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Ecstasy for the Gold – Examining if there is a bubble in the Gold Market

|Includes: Randgold Resources Limited (GOLD)

 By: Lior Cohen;


As the gold price continues to roar up the ladder and on its way to pass the 1,400 USD/t. oz. mark, one might think if this price is justifiable for this precious metal. Could it be possible that there is an economic bubble in the Gold market?

I think it's well known that many investors and traders fell back on Gold because it is considered a safe heaven when the level of uncertainty as the markets rises. What is the uncertainty? We all know them, it includes such as: the U.S. economy's peril condition after the 2008 bank crisis; Europe's decline with Greece and Ireland nearing bankruptcy, and with other countries on the target such as Portugal. Therefore many consider commodities for investment, and in particular Gold, which has proven to be with stable demand for many years.  


In order to have a bubble in a certain market, the current prices of an asset shouldn't be detached from its real price, i.e. the demand/supply price. If the asset is priced more then its worth then we have a bubble ready to explode.


In order to check this claim in the Gold market, I have gathered data about the total world demand and supply in tons between 2004 and 2010 (Q4 2010 was an estimation) and compared it to the average yearly gold price.


If there is no bubble it should mean that the rise in the Gold price should be inline with the rise of demand or the lack of the supply to maintain the demand.  


So let's get started…


In the table below there is the gold price in yearly average for 2004-2010 (2010 is up to October), and it is compared with total world Demand for Gold, total world Supply and the supply surplus or deficit (supply minus demand). The last figure shows that if the demand isn't provided then there is merit for the price to rise because of lack of Gold.




The table shows that in the past couple of years there is no shortage of Gold and if any, a surplus; furthermore, the demand is lower in 2010 then it was in 2008.


The table below presents the year to year change of the demand, supply and gold price (percent change).




In the following graph you can see a time series of the price of gold chart and total demand vs. total supply for the years 2004-2010 (yearly scale).


A price of gold chart (USD/t. oz.) & Demand vs. Supply (tons) 2004-2010



 The graph shows that while the gold price rises very sharply the demand and supply didn't rise in the last couple of years.


Could it be a matter of inflation? I.e. the prices of most commodities rose and therefore the relative price of gold didn't change much. Perhaps, however I don't know of any high inflation that we have recently suffered from in the Western world (e.g. Crude oil prices and natural gas prices aren't higher then they were a few years back).


So what is the bottom line?


I think we should consider that Gold is at a very high price and could be separated from its "real worth". If it's true, then it means that Gold is overpriced and its market is a bubble ready to pop any time…


When, if any, this bubble will burst? Good question… I can't give a good estimate because it's a tough question…however, I could speculate that it could happen when investors will try to move their funds to somewhere more attractive. Therefore the answer relies on the question when will investors gain again trust in U.S or Europe's' financial markets to invest in them; nonetheless, this bubble burst could take a long time (even years), because there are no apparent good alternatives as I have pointed out at the beginning, and as long as the trust in the major markets isn't restored, it will be hard to persuade anyone to move from Gold. 

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