Why gold is not in a bubble

You probably think gold is in a bubble. After all, it hit new highs in dollars, pounds and euros this week – and has pretty much quintupled since its lows of 2001.

What’s more, everyone from Germany to China is still nuts for it. Earlier in the week, the FT reported that the Germans have been snapping up coins and gold bars faster than they did even in the aftermath of the Lehman Brothers’ collapse. In the UAE, you can buy bars direct from a vending machine. At Harrods, you can pick up a variety of gold coins over the counter. And – as the gold bears are keen to point out – you can see ads for the purchase of gold all over TV.

But look at the actual price of gold and it is hard to see real evidence of a bubble. Gold may have hit new highs in nominal terms, but it hasn’t come close to hitting its old highs in real terms. Adjust the 1980 high of $850 for US inflation and you get a price of around $2,400 – a level only the most bullish are predicting even now.

Then look to the last few years. The bears would have you believe that the gold price has somehow gone “parabolic”. But, in fact, the price in US dollars has only risen around 25% in the last two years.

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Compare that with, say, shares in Rockhopper Exploration, the lucky owner of the prospects where oil was struck off the Falklands recently. Its shares started the month at around 40p and have since more than quadrupled. But no-one is shouting “bubble!”. Far from it; instead, they are all claiming the company has seen a transformational event, which makes its shares worth more than they are even now (which arguably they are).

But hasn’t there been a transformational global event that has changed the case for gold, too? Back when gold’s bull run kicked off, there were precious few gold bugs and we tended to make the case for the metal based on likely demand for “bling” from the new middle classes of emerging markets. We only mentioned in passing the fast rising US national debt and the nagging fear that fiat currencies might not be all they were cracked up to be.

Today, however, gold has reverted to its historical role as the global currency of the last resort. You no longer buy it because you think the Chinese and Russians are likely to increase their consumption of gold-plated mobile phones. You buy it because you think there is a chance that governments, caught in a debt trap from which there is no honourable escape, will eventually think they have no choice but to print their way out of it. And the risk of hyperinflation is a transformational event for gold, it being the only global currency that can’t be printed on the whim of a central bank.

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All that said, there is a strong chance that we might see a short-term fall-off in the gold price. Why? Partly because high prices are putting off India’s jewellery buyers. Partly because there is likely to be a short hiatus in new investor buyers coming to the market – if you haven’t panicked yet, you will need a new crisis before you do. But mostly because, after the mini-inflation scare following the ECB’s bailout plans for Europe, we seem to be having a deflation scare. Prices may be stubbornly rising in the UK, but Spain is now in outright deflation (exclude energy and food, and prices are falling) and core inflation across Europe and the US is very low.

The endless money-printing across the world has not yet brought us proper inflation simply because the mechanism for passing it on isn’t working very well: the banks are too busy repairing their balance sheets to lend it out. But there is nothing like deflation to bring on hyperinflation: governments desperate to prop up prices and economies, despite being broke, print reams of money – money that eventually enters the market in a rush, flipping deflation to inflation.

If you can get a copy of Adam Ferguson’s 1975 book When Money Dies (soon to be republished), you will find an excellent account of how this happened in the Weimar Republic. It might not happen again but, at this point, it would surely be foolhardy to discount it entirely.

Finally, a word on the ads for gold on TV. There is much muttering about them being a sign of the top. But that is to misunderstand the direction of the flow. The ads aren’t selling gold to willing punters, they are persuading them to sell their gold at a discount to the spot rate. That’s a very different thing – more suggestive of awareness of gold beginning to enter the public mind than of a bubble. Either way, I’d ignore the ads. If you have gold, you should hang on to it. If you haven’t, you should use the pull-back in price to get some.

I’ve written here before about the Blackrock Gold & General Fund and gold ETFs but another fund that might be worth holding is Junior Mining, which specialises in smaller mining companies..

• This article was first published in the Financial Times

  • Bertha Vanation

    When you add in Wall Street manipulation that is keeping gold prices artificially suppressed, the true inflation adjusted figure should be somewhere near £6,000/oz.

    There is also the added spectacle of the Chinese & other markets that did not exist during the last highs of 1980.

    As MSW rightly states, governments throught the world are debasing their currencies with inevitable consequences.

    We are in uncharted territories and putting all these fundamentals together, the upper price of gold will be an unknown quanity in the true sense of the word.

    Anyone thinking this is a bubble now clearly does not understand what a speculative bubble is.

  • Taddish

    Two issues bother me when the subject of an escalating gold price arises.

    1. Is it not true that there is less actual gold in the world than is the pieces of paper that certify “gold investments”. I believe the ratio is now less than 1:100 and reducing. Why is this possible? It follows that if just 1% of the holders of “gold investments” asked for the actual gold in bullion or coin form, then there would not be enough of the stuff to satisfy demand.

    2. So unless investors ask for the real stuff, what is going to cause an increase in the price of gold? Surely the “powers that be” can just print more certificates to meet demand and the price will remain static, or at the discretion of the “powers that be” to raise or lower it.

    Surely this is not a sustainable situation.

  • Simon

    Those are very interesting and good points (IMHO).

    What then makes “gold investments” a good hedge against failing currencies if these too can be printed at will?

    I cannot yet foresee that we will one day revert to trading in gold coins for our day/day needs. So why then is gold a good hedge against currencies?

    I would be interested in hearing views to explain this as I am neither gold bear or bull just trying to better understand why I should buy gold as a currency hedge.

  • Bertha Vanation


    The essence of gold is that that its value has remained essentially static throughout 5000 years of history.

    A difficult concept to grasp when witnessing rising gold prices in currencies but consider that what rising gold prices really reflect is the debasement of fiat currency in relation to the value of gold. Thus it takes more paper ‘tickets’ to purchase the same amount of gold.

    This is why gold is a good hedge against inflation. Gold does not erode with inflation, it can’t be printed.

    With regards to the previous point of ‘paper’ gold or EFT’s, the day may well come when the institutions dealing in these will either, pay out the current value of fiat currency for the gold or simply default when they realise they can’t cover their commitments leaving the investors shirtless. This is why it is ALWAYS advisable to hold physical gold rather than the paper ‘promises’.

    I hope this explains some of the previous points raised.

  • Simon

    Bertha Vanation

    Thanks for taking time to explain.
    Your points also make sense and have confirmed my feeling that if I where to invest in gold, I would only buy physical gold (as a small investor I can hold this easily – I understand why larger investors hold “paper gold” instead).
    Thanks again.

  • jason

    Merryn Somerset Webb is quite the dishy bird ain’t she? Made all the more so by being so dead on in things financial. She’s golden in fact and I’m glad that she is the editor-in-chief of this top notch publication. Don’t wait for the dips in gold, buy now, your risk is all on the upside for a long time coming.

  • Midas Mick

    Interesting! The comments reflect my own musings on the subject.
    After researching the best way to go for 2 months + I finally decided on a physical gold investment, largely since paper holdings are open to the sort of abuse outlined by Taddish.
    I have held gold in small coin for years but to facilitate a more substantial investment, I eventually decided on “Bullion Vault”. Worth checking out as it allows small investors access to cost effective gold investment. I also liked the simple interface their software offered.
    I have found it simple & inexpensive to use and the service offered addresses many of the concerns addressed here.
    My primary concern, as for most gold investors, is to protect a good proportion of my capital from those who appear to be seeking to destroy its value.
    Since most folk I know think gold is too expensive to invest in & don’t understand its hedge properties, I think Berta Vanation & MSW are spot on the money.

  • Geoff

    A big thank-you to the author for adjusting for inflation. It’s so simple to do, and yet most people (even the “experts”) don’t do it. It makes me want to smash my face into my monitor whenever I read about the “experts” going on about gold hitting historic highs. It’s not hitting historic highs, and it has a long way to go. This is the problem with measuring things using a unit of measurement (dollars) whose value fluctuates.

    In this interview with a gold “expert” I posted a comment about gold being 50% off it’s all time high, and silver being a whopping 85% off. That’s a heck of a deal, whether it’s gold or dish detergent.


  • John M

    Gold bugs like myself believe that when gold stories hit the main media (i.e Daily Mail rather tha FT!) that will be the beginning of the mania phase when the price of gold (and silver) goes hyperbolic. Like Midas Mick, I chose BullionVault.com and am very happy with the service. I own the bullion, no counterpaties, and charges are low. All those who say gold is too expnesive now will be kicking themselves in 5 years time.

  • Tony

    The fact that so many people are convinced it will go north makes me glad I have substantially reduced my holding.
    I may regret it but Ive banked enough to pay off the last part of my mortgage. Just happy to listen to all the after dinner chat about gold and not have to join in!

  • Dave O’Carroll

    It’s easy to get caught up in the frenzy that every goldrush shows since time immemorial. Bitten bugs reach dizzy heights only to plummet down with a deathly thump like a drifter in an Eastwood movie. Everything screams gold, like a primeval bogeyman reaching from beyond the grave where the God ‘Au’ rests, smiling a golden smile at the frailties of his paper replacement. A smile that frightens you, Gordon used it to useless effect only recently. What use is it apart from glitzy trinkets? Its value stored at the whim of man, on a given whim. Is it any less fiat than a plethora of failing fiat currencies? Its the fear we should focus on, for fear will bring its own reward. Be a Gold fearing man for the Greek have inherited the earth, earth to earth ashes blah blah. Clearly I’m getting too Biblical for any sane discussion but that’s the point it is insane & in a mad world anything can happen once fear takes hold. Maybe a bit of insurance is a sensible strategy, if only for peace of mind

  • newbe

    Merryn / All : What about the previously MoneyWeek much recommended ETF PHAU? Isn’t there a place for a bit of physical + PHAU?

  • Jim

    The puzzle for me is, who are the people selling it, obviously they have already bought it but why are they selling?

    If all reports are true then by rights nobody should be selling as they are using gold as a hedge against inflation/hyperinflation.

    I’m puzzled and sceptical!

    If someone kept selling something (a share, fund, artwork, luxury goods, etc) telling everyone else that its value is going to rise in the future then why are they selling it?

    More inportantly to ask ourselves where have we read/heard that before?

  • Michael

    I’m a newbie to these articles. Gold is a bit expensive for me. Question: Does it have to be gold, or can it just be gold colored?

  • jj

    The fact that there are so many people believing that gold is too high should be enough evidence that it will continue up.Not in a straight line but generally up.I remember,during the housing mania,here in So California,agreeing with my friends that house prices had gotten too high,several years before prices topped out.When most people are convinced gold should continue higher is when the top is in sight.