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Smart Investments, Redlands, Ca.

Is There a Gold Bubble?


March 10, 2011




Is There A Gold Bubble?    


For quite some time now, gold has had the wind at its back.


Typically a gold investor is someone that is concerned about the stability of currencies and the economy. They own gold as an alternative to owning a currency or an investment denominated in one. The thought is that gold will provide a more stable and reliable store of value during a period of financial or political instability than will the currencies that we use for day to day transactions.  


I have always felt that the best use of investment grade gold is as a hedge (an insurance policy) against political or economic instability and used as a component of a balanced investment strategy.  In light of the following, I am beginning to think that this strategy might need some interim revision.


Certainly the past 3 or so years could be classified as financially unstable, so it makes sense that gold would attract a larger number of buyers, causing the price to go up. But I think another factor could be that alternative investments, a certificate of deposit, for example, have become relatively less attractive. I chose CDs as an example because, by their nature, they pay interest in cash. Interest rates for the past few years have been at rock bottom. As a result of these very low interest rates, CDs donít provide much competition as an alternative to gold. Also, as a result of economic instability, other competitive investments, like stocks and mutual funds are seen as being very risky.


It also seems to me at least one component of the increase in the price of gold has been the herd mentality.  I think some of that is a result of a very active group of folks offering gold to investors often leaving the impression that there is nowhere to go but up.  


A brief review of Goldís characteristics: Itís a little bit difficult to own in large quantities (itís REAL heavy for its size).  When you get down to it, it really doesnít do anything. It doesnít have earnings, interest or pay dividends, and itís just as difficult as a government bond to use at the grocery store to buy a gallon of milk. Gold has a relatively small number of industrial uses. In reality, the only reason gold has any value at all is because we all think it does.


Gold investors need to remember that the price of gold is subject to the same economic laws as other investments. Just like other types of assets, the price of gold must obey the law of supply and demand. If there are more people bidding for bars of gold than there are those willing to sell, bidders must up the price they are offering to pay Ė in other words, the price goes up.  On the other hand, if there are few buyers, a person interested in selling might be faced with lowering the price they are willing to accept to attract a buyer.


My concern about the price of gold is simple Ė I think that anyone who is likely to see gold as the end-all of investment opportunities already owns some. These die-hard gold bugs already have their stash buried in the back yard or in a safe. Judging by the very heavy volume of transactions in gold, and remembering that every transaction has a buyer AND a seller,  I suspect that a number of these folks (along with others) are also buying and selling gold on a daily basis for short term profit. I think this observation might reveal the existence of a speculative bubble in the price of gold.


Hereís my prediction:  


I think we will see significantly higher interest rates in the near future.  As rates increase, CDs, bonds and other stable value investments will begin to offer a higher rate of return. Also, the dollar will strengthen. These events will provide competition for gold, especially among institutional and sovereign (foreign governments) investors. As gold loses some of its support, prices will moderate.


In short, I think the hedge worked. Now itís time to consider taking profits in gold holdings.


Barrick Smart



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