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A Bubble in the Pot of Gold?

|Includes: SPDR Gold Trust ETF (GLD)

The comment I posted in response to Jared's Condor Options feature article, Why Conventional Hedging Methods Fail, alluded to my opinion that gold is the current leading candidate for what I'll call “bubble watch”. A growing number of analysts are jumping on the gold-bubble bandwagon, but predicting when a bubble will burst can be frustrating (and capital-crushing).

My comment referred readers to Didier Sornette's book Why Stock Markets Crash: Critical Events in Complex Financial Systems, and my interest in applying his model to gold futures. Sornette has a team of mathematicians and a super-computer at his disposal (not to mention the proprietary details of his latest models), so my efforts are feeble in comparison; nevertheless, a chart of gold prices, overlaid with the four most recent market bubbles (technology, housing, the financial crisis [represented by SPX], and oil) tells an undeniable cautionary tale.

What I see in the above chart is an exponentially accelerating price trend, with increasingly frequent sharp sell-offs—a crude, but fairly accurate, description of Sornette's bubble model. Granted, chart analysis can be subjective, to say the least, but in combination with that indescribable intelligence we call “intuition”, the chart of oil prices in June of 2008 told me the price of oil was in a bubble that was in imminent danger of bursting. The pop came less than a week later.

Now, I'm not predicting that gold will crash next week, next month, or even next year. I merely wish to point out how precipitous the run-up has become, and that the chart suggests it would be wise to be cautious. (If you invested in gold back in 2002 [or 2003 or 2005, or even 2009], would it be smart to sell some of that stake now? Uh...yeah.)

Getting back to the application of Sornette's model to gold, the latest information I could find indicates that it accurately (but not all that precisely) predicted the critical inflection point in October 2009. However, the bubble (yes, I'm sticking my neck out and calling it what it is—but I won't go so far as to predict exactly when the bubble will burst) began reflating less than three months later—so, clearly, there's a larger-scale pattern playing out.

For want of a super-computer...

Disclosure: No position in gold.