market. That will drive gold much higher. For some investors, gold is only an insurance against an overall asset meltdown, fine. For some investors, gold is a real asset class. Either way you look at it, gold will benefit. Interestingly, we have insurances against virtually everything. But do we have an insurance against a wealth destruction? Ask your broker or financial advisor which asset class performed best in the last 3 to 5 years? The answer is gold, have you participated in that run? No, don’t worry, you missed the first 200% percent but there is still more to come.

The system as we know it today has some serious problems and governments around the world are doing everything to move asset values up again to prevent an era of global deflation. Re-inflation is the key word or asset dilution against real assets. I just recently had a very informative discussion with a pretty famous professor in economics. He is very sure that we either enter a new era of hyperinflation or a serious deflation. In both ways, he is sure that interest rates will soar.

Deflation and interest rates will soar? Well, I was somewhat confused. But, it is possible. Imagine, we have a severe deflation and everything besides gold and some other commodities (real assets) lose value and therefore the majority of money is chasing these very sparse investment spaces of real assets. In this scenario, liquidity gets absorbed out of the financial system and banks don’t have our savings for credit spending. The only way to attract money back into savings accounts are much higher interest rates. This means that we can have soaring interest rates in an inflation and deflation scenario – both scenarios support gold. To make this clear, gold is the asset to be invested and not silver nor platinum or palladium. Only gold has monetary characteristics.

The next big thing after the current problems are solved, will be a global currency crisis and a crash in the government bond market. Not today, but in the next 3 to 5 years. In this stage, gold will truly soar and enter its bubble stage – but that’s still a long way to go.

So what about gold shares? Besides holding gold, gold shares are offering great leverage and are, compared to physical gold, too cheap. Do I like gold stocks? Yes I do in certain cases. Unfortunately, most gold companies are very poorly managed and have a comparably low profitability compared to other sectors. Besides being only marginally profitable, gold stocks belong to the stocks with the highest risks.

Nevertheless, I’d buy some gold stocks now because of the imminent net profit leverage. Because of poor management and a poor performance in regard to the bottom line, a lot of investors do not invest in gold stocks. That’s also a reason why gold stocks are not commonly found in portfolios. Just a comparison to illustrate this issue:

P/E forward = Price / Earnings Ratio

P/B = Price to Book Ratio

EV/EBITDA = Enterprise Value to Earnings before Interest, Tax, Depreciation, Amortization

Well, I’ve outlined (with red) the key numbers in which sectors such as technology, energy or pharmaceutical are superior to gold mining stocks. Unfortunately, gold mining stocks are very likely in every other category never the best, and therefore they never find their way into portfolios based on such valuation methods. Aside: The most important valuation method for all mining stocks is the NPV (Net Present Value). Just imagine, a mine will be depleted within one or two years, of course the stock will trade on a very low P/E multiple, but this does not mean the stock is cheap. NPV is a good measure to figure out if a gold stock is trading relatively low or high to its NPV.

The same is true for the Gold/XAU ratio (even though this is only a static comparison and says nothing in regard to profitability). Today, the Gold/XAU ratio is approx. 7.5 – in the past, a ratio of > 5 was considered a buying opportunity (gold stocks cheap vs gold bullion). Today, all equities are neglected and therefore also gold stocks trade with a significant discount. Once the overall equity market has found its bottom an ounce risk aversion declines, money will move again into equities and also into gold stocks. There is still room for a 50% upturn and gold stocks are still cheap – in case the bullion price is holding up.

Now, gold stocks are ready to close some of the financial gaps: while input costs are declining (e.g. oil, labour, materials, etc.), sales revenues are rising (gold). Overall, this means that the bottom line will benefit. Most other companies - outside of gold mining - are facing declining profitability. Therefore, investments in senior gold producers are a good idea – my favorites (because of the expected leverage on the bottom line) are Newmont Mining (NEM), Barrick Gold (ABX) and Goldcorp (GG) and more speculatively Randgold (GOLD).

Disclosure: The opinions expressed in this article are those solely of the author and do not necessarily agree with the author’s employer. The author is long physical gold and owns gold shares.

Comments

[mr freddo:]

Investing in gold is a bumpy road. The price swings can be dramatic as central banks can enter the market at any time to temper the enthusiasm toward gold. But the long term trend is bullish and as the author points out, gold is not yet an investment that the average investor has in his portfolio. I am using GLD and GDX and will add to my position while I trim the long side of my portfolio while there is still some long side left.

Feb 23 12:00 PM

[GMiki1:]

Maybe the COMEX shorts will start covering. When I say shorts, I mean mostly J. P. Morgan. And Jamie Dimon seems so nice on TV. Insert bad word here.

Feb 23 12:09 PM

[E.D.Hart:]

I agree with most of what you say, except the part about silver. I expect slver to rally more than gold as economic activity picks up minimally. Silver does indeed have monetary characteristics.

Feb 23 12:32 PM

[Roger Knights:]

"The next big thing after the current problems are solved, will be a global currency crisis and a crash in the government bond market. Not today, but in the next 3 to 5 years."

... or months.

Feb 23 12:48 PM

[silverwood:]

Dan good post, but I agree with E Hart and I will repeat a post I made on another topic which is why I disagree with you on silver.

Yes, as the saying goes...There is no fever like gold fever!
I agree with the author we are no where near the mania stage, but gold is gaining more main street media attention now that the psycological number of $1000 is here.

But will gold be the big news getter and the winner of the go to asset in the near future? I think we will all be surprised who will be the winner of that horse race. It will be a stunning come from behind victory for SILVER!

Yes silver, hardly ever talked about in the media and written off as a Hunt brothers scheme. But these facts remain;
1. Silver has a long monetary history just like gold. But a very important industial component which cause silver to be consumed.
2. Silver can act as a long term protector of wealth and when gold price climbs it will be viewed by middle class as too expensive so silver will be the "poor man's gold"
3. Base metal miners who are cutting back activity account for silver's main supply, so supply will decrease as this environment persists.

So the cry of there is no fever like gold fever will be heard, what may be the louder cry is...

HI HO SILVER AWAY!

Feb 23 12:51 PM

[Charles Fuchs:]

Silver is key.... I see a %10000 return in 3 years!

Feb 23 01:26 PM

[Mad Hedge F...:]

Gold’s upside breakout through $1,000 on big volume last week is creating a lot of chatter among the trading classes. Historically, investing in gold came at a big opportunity cost because it didn’t pay interest or a dividend, and you had to pay the cost of storage and insurance. With short term Treasuries now yielding zero, this opportunity cost is now, well, zero. There is a new profusion of gold proxies trading on financial markets where you can open an account for free, eliminating all other costs. I found five listed gold futures contracts with 50 and 100 ounce specs, and six traded gold ETF’s worth $32 billion, like the Market Vectors Gold Miners (GDX) traded on the NYSE. For the past year there has been a nearly perfect inverse correlation between gold and long Treasury bonds. Does this make it the new deflation play? No matter how inflationary the long term impact of Obama’s programs may be, the fact is that everyone is staring at deflation on the plate in front of them right now. And let’s face it. Investment in any other instrument, be it in stocks, bonds, commodities, currencies, and real estate, pretty much sucks right now. Finally, take a look at the charts for two leading gold stocks below for Peter Munk's Barrick Gold (ABX), the world's largest gold producer, and Newmont Mining (NEM), and see how they anticipated the barbaric relic’s recent up move. The only thing missing from the bull case for gold is a collapsing dollar. Could that be the next shoe to fall? Many believe that a retest of last year’s all time high of $1,050/oz is a chip shot, and a move to the inflation adjusted all time high of $1,500/oz is doable.

Feb 23 02:13 PM

[TheRogueTrader:]

Your definition of what a bubble looks like is spot on....we are not even in the beginning stages of a Gold Bubble yet....the patrons at the bar, the store clerks and the taxi drivers are only talking about "is this a good time to buy real estate?"...Gold is not even on their radar yet....

Feb 23 02:15 PM

[Conan the B...:]

Ho, ho ho, The US nationalizes all banks, there is a run on the Treasury, No one can get anything from the Banks. The stock market shuts down, and there is a Worldwide run on the US Treasury. The Dollar Tanks.

Physical gold is the only viable currency. Stock certificates cannot be exchanged with the closure of the Markets. Only the strong survive.

Wot, me worry? nope , I've got 35 years of accumulated gold jewelry and diamonds, emeralds, opals inlaid into same. I can chug to a Pawn shop on my bicycle and redeem a bit here or there, to keep us going.

Food? not a problem as long as water is available. my annual supply of MREs should be enough.

Got to get into Canada somehow, to get some gold/silver from the Vault. I took delivery of my CEF certificates.

Who knows, I may be a millionaire there.

Feb 23 02:31 PM

[ibejack:]

The uber wealthy generally know the true value of gold and they are smart to allocate the 10-15% of real wealth to these assets.

Feb 23 02:40 PM

[Consider_this:]

Your theory (taxi driver, hyperbolic curve) is not a necessary component to a bubble -- only that the bubbles have been allowed to grow and involve people on the streets. There are plenty of bubbles that have burst much earlier before growing to "down to mainstreet taxi driver" status.

You want to test for bubble in gold? Go to SA archives and look at any articles that bash gold. Look at the comments. Then go to any articles that praise gold, look at the comments. Put the "agree" and "disagree" comments appropriately and you'll get your indicator.

My non-scientific observation shows a HUGE number of people following gold -- that is your indicator. You want it to grow and grow by a significant percentage, and if it stagnates and shrinks, your gold investment is in trouble. A leaky bucket in following is a bad scenario to try to grow gold demand.

The number of people who go fanatic about gold is increasing; and their conviction is downright scary in the -- "I'm so sure! It can never happen other way". The last time few times saw this psychology:

1. Oil will go to 200, it can't go below 100!!!! There's no production capacity left! Peak oil!
2. Houses only go up! They aren't making anymore land! Rent and throw money away!
3. Nothing matters except eyeballs and clicks!! pets.com has huge amounts of clicks on first day!! You can't lose! Traditional companies are so passe!
4. Fiber optics mania. The orders for fiber cables have tapped out next 30 years of production!!! Nobody can buy fiber optics fast enough! You can't lose investing in fiber!!!

I say... if you're right, good for you. I choose not to play manias. At some point, you're going to have to buy medicines, food, oil and household goods. When that time comes around, you'll need to talk to "my" companies; whether we exchange in gold or not.

Feb 23 03:27 PM

[rick flair:]

Any commodity which has risen steadily for 10 years and is only up 4 times, is by definition NOT in a bubble.......the chart has nowhere near the look of a bubble , and the zeitgeist is nowhere near the panic/fear/greed stage yet. We are about 60% thru it, as it SLOWLY DAWNS on the frogs that they are getting boiled ALIVE....

1 VERY IMPORTANT POINT you must remember. Gold and silver 'disappear' from the system, around 2 years before the actual OFFFICIAL devaluation event occurs...we're only now having trouble accessing PM's in any size from dealers. Lets chalk it up to the 'you'll find out' catagory.....

Feb 23 03:39 PM

[E Thomas St.:]

Wouldn't a bold declaration stating that some asset is not in a bubble despite a large gain be right in line with every other bubble that we've experienced? I don't see why gold is "different this time".

Also, for everyone going long gold, when do you plan to sell? And if you never plan to sell is that based on the belief that entire societal collapse is around the corner? And if you hold that belief firmly, wouldn't you be better off purchasing goods that will sustain you in the future (Like guns, ammo, PVC piping, solar panels) rather than trying to purchase wealth for the future?

Feb 23 04:25 PM

[Cesato:]

I would agree with mr. freddo regarding the dramatic swings in price. I like history and it took Gold 10 years to break out of the USD 250 - 500 range even with a double top formed from 1982 through 1988 to then reverse in the year 2000 and break consistenly to the upside in 2005, does USD 500 - USD 1030 - USD 680 - USD 1000 - ?????, which has been the swing since 2005, seems familiar to you? Well what I try to say is that whoever invest in Gold sets it's own time frame, whether the buy is fundamental, speculative or else. Long term ownership of Gold is the answer but again buying in one those massive dips (50%) as it happened if the year 2000. Oh sorry I just missed it at USD 680 in 2008!!!!

Feb 23 04:49 PM

[phdinsuntan...:]

let them to seel some bars to cover the hole and all is fixed !

Feb 23 05:19 PM

[Ali Wahab:]

Great article. The gold story has a lot of credibility and is poised to go up further, however, I feel that there has to be some sort of correction. I bought gold around $450 per ounce a few years ago mainly because of the global turmoil. Quite happy at where it is. Should have bought more. The way global markets are moving (downwards that is), there is bound to be pressure. Also do note that Indians are trying to cash their gold, to capitalize on the high prices. Indians are smart, do remember that (I am not an indian). I also read an interesting piece at the beginning of the year from UBS. One of the ten surprises they have mentioned for 2009, could be Gold falling to $300 an ounce. Though it may not fall this much, the probability of a correction is quite likely.

Feb 24 02:37 AM

[svosavvy:]

I have the greatest confidence gold could still see plenty more short term upside hence "bubble" filling with air, and I believe when inflation actually shows up gold may be a good hedge. Until then I think it's a trade not an investment. Wealth destruction is occurring to equities. We are in a "deflationary spiral" and each new shoe to drop only speeds the tailspin. Gold the classic inflation hedge is rising against the dollar (unnatural), this imho is "irrational exhuberance". But "markets can stay irrational longer than a person can stay solvent" I'm staying out of gold in short term unless we see big spike real near term like $1250 then I'll get negative. If you want an inflation hedge find a nice well managed company that pays a good dividend, then hold your nose and average into their smelly common stock. I find "safe havens" to be a bit redundant, like your mother always said would you jump off a bridge too if everyone else was doing it. And as far as the authors bubble tenets from above, everyone IS talking about it, gld is turning into a bloated turd. Every muckety muck financial guru on tv is high on it, even that susie orman. Then author goes on to say the hedge funds are buying, let's see, a hedge funds have never made a bubble before have they:) cheers

Feb 24 06:47 AM

[Truefire:]

Long Gold till its a 1:1 with the dow, roll your profit into the Dow, Grab a cocktail & sip it pool side, nice!

Feb 24 07:27 AM

[ROLEXDAYTONA:]

GC at 1030$? Ha,ha you are done, I remember when GC was 1000$ few days ago I my call looked to some like it will be broken through that number by next day, but I urged you about a BIG HAND that will hit GC near this price.I am damn short.

Feb 24 10:40 AM

[bagman432:]

Sorry, you are mistaken about silver, platinum, & palladium. When the dollar crashes which at some point seems inevitable, it's clear that all precious medals and most commodities will rise together. Gold is great but don't think for a minute that it's going up while the other precious metals languish. In fact, don't be surprised if silver does substantially better. The reason is simple. As the majority of middle class Americans wake up to the fact that their life savings are being wiped out by a major dollar devaluation you better believe they'll be buying the less expensive metal first.

Feb 24 11:17 AM

[5142152-337:]

Uh oh, I can see it happening. Now we're gonna be called SILVER-bugs. Gold-bugs will get some needed rest.

I proudly carry that banner...silver bugs are a force to be reckoned with. Why not go with a winner? When silver triples is current 14.25 price, the haters will be saying "it will never last", while we (savvy silver bugs) are selling to the sheeple who are jumping on the bandwagon.

Hi Ho Silver (with my apologies to the Lone Ranger and silverwood).

Feb 24 11:32 AM

[Maxe Paul:]

Your statement that all gold stocks are badly managed sounds rather overstated, you may even get a dividend, god forbid! It always amazes me that some people think they will one day pay for their food or a house with a few gold bars, such a ridiculous theory.

Barrick is hardly a poorly run company, or Lihir gold for that matter. The main interest in gold buying ATM is because of default debt risk by European countries. Before you buy gold you should at least know why it's going up!

Feb 24 12:12 PM

[silver-bug:]

Preach it, brother! Amen!

Feb 24 03:33 PM

[silver-bug:]

This was a comment to: 5142152-337


On Feb 24 03:33 PM silver-bug wrote:

> Preach it, brother! Amen!

Feb 24 03:35 PM

[Wyatt Nevada:]

In the not too distant future you will probably see the U.S Dollar fall to all time lows due to the amount money that the government is printing. Since March of 2006, the U.S. government stopped releasing the M3 numbers to the public so they would not have to disclose the amount of money that has been printed and released into the system.

As it stands right now, we have no idea how large that number is but it is most likely in the trillions. The new administration is going to print trillions more "fiat" dollars that will add to an already overburdened system to try and "correct" our financial system - which is indeed is locked up.

If - as the Obama administration declares - that they will make the government's actions more transparent to the American people and this information is released - the gold and precious metals markets are going to go nuts!

Talk about a rally!

Feb 24 08:43 PM

[Roger Knights:]

"I also read an interesting piece at the beginning of the year from UBS. One of the ten surprises they have mentioned for 2009, could be Gold falling to $300 an ounce."

That wasn't UBS, but an individualistic pundit with a good track record named Kass (or something like that). And he didn't exactly "predict" it, but listed it as a possible "surprise" or contrarian event.

Feb 24 09:04 PM

[know nothing:]

Copper is also a good buy if you are trading commodities. Silver is a good physical hold,as is gold. Silver may offer the better gains!

Feb 24 09:13 PM

[doctordoctor:]

gold has become an international currency, not a commodity. when you compare it on that basis to paper money, or worse, government electronic credits, its quite attractive. everyone expects massive inflation down the road as the global money supply balloons without end. and that can happen very quickly. sluggish economies, massive "printing" of dollars, and eventually sellers will realize raising prices will not kill demand. in fact may cause increase demand as people buy now to ward off future price increases. ah the smell of german history.

Feb 24 11:34 PM

[happyeconomist:]

I agree with the assessment. Very wealthy middle easterners and north asians have gotten creamed in the markets. They seek safety. They will buy into gold. It's traditional for them almost to the point of religious. Much of this sits with the Swiss private banks, watch for their actions. I'm long.

Feb 27 10:17 AM