Gold bubble? No chance

I’ve sent a lot of ideas your way over the past year or so. That’s what The Right Side is all about: potential profit opportunities and ways to protect your wealth. I hope you’re enjoying it.

Today I want to check in on one of the assets I’ve talked about most: gold. Every now and then it’s worth taking a bit of time to reflect on your investments.

And right now the gold run is giving us that chance.

Since gold came off its top in summer, it’s been pretty much range-bound.

You can see that from the chart of the popular London-listed gold ETF (PHGP:LON), shown below.

The chart looks unconvincing to me. Directionless. Will the bull resume its upward momentum? Is it finished? Or are we just due some more sideways action?

Three-year sterling gold ETF chart

Physical gold ETF, last three years

It’s time to take stock.

Well, if you’re a long-time reader, you know me. I’ve got gold in my bones. It probably won’t surprise you to learn that I’ve got a feeling the bull will resume its upward drive.

But beware. Many commentators will tell you the market has reached its climax. They’ll warn you the bear is lining up in the wings.

People are calling this the end of the gold market bubble. I think that’s rubbish.

I want to show you four good reasons why gold hasn’t reached the top. This isn’t a bubble… yet! I’m sticking with it.

Gold and the zero return environment

The latest pullback in gold was a little bit odd. On 29 February (a day that shouldn’t really have existed!) gold took a great big whack. As Ben Bernanke stood in front of Congress and suggested further quantitative easing (QE) might not be necessary, precious metals plunged.
Gold fell an amazing $100 within the hour. I’ve got to admit I wasn’t expecting that.

Many pundits are now convinced that this is the end of the millennium gold bull. They’re probably thinking: “Great. Now QE is over things can get back to normal again. No more of all that flaming talk about gold too!”

But hang on… not so fast.

First off, I don’t believe QE is finished. Not by a long-shot. They’ve been at it for years over in Japan with no sign of giving up. And it’s only just kicked off in continental Europe. Before long I expect our friend Mr Bernanke to have a change of heart. He’ll be back at the printers before you know it.

Anyway, QE isn’t the only thing that’s been driving the gold market.

What’s really got investors interested in gold is ‘negative interest rates.’ That is, all the while inflation is running higher than returns on cash, then why not hold gold?

Negative rates have turned modern finance on its head. It’s why most people (including the mighty Warren Buffett) just don’t or won’t understand what gold is all about.

But when cash and bond returns are negative, then it’s totally logical to buy a ‘zero-dividend’ investment. And the Fed has signalled that we’re going to be stuck with negative interest rates for years.

All right, so gold may not need to provide an income during these strange times. But surely its price has risen way too much for comfort, say the bears. Gold is up around six-fold since Gordon Brown’s bottom. How can that not be a bubble?

But let’s just get the rise in context.

Gold’s rise is nothing compared to some commodities

Gold has undoubtedly done well over the last decade or so. But let’s not forget, so have other commodities.

Oil is up not six times, but nearer 12 times! Other commodities have done better still.

Yet most investors accept rising prices in other commodities. You don’t hear bubble talk just because there’s insatiable demand for oil and the market’s up many times over.

That’s because oil’s uses are obvious and there for everyone to see. It’s plain as day that the world is clamouring for energy. And the world is clamouring for food and metals too. These are the raw materials needed to make the world go round.

But when it comes to gold, it’s a different story. Who needs gold? What gives it the right to go up many times over when there’s no fundamental need for it?

But of course there is a need for gold

It’s true that gold doesn’t really have any meaningful method of valuation. And that can be very frustrating. Especially for anyone involved in finance who is used to using ‘fundamental’ analysis to bring meaning to their investments.

This makes it incredibly easy for detractors to declare gold to be in bubble territory every time the price shifts upwards.  Crikey – nothing could be easier!

But let’s look at this the other way round.

What we can assess more meaningfully is the amount of paper currency in circulation.

Number of US dollars in circulation (monetary base)

Here’s a chart from the St Louis Federal Reserve bank. It shows the amount of dollars in circulation (monetary base). Notice how, up until 1971 the number of dollars in the world was relatively static. At that time gold traded around $35.

And then look what happened. The number of dollars in print started to rise exponentially. In fact, you may have to look closely at the chart to see the 2008/2011 mega-spike. It’s kind of shaded by the grey line (which shows periods of recession).

By gum. If like me you think there’s a correlation between the gold price and the amount of currency in circulation, then I think you’ll agree: there’s still room for an almighty upwards correction in the gold price from here.

And anyway. Just look at who’s buying the stuff…

Today demand for gold comes largely from the emerging markets, especially India and China. Both individuals and central banks are getting quite keen on precious metals. They’ve seen the chart… they know the score.

These guys understand what gold means to a currency regime. Precious metals have always been at the heart of currency. It’s just that we seem to have lost sight of that fact recently.

How can this be a bubble when only a very select few are getting stuck in?

I mean we’ve had an 11 or 12 year bull-run and yet Westerners have been emptying their pockets. If anything, your average Joe has been trading in gold at the ‘gold bars’ in the shopping mall.

As an investment class, gold is incredibly tightly held – only between 1% and 2% of global investable assets are gold related. Who’s got it? Mainly central banks, Asian investors and a select few from the West (including me!) I mean, next time you have a dinner party, bring up the subject of gold. I’ll bet hardly any of your guests own it in any quantity. If they do, they’re in the minority – the smart minority.

This doesn’t look, or smell like a bubble to me.  For a bubble you need widespread ownership… like we saw during the dotcom craze.

To my mind gold is in a period of consolidation. It’s sliding sideways as the market takes stock. There are all manner of reasons why gold should go up. I’ve not looked at them today. All I wanted to say is that there’s no reason to believe we’re in a bubble.

5% to 10% of your assets in precious metals is my advice.

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  • Richard

    Hi Bengt, Do you agree with the theory that gold eventually reverts to a price backing the currency in supply (US$)? I.E. People bid the price up as they lose faith in paper money. By my quick calculations, gold has actually increased by more than money supply since we came off the gold standard. Interested to hear your thoughts.

    I should say I still believe gold is heading higher too.

  • Jeff

    Trouble is, the louder the “detractors” shout the more bears appear!

  • buyers of new york

    there is def no bubble in gold, i believe gold should be worth more Gold Buyers say the value of gold should be higher.

  • James

    What refreshing common sense. Thank you.

  • Warren

    Sir I fully agree with your article, it was refreshing to read. My wife and I are retired in our seventies, saw the way our global economy was heading and our ignorant politicians who where not fixing the problems.We began buying up gold bullion when it was $400 dollars per ounce. We are so convinced of its future upward trend we now have 50% of our funds in gold bullion. We find dips in gold like today are exciting and do not worry us in the least. As you mention we know of no one else possessing gold. Sir your articles are well thought out,do keep up the good work.

  • Mike

    The chart movements since the Sept/Oct peak look like a potential bullish wedge forming to me. But how long will it take before it breaks back to trend? I agree the long term trend will probably continue in the same way as the long term downward trend of the US dollar against the other majors. I don’t view that as a sound reason for buying or selling either right now, any more than I would bet upon the shorter term breakout direction of that wedge or the duration of the current dollar rally.

  • Bob

    Having read money week, I purchased on the 16/01/2008 Blackrock AM UK Gold & Gen Fund on one of there recomendations at 11.23p, today the price is 13.56p.
    Not such a great return, where have i gone wrong?

  • Commodity broker

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