Investing In Gold: Is A Bubble Popping?

Posts on investing in gold typically offer a variety of explanations for price swings: Central bank actions, buying in China and India, Quantitative Easing by the U.S. Federal Reserve, money supply growth in various countries, future inflation and discord in Europe.

While these are interesting discussions, there is a simpler explanation. The price of gold mirrors the most fundamental relationship in economics: the relationship between prices, supply and demand. Current gold prices reflect this equation:

Declining Demand + Increasing Supply = Declining Prices

Recent price declines (through March 8, gold prices are down 5 percent this year and 17% in comparison with their September 2011 peak) are not an aberration. Total demand for gold (in tonnes, according to the World Gold Council) declined 4% in 2012 compared to 2011.

Among the four categories of demand, three declined in 2012 (compared to 2011):

• Jewelry -3.2%
• Technology -5.5%
• Investment -9.7%.

The only demand category to increase in 2012 was official sector demand. Net purchases by the official sector increased 17%.

Unfortunately for gold bugs, demand trends are not good and prices will continue to decline if demand does not increase.

Take a look at the four sources of demand to see why demand may continue to decline.

Historic demand for gold in tonnes
Year	Jewelry	Investment	Technology	Official Sector	Total
2002	2662	352	358	-547	2,827
2003	2484	341	386	-620	2,592
2004	2616	480	419	-479	3,036
2005	2719	602	438	-663	3,095
2006	2300	674	468	-365	3,077
2007	2423	687	476	-484	3,103
2008	2304	1189	461	-235	3,719
2009	1814	1402	410	-34	3,591
2010	2017	1583	466	77	4,143
2011	1972	1700	453	457	4,582
2012	1908	1535	428	535	4406
Investment total includes bar, coin, ETF, etc. Source: World Gold Council.

Click to enlarge

Investment Demand -- The 9.7% decline in investment demand (bars, coins, ETFs, etc.) in 2012 seems to reflect typical investor behavior: Buy high and sell low.

Declining or even flat gold prices will cause many investors to switch funds to the next hot category. Falling prices will not tempt these investors to buy; falling prices merely tempt them to stop buying or to sell more. It is not a virtuous circle; it's a wicked circle.

The introduction of gold ETFs (SPDR Gold Shares (GLD) and others) probably helped drive up gold prices. ETFs were a new way to invest in physical gold. They increased demand, partly by allowing investors to shift assets from gold mining shares to the new ETFs and partly by bringing in new investors. As prices rose, more investors piled in, driving prices even higher. When prices flattened and declined, investors began pulling out.

Disinvestment has been readily apparent in 2013. The amount of gold held by the major ETFs declined from the end of December to March 8. For instance, physical gold held by SPDR Gold Shares was down 8% and iShares Gold Trust (IAU) was down 1.8%.

Official sector -- The 2012 increase in official sector demand provides no assurance that total gold demand will increase.

• Official sector demand is the most volatile category. Historically, the official sector has swung from net purchases to net selling and back again. The official sector recorded net selling in 8 of the last 11 years. The total for that 11-year period was net selling of 2358 tonnes.
• Even in 2012, official sector purchases represented only 12% of total demand. The only smaller sector was technology (9.7%).
• Central bank purchases would have to climb much higher to cause total demand for gold to increase. And total demand is what drives prices.

Jewelry -- The 2012 decline in jewelry demand reflects a long-term trend. Jewelry demand in 2012 was 28% lower than in 2002 and 42% lower than 1997. In 2012, jewelry demand represented 43% of total demand for gold. In 2002, it was 94%.

China and India often are mentioned as saviors here; supposedly, jewelry demand from those two countries will increase so much that total jewelry demand will rise in spite of declines in other countries.

Possible, but not likely. Jewelry demand trends in China and India are not a source of growth.

In 2012, gold jewelry demand from India was lower than in any year since 2003. Year over year, Indian gold demand declined every year since 2008. Chinese demand was flat in 2012.

Technology -- Technology demand peaked in 2007. It has declined for the last three years.

Supply -- While declining demand is one reason for recent price declines, another is ever-increasing supply. Total gold supplies ("above-ground gold") only increase; they never decrease. If production stopped, supplies would stabilize but not decline.

Production is not stopping; it has been increasing over time. According to the CPM Gold Yearbook (calculations by the author):

Average Gold Production Per Year Since 1949 (thousands of troy ounces)
Period	1950-1959	1960 - 1969	1970 - 1979	1980 - 1989	1990 - 1999	2000 -2009	2010 - 2011
Yearly average	29,957	43,794	42,664	50,198	73,144	78,041	80,607
% increase	NA	46%	-3%	18%	46%	7%	3%

Click to enlarge

Conclusion

Is gold a bubble that is starting to pop? Demand trends indicate that may be true. Jewelry demand has been in a long-term decline, technology demand is in a medium-term decline and investors seem to have lost a lot of enthusiasm. Total world supply continues to grow. An increase in demand by central banks would have to be huge to counter those trends.

Investors purchase gold on the assumption that some future investor will buy at an even higher price. This is called the "greater fool theory." It's a shaky assumption when demand is declining and supply is increasing. Gold investors should be concerned.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Comments

[maui1]

either we end this insanity, or this insanity will end us

lets not wait and do nothing, hoping for what the future will bring, unless we a willing to accept what the future will bring.

[maui1]

here is the deal......from my stand point

gov't creates laws and regulations, which in-turn creates unknowing confusion, that creates a need for more laws and regulations to define the confusion the way SOMEONE wants it defined. this race has no ending, until it kills itself. we are far along the way to this death.

try and talk to someone about one of the confusing off-shoot issues, like healthcare, guns, marriage, ect............

all the discussion is about the rights and wrongs of the laws and regulations, and the need for more of them (laws/regs), to "FIX" the problem, one way of another, depending on who can persuade the public thinking, depending on the money behind the persuasion efforts.

no one ever looks at why there is a problem, and if they did, they would see that the initial laws and regulations, created by gov't, involving something that they should not be involved in, CREATED the confusion in the 1st place.

if we REALLY want to fix things, we need to put gov't "back in the bottle", get rid of their laws pertaining to INDIVIDUAL rights, and lets stop discussing issues that have no direction other than to 'the end'!

[Michael Bryant]

We have complex laws to keep lawyers in work. We have complex tax code to keep accountants in work. If we get rid of these, well, if your a lawyer or accountant, I'm sorry for you.

[maui1]

yesterday gold and silver went up......., I sold silver knowing (without a doubt) that silver would be controlled down today. It happened and I bought silver back, saving 1 dollar an oz on the exchange.

our gov't is so afraid of the public losing confidence in the dollar (all fiat money, ftm) that they have to control the prices of gold and silver, to the point of being so consistent that you can bet on it happening.

[maui1]

everyone is looking at this issue, backwards.

it is not the value of gold that is the question here.......it is the value of fiat currencies that are the value question.

gold only reflects the value of this fiat paper.....

gold's value never changes, unless their is a forced change, which can and does happen with every commodity in today's controlled (?) economy.

[Michael Bryant]

"gold's value never changes..."
You repeated my earlier post. LOL!

Anyway, totally agree. As value of dollar goes down, gold value goes up.

[Arthur Stein]

The new SA article
http://seekingalpha.co...
The World's First Gold Factory by Bruce Pile is worth a read.

Relates to this issue: is it possible for new production to significantly increase? A lot of the postings on gold price seem to assume that new production can only stay the same or decline.

[Michael Bryant]

Of course production will increase. Gold and oil have a fixed amount on Earth, but we haven't found all the gold and oil on the Earth. As gold prices stay above the cost of mining it, production will rise. The support price for gold is the cost of mining it. So, what is that cost? For silver, I think it is $7-$20 an ounce depending where it is mined.

[maui1]

i don't think that the world could supply gold at a rate of 1 trillion dollars value a year, unless the value of gold is given a true value that would match what gov'ts are printing.

[Ray of hope]

LOSS OF FAITH

The value of the dollar depends upon people's FAITH and trust in the government.
What is the religious concept 'Faith' doing in economics? Doesn't the market run on reason?
Whatever the answers are to the above questions, when people's faith and trust in the government fails, gold will soar.

Peace goodwill ... Ray

[User 6707651]

the converse is also true- gold is priced according to people's faith in it as a medium of exchange, if the faith fails, it crashes

[maui1]

they don't want to take our gold, but they don't want gold prices to reflect the real effect of money printing.........

again, Americans are stupid and not willing to look past the obvious, so our gov't does not wamt to make it's money printing obvious, by having gold prices scream that our gov't is robbing us blind..

[maui1]

the cypress issue is the same thing as is happening in the USA, but the reason for the direct tax, is that they can't print their way out of trouble as we can. the rest of the Euro zone does not want to pick up the tab for Russian money loss.

the USA does not have to ask other countries for permission to print, so it can tax savings indirectly, by zero interest rate returns and inflating what is left in peoples savings, by printing dollars.

people in the USA can get around the USA gov't indirect confiscation, by moving their money into the stock market or housing, which is exactly what our gov't wants us to do and also the same thing that caused the last bubble crash and again, wealth confiscation when it happens again.

so......In the end....the people of the USA, are just as helpless as those in cypress, but we are to stupid to see anything other than what is right in front of our faces, like a direct confiscation, like the confiscation that is happening in cypress.

so to all of you that think "it can't happen here", you better re-think what you are saying and you better start protecting yourselves from those that we pay to protect us.

our enemies are not North Korea, Iran, China, or illegal's. our enemies are now the same people that we put in power to protect us. they have stolen that power to rob us of our money and our individual freedoms.

term limits is the fix that starts the fixing of all other of our countries issues. life long politicians are the common denominator to all of our problems, and the most important thing that this country must address.

[Tampa-T]

Some good points maui1.
And for all the reasons you mentioned is why the govt doesn't need to worry about taking anyone's gold from them.
Why bother taking their gold when you can take their FRN's without any resistance.

[Michael Bryant]

@maui1:
" so it can tax savings indirectly, by zero interest rate returns..."
I had a savings account in the bank since 1990 and they never gave me more than 0.05% interest. Savings account interest hasn't changed much. Sure, interest rates on 5-year CDs fell from 5% to 3%.

The Feds 0% interest rate is the interest the Fed charges the banks. Thus, they are getting a 0% interest loan.

And the fix is not term limits. It is getting rid of lobbyist, super PACs, political parties, and re-election campaigns. If no one was re-elected, then the politicians would not spend time campaigning while in office. If there were no political parties, maybe we would get more politicians with new ideas and we will have voters who vote for the politician and not the party. If there were no lobbyist and super PACs, maybe the politicians would work for the people and not whoever has the money.

[maui1]

NOT having term limits is the reason for the lobbyist, super pacs, full-time campaigning, ect.

take away the long term value of having a politician in your pocket, and the rest goes away.

everyone always looks at problems that are 'in their face' and never takes the time to look to see where the problems comes from.

[Fyiadvisor]

The author of this ridiculous article closes with the statement: Investors purchase gold on the assumption that some future investor will buy at an even higher price. This is called the "greater fool theory." Are not ALL investment purchases based on such a theory? Ultimately all purchases are based on a price pt at which a buyer is willing buy and a seller willing to sell! End of story!!

I do think we will have a bubble in gold, although it may take the form of a collapse of the monetary and a return to some form of gold as money in which case, the bubble will not end, it would simply transition over to the new system in which gold would go from being a non-money asset to money.
I have been following this market since the late 90s. I remember reading that gold was in a bubble at every price above 320 dollars. I very much like the writings of William Fleckenstein, an American investment writer. He has pointed out how often you read in the financial media or by writers such as this that gold is already in a bubble, a point he quite rightly disputes. Fleckenstein has pointed out that the people who say this did not identify the equity bubble, did not believe that we had a housing bubble, nor have they identified the current genuine bubble, which in the bond market. But now these same people are so good at spotting bubbles that they can tell you that gold is in one.
Most of them did not identify gold as something which was worth buying at the bottom, have never owned a single ounce of gold, have missed the entire move up over the last dozen years, and now that they’re completely out of the market, they smugly tell us for our own good that gold is in a bubble and we should sell.
So, I don’t know that we need to listen to those people and take them very seriously.

[Michael Bryant]

When nobody is taking about it, then we are in a bubble. Likewise, if everybody is buying and saying it will go higher and higher, then we are near the peak. Be greedy when others are fearful. Be fearful when others are greedy. Still a lot of people in cash, not stocks, gold, or bonds. This is the main reason I think stocks and gold will go higher. As long as interest rates don't go up, bonds may go higher too.

[maui1]

gold and silver ARE a fear trade, no doubt, but does our gov't and the rest of the world gov'ts give us reason for fear........you bet your life (or dollar) on it every day.

past gov'ts should give everyone reason for fear, as each and every past gov't has moved from hard assets, to gold (or land) backed paper money, to fiat money, then failure.

why does anyone think that this fiat paper experiment will end any differently than all the rest? especially since we are tracking all the past fiat currencies paths almost to a tee!

[Qwertex]

Despite this article being rudimentary and looking at a narrow part of the price function, past present and future, it's articles like these which make me re evaluate my position.

Most great investment decisions involve foreseeing a change in trend or a game changer. Gold investors see both. The above data on basic demmand actually says that demmand is falling, regardless of everything else.

So i factor that into my investment decision as a negative. Will it make me exit my position? No. The fundamentals of the trench change case are unchanged. However at the same time enough bearish information does mean i won't add to my gold position either.

[thechaser]

abegaz-

i am a bull on humanity and its proven ability of harnessing its native goodness and capacity to learn and apply what's learned to benefit themselves and mankind;

i am a bear on the degree to which the power elite has manipulated the control of the money and credit over the last 200-300 years to further their political and economic needs to the detriment of mankind;

living in places far removed from the niceties of life in the utopia called the USA gives one a good appreciation for the broad scope of the human condition and human ability

the capacity of humans to function economically at levels far below the concept of money is fascinating to not only observe but to participate in, as I do often;

money and its poor sister, credit, are solely objects of faith and belief and i as well as millions of other sane and rational people have and are concluding that what we have placed said faith and belief in has been mis-managed and now wish to consider alternatives whether they be old like gold or new like bitcoins;

[Tampa-T]

chaser,

Speaking of bitcoins, are they the new gold?
Have you seen a price chart of bitcoins, now up to $65.

There are a few articles here on SA about them but they are still pretty much UTR it seems.

[HAPPIESTHIHOSILVER]

CHINA.....TIC FLOWS...China will downplay the purchase of gold until it is done stockpiling vs its currency reserves. China well could overbuy and then use excess purchases for profit or trade. this will develop over the next 3 to 4 years in which a manic phase should occur, and a 5figure price tag. i only question who will be buying should gold attain 5,000 - 10,000 an ounce. let the chips fall where they may.

[CincinnatiRick]

I don't see gold as an investment...merely insurance against the world going all to hell. You could make an argument that the amount of gold held should be calibrated according to the current prospects of same. The premium you pay on that insurance is the return foregone from being unable to otherwise deploy the amount spent on gold.

[Arthur Stein]

Jewelry demand is partly economic and partly taste. Demand has been declining since 1997. I think it is more a change in taste. We have not had one long recession since 1997.

However, it is hard to tell and tastes could change.

[Cash_is_king1]

When all paper currencies cease to have any value which is highly likely given the volumes of debt in the world, the only unit of exchange that will have validity will be gold.

[sewiet]

I'll just say this: at the end of the day the day is over. No one of us (at least on earth) is able to see what's going on after that. I think there is no absolute truth about the value of Gold. Fact is: it will always have a certain value (did you notice the word 'certain'). With FIAT currency this is not the case as proven often enough over all those years of it's existance.
The bubble question is always related to the current sítuation. Our situation is: we see our money just run away.

One solution is to wait and see. Beeing moneyless doesn't kill you right away. People kept helping each other during hard times. Believe me this will happen again. Taken this case you should just try not to loose to many friendships or try living in an environmment of 'nice' people. A crisis will go away after a certain time. In the worst case you start from scratch, but hey your still on the good old planet earth.

Second solution: prepare yourself. Try to invest carefully selecting your assets and don't put it all in the same basket (money, stocks, precious metals, houses...). Have at least something hard.

I think the author is probably missing the point, because he is too much in the analysis of the current past. Before a crisis like the one I believe we will run into the approach should be towards the near and approaching future. And this one is defenitely not looking bright. One tiny little country (Cyprus) has got some little billion euro problem and the world is almost under choc. This is not good. And I have to say the current status is not even bad. I think it is much too good given the current situation. And if I am right then I can hold any Gold. Be it currently quoted at 1000$, 1500$ or over 2000$. Just make shure it's real.

[Charles Waligora]

"The 2012 decline in jewelry demand reflects a long-term trend."

You can observe trend and label it "long-term" to bias the reader to believing there is no end in sight, but cannot discuss the context of the recession that caused the sudden drop in demand?

This is very interesting in this context for two reasons: one would rationally believe that as the economy does better, demand will be restored to jewelry and clearly, demand has not been restored as of 2012.

Yes, this appears to support a continuing trend. But, it can also support two other possibilities:

1> There could be a delay in a return to purchases of jewelry lagging the recovery.

2> The recovery isn't as much of a recover as the numbers suggest. Perhaps a large part of the populace is STILL impacted by the recession, at least as of 2012. Who knows what 2013 will bring.

[HAPPIESTHIHOSILVER]

TIC FLOWS, Chinese purchases, fiat fear = 5 figure gold, 20/1 gold-silver ratio. enough said

[HAPPIESTHIHOSILVER]

interesting comments from both sides on the value of gold. the cash for gold and silver shops are closing rapidly. reason: those selling metals for melt can only do it once. demand is, lets use the the word brisk, at this time. recent articles suggest the dollar basing and continuing its value rise. the only, and i mean only thing that matters in determining metals prices for the next 3-5 years is demand from China. i will go out on a limb and guess the Chinese have been slowly implementing a conversion to adding gold reserves. the decision has already been made, and China wants to buy gold as inexpensively as possible so as to not drive prices to new all time highs. watch the tic flows. once they go negative month after month, it is only a matter of time before gold not only breaks to new all time highs in dollar terms, these highs will be of manic proportions, likely 5 figures. i still prefer buying silver and selling gold on a ratio basis for safer trade, but at 62 yrs old in failing health, i think i will just convert everything, EVERYTHING, to silver bullion and SLW stock.

[Abegaz]

I certainly agree the Chinese have an agenda to buy Gold and add more to their reserves. There is little doubt they have already reached 4000 tonnes and a closer reading of the recent comments from the PBOC confirms as much. They have recently picked up another mine in South Africa continuing a trend that has been expanding for some time.

They have also avowed they will not support current prices though and that should tell us that they will welcome weakness during their accumulation process.

I do not doubt them for a moment.

[pollyserial]

Happiest: I say this with all due respect to a 62 year old in failing health. I am a believer in precious metals at this time. But I would NEVER put 'everything' on anything. Dream your dream but don't risk everything on it. Diversify. It's hard work but worth it. Professional traders never put more than 2% on a single trade, for a good reason. There has to be a scenario in which you imagine yourself to be wrong. Ask yourself: what will you do then? Whatever else might be wrong with it, the dollar is more stable than the price of silver, right now, and right now is what matters.