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I have never owned gold in my investment portfolio. I have always leaned toward US stocks, and toward solid fundamentals that I feel give me at least an idea of an asset's worth.

Gold does not have such exact fundamental bases; there is no P/E ratio for an ounce of gold. That's not to say there is no fundamental analysis involved in gold investing. Obviously, factors such as the expansion of the money supply in the West, fears of subsequent inflation, and the continuing overhang of a worldwide economic slowdown -- or, to some, an outright collapse -- have all contributed to gold's rise over the past couple of years. And some analysts do use more standard asset valuation techniques when measuring the gold market. For example, in this New Yorker article, the author notes that Bridgewater Associates' Ray Dalio believes the price of gold should approximate the money supply divided by the gold stock. Last month, The New York Times' Paul Krugman wrote two pieces (here and here) linking gold prices to low interest rates, as did Eddy Elfenbein a year ago, who reached a similar conclusion using a different model.

Of course, defining the worldwide money supply is a far more difficult, and uncertain, calculation than ascertaining market capitalization or free cash flow, and my own experience majoring in economics has made me skeptical of the real-world utility of economic models. (Economics remains the only science where two mutually exclusive hypotheses can each be proven mathematically.) This aspect of gold investing -- the inability to make a cold, hard value assessment on an asset this is ironically valued precisely for its cold, hard value -- has led me to ignore gold as an asset class for my own portfolio. In fact, my one article on gold for Seeking Alpha, written back in July, focused on the split in returns between physical gold ETF (GLD) and the gold miner stock ETF (GDX). I noted that the two ETFs had diverged by 17% in three months, and offered one possible explanation: that equity-focused investors (like myself) were far less bullish on -- or even just less interested in -- the metal than commodity traders, who were more apt to purchase and/or trade the physical ETF over the equity fund. (In fact, the spread has widened over the three months since I published the article, though its cause remains unclear. Yet the fact that the GDX is almost exactly break-even with the struggling S&P 500 (SPY) year-to-date shows the lack of enthusiasm for the asset class among stock investors, whatever the reason.)

All that said, I have followed the gold market for the last two years. As an outsider, I have found the argument over its valuation interesting, and the recent bull run has made the metal a common topic of conversation even outside the investing world. Without enough training to create a pricing model -- and with enough training to be skeptical toward the models created by others -- I have relied on psychological analysis of the market to gauge my sentiment toward gold as an investment. While admittedly unscientific, the current gold run -- and investor sentiment toward the asset class -- triggers alarms based on my history with the market, and a few of my market rules:

1. You should never buy what Glenn Beck is selling.

This is not necessarily meant as an attack on Mr. Beck (although there have been plenty of accusations that Goldline, one of Mr. Beck's main sponsors, has been treating customers unfairly at best). But it's worth pointing out that the same advertising spots on radio and television now purchased by Goldline and other gold salesmen (and gold buyers) were purchased five years ago by mortgage servicers, and day trading outfits a few years before that. Bubbles aren't bubbles until they reach the masses, and they don't pop until the masses have bought in, too. The fact that krugerrands are being sold next to 9/11 "collectors' coins" and the Shake Weight should make gold investors nervous.

Whether through market manipulation or just ignorance, the individual investor is often the last in at the top and first out at the bottom. There's a reason they are casually referred to on Wall Street as "pikers" and "dumb money." I still remember talking with a relative on Christmas Eve 1999 about his $6,000 purchase of stock in BigHub.com -- "Hey, the Internet is the future, right?" he said confidently. There was no better sign that the dot-com bubble was about to end, as it did less than three months later.

"This time is different," the victims of the bubble famously say. And, actually, this time is different, as the little guy not only seems to have begun the run-up in gold, but his so-called "dumb money" has been winning for a few years now:

(Click chart to enlarge)

GLD vs S&P 500 5 year chart

5-year chart with GLD in blue; S&P 500 in red. Chart courtesy Yahoo! Finance

So is the little guy right this time? Or is this just a bubble that has lasted longer than subprime mortgages and dot-com stocks? Will the gold rally hold, or is the only difference that, this time, the "smart money" will follow the "dumb money" over the cliff, instead of vice versa?

2. Beware of specific predictions based on vague conjecture.

So often when I read about the bullish case for gold, it is always expected to reach $2,000, $2,500, or $3,000 an ounce. Why? Because we have ten fingers and like round numbers?

Give me a price target based on technical analysis, or a fundamental valuation accounting for changes in the money supply or real interest rates. Discuss gold's history as a store of value. Give me a target based on historical movements, expected interest rate changes, or even an estimate relative to the 1980 inflation-adjusted peak above $2300.

The constant stream of round-number gold predictions -- "it's going to hit $2000 in 12 months" -- reminds me of the late 90s Internet soothsayers. The Dow was going to 20,000, or, infamously, 36,000; the NASDAQ to 5,000 (it did, if only very briefly). Many of the brokers with whom I worked in 2000 and 2001 were fond of similar targets. "We think this stock can go to $100!" These random, round targets are a sign of intellectual laziness, and, often, of hope replacing clear-headed logic.

3. Bubbles are often driven by a constant, overarching story that does not take valuations into account.

To the gold bulls: I know. Countries are printing money, inflation is coming. "Fiat money" (which is the new "bricks and mortar," said with the same dripping derision used for that term in the late 1990s) is being debased, and gold is the one true store of value.

That may all be true. But gold bulls have been saying the same thing for nearly two years. Inflation hasn't come, more money has been printed, and gold is up 60% in dollar terms. Is that enough? Too much? Too little? How does it change the investment thesis?

It is not enough in investing for the story to be correct. As I noted in my piece on the Internet bubble in July, the story of the dot-com stocks turned out to be true, if somewhat exaggerated. The Internet is ubiquitous, as was predicted. Adoption -- particularly in e-commerce -- was slower than predicted, but given the absolute carnage in the stock market caused by the dot-com bubble, one might think that the Internet turned out to be a massive disappointment, a mere plaything. Of course, it did not. Even if it didn't meet all of its expectations -- such as self-driving cars and widespread telecommuting -- the Internet has truly been a revolutionary system.

Yet the biggest tech stocks in the world at the time -- companies like Cisco (CSCO), Oracle (ORCL), and Amazon (AMZN) -- have nearly all seen massive declines in their stock prices. (Only AMZN has surpassed its 2000 peak.) This despite the fact that the bulls were right. The three companies are leaders in their industry. Their earnings have multiplied. And their valuations have cratered, at least in the case of Cisco and Oracle. The story was right -- the price was wrong.

Dennis Gartman beautifully summarized the current downside risk to gold, when quoted in this article last month:

The fundamentals of central-bank buying remain intact, as are the fundamentals of problems in Europe, and weakness in the U.S. dollar, and debt concerns.

None of these have changed; but markets discount; markets anticipate; markets move ahead of fundamentals. And markets plunge when the fundamentals are their best, not their worst. This is a difficult lesson for most investors/traders/analysts to learn.

4. The less people question their sentiment, the shakier that sentiment will turn out to be under duress.

There are few groups of investors right now -- with the possible exception of Sirius XM (SIRI) stockholders -- with more confidence, and less patience for any contrary views, than gold bulls. Any hesitation toward a complete acceptance of the bull case for gold is met with derision. It gives a contrarian investor like me the chills.

As I noted before, a solid story cannot atone for an inflated valuation. Yahoo! (YHOO) traded at a triple-digit P/E in late 1999 and 2000 because investors thought it would become a dominant web portal. And, indeed, Yahoo! was the second most-visited site in America in August, and has grown earnings by eight times over the past decade-plus. And we all know how that turned out -- the stock has lost 80% of its value. Solid investors, like wide receivers running a crossing route, must have their heads on a swivel, looking for what danger looks ahead. Confidence -- and particularly overconfidence -- breeds complacence. And complacence can lead to disaster in investing.

All these factors have combined to make me skeptical of gold's valuation at this point. I would stop short of calling it a bubble -- its relatively steady, even climb doesn't show the classic signs of mania -- but I do fret about its valuation. The question is: would I short it?

Not on your life, and not with your money, let alone my own. Why?

5. When people are asking if it's a bubble, it's not a bubble.

This rule has a corollary as well: if people are asking if the market has hit the bottom, the bottom hasn't been reached. In a downturn, the market needs a "capitulation": the last holdout bulls must finally give up, ending the sell-off and allowing for the market to rebound.

On the top side, it's the same thing. As long as writers like me are questioning the bull run, and gold prices can climb the "wall of worry," the top has not been reached. There is still too much skepticism, too many unconverted buyers, for the bull run to end in a last blaze of glory, as they usually do. As gold bulls are fond of noting, gold's share of portfolio allocation is still relatively small compared with levels seen at the 1980 peak. In addition, despite the metal's presence on cable television and talk radio, it still has not been considered a mainstream choice for investments. With the first of the baby boomers now retiring, and perhaps moving toward more active management of their portfolios, there could be many more individual investors willing to enter the gold market, adding to the existing demand from central banks and industrial users.

For me, the telltale "sell" signal for gold will come when investors truly begin to believe that this volatile, zero-interest asset, which actually costs money to store, is as "safe" an investment as the bulls claim. When you see mutual funds and corporations parking excess cash in gold; when investment advisors are recommending positions in GLD or physical gold to their baby boomer clients; and when analysts stop writing skeptical pieces on investing in gold: that's when you will have seen the top. From an armchair psychology perspective, it appears we're a long way off.

So might I then try and trade the metal short-term, waiting for the bubble smoke signals to waft over the market so I can exit the position before the rush? I don't think so. I will leave the last word to Warren Buffett, a noted gold bear, whose advice on speculative equities seems relevant to the present market for gold. From the Berkshire Hathaway 2000 letter to shareholders:

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities -- that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future -- will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands.

Investing in the gold market right now is speculation -- it is trying to time one's exit before the inevitable stampede begins. Aggressive investors can try and pull that off, but, to complete Buffett's analogy, they best have brought along a watch.

Source: A Look At The Psychology Of The Gold Market