The Bursting Gold 'Fear Bubble' Vs. The 'Confidence Bubble' In Policy Makers, Economists, And Markets

Includes: GLD, IAU
by: Tim Iacono

The recent sell-off in gold (NYSEARCA:GLD) has spurred an avalanche of commentary on the relative merits of including the precious metal in one's investment portfolio and, not surprisingly, there has been a fair amount of gloating by those who never thought much of the idea in the first place.

A plunge of over $200 an ounce in just two days and a gold price that is now almost 30 percent below its 2011 record high has many pundits declaring victory over a metal that, aside from jewelry and limited industrial use, has little value.

Little value, that is, aside from functioning as money and a store of value for thousands of years.

The fact that, to some extent, gold is in competition with current day money gets little attention from the yellow metal's detractors.

Rather, most who now kick gold while it's down (after 13 years of impressive gains) focus on the world's economy and global financial system having sufficiently healed after the multiple crises of a few years ago as reason not to be fearful any longer.

Fear, they say, is the reason that people buy gold and, now that things are looking up, there is little reason to own it.

A lot of investors seem to have come to that same conclusion.

Billionaire Warren Buffett, who has been quite vocal about his dislike for gold, put it this way:

Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything.

One of the biggest reasons why investors have been fearful in recent years is that the many trillions in central bank money printing around the world was expected to lead to higher inflation.

Clearly, in most of the West, it has not.

That doesn't mean that it won't, particularly now that the U.S. and Japan have sharply accelerated the amount of money they're creating each month. But, for the time being, there is little to be fearful about rising consumer prices as evidenced by yesterday's report on inflation from the Labor Department.

Other reasons to be fearful include such things as another financial crisis and another round of plummeting asset values similar to what was seen a half-decade ago.

Here too, now far enough removed from this tumultuous period, there is less reason to be fearful. But, when looking at the anemic economic growth around the world and the tepid rise in asset prices that have come, in large part, as a result of unprecedented levels of deficit spending by governments and money printing by central banks, conditions today aren't quite as rosy as policy makers would like people to believe.

For better or worse, the global economy and financial markets around the world are based on confidence - confidence in policy makers, economists, and markets.

Confidence was shaken to its core just a few years ago and it's not clear whether it will ever be fully restored.

What's all this have to do with gold?

Rather than attributing the recent decline in the price of gold to the bursting of a "fear bubble", it seems equally appropriate to credit a re-inflating "confidence bubble" and, when looked at in this manner, this should give pause to anyone who has recently sold their gold.


Because this renewed confidence really isn't warranted.

Policy makers in Europe have just set a dangerous precedent in confiscating depositor savings to fund bank rescues and this only heightens the distrust of government officials. This comes as the European sovereign debt crisis enters its fourth year (or is it the fifth?) amid growing unrest and recently heightened possibilities of one or more nations exiting the currency union.

Here in the U.S., amid soaring use of government programs such as food stamps and disability insurance, elected officials have yet to deal with debt and deficits in a substantive way as the central bank continues to purchase most of all new Treasury issuance and, like Japan, monetizing large amounts of debt has become the new official policy.

Policies such as this rarely end well.

There is currently an enormous amount of misplaced confidence in the world's economists who, now five years after the last crisis, have not made any major changes to the "models" that guide them in understanding how the world economy works and predicting its behavior.

Failing to include large parts of the banking system and ignoring rapid credit expansion in these models was a major reason for not seeing the last financial crisis coming and, to this day, the Federal Reserve denies that low interest rates were a major cause of the last crisis.

Despite modest efforts to try to spot future bubbles, central bankers remain ill-equipped to do so (and probably wouldn't do anything about an asset bubble if they spotted one for fear of slowing the recovery).
Moreover, economic policies are increasingly geared to helping the rich and hoping that this prosperity somehow finds its way down to the masses and this will continue to cause unrest.

Growing confidence in financial markets is also misplaced, though, the higher stock prices go and with each new housing report that shows more home price gains, faith and trust grow.

That's the nature of bubbles.

Despite Fed liquidity driving stock prices higher and regardless of the near total dependence upon the government for mortgage finance, so long as asset prices move higher, confidence rises.

The 2010 "flash crash", high frequency trading, the LIBOR scandal, the MF Global meltdown, the non-prosecution of HSBC, and untold other developments since the 2008 financial crisis are now quickly fading from memory as housing and equity prices move higher.

Concern that there may be fundamental flaws in our understanding of the economy and the financial system related to the nature of money and reasonable expectations for economic growth and credit expansion quickly fade as this "confidence bubble" re-inflates.

Yes, you could interpret the last dozen paragraphs above as the view of someone who is too pessimistic about things, but, just look around you here in 2013 and consider what has happened over the last few decades as we've leaped from one bursting asset bubble to the next.

I doubt that what we've seen in recent days was the bursting of the gold "fear bubble".

There is still good reason to be fearful.

Disclosure: I am long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I also own gold coins