If the price of something has risen by 45.06% in the space of a year, does that mean it is a price bubble?
Not necessarily, but it’s a question worth asking.
Take a look at the chart for gold priced in US dollars below:
Even in the last two months the price has burst through the USD$1,000 level and is now trading comfortably at USD$1,164.
The story of the Australian dollar price of gold is not quite the same, but I’ll address that tomorrow. Today we’ll just look at the US dollar gold price.
We all know that the price of something can’t go up in a straight line forever. It has to ‘correct’ at some point. But is gold different? Is it possible that the price of gold can keep going up?
Well, let’s take a look at gold to see what it is.
Ask any gold bug what gold is and they’ll reply, “Gold is money.”
And of course they’re right. Gold has been used as a medium of exchange since it was first discovered – probably, we weren’t around then so we can’t know for sure.
There’s a few simple set of reasons for that. Some of which include – it’s rare, it’s non-perishable and it’s relatively transportable. There are other reasons as well, such as it’s not easy to produce more of it.
All that exploration and digging and refining takes a lot of time, effort and, yes, money.
That’s compared to paper or electronic money which isn’t rare, it is ‘perishable’ in that it can be erased by the click of a button, but it’s just as easy to produce more of it, also by the click of a button.
The one thing paper money has in common with gold is that it’s relatively easy to move it around. Although at today’s prices an ounce of gold would take up less space in your wallet than twelve $100 notes.
So arguably, gold is easier to move than paper money.
But that doesn’t really help to explain whether gold can keep going up or not.
If we look at a longer term view of the gold price, you can see that gold has had plenty of corrections over the last thirty-odd years:
In fact, following the last peak nearly thirty years ago, gold went into a long term bear market. That was until Alan Greenspan started the disastrous policy of keeping interest rates artificially low at 1% during the early 2000′s.
Since then – just as then UK chancellor of the exchequer Gordon Brown decided to sell half the UKs gold stock – gold has barely looked back.
In US dollar terms it was trading below USD$300 an ounce in 2000 (Gordon Brown’s selling price!), compared to USD$1,164 today.
In percentage terms that’s an increase of 288%.
If we were talking about the housing market or the stock market we’d quite rightly say that following such a gain it was a bubble waiting to be popped.
In that case how is it possible for gold to buck that?
Look, let me state for the record that we don’t consider our self to be a diehard gold bug. But even so, do you know what, you don’t have to be a gold bug to see that the case for gold is as compelling today at USD$1,164 an ounce as it was at USD$300 an ounce.
All you need to do is accept that gold has certain benefits when compared to paper or electronic money. Those are the benefits I highlighted above.
If you accept those benefits are valid then all you need to do is look at the policy actions of certain central banks to see how they are eroding and even destroying any remaining value there is in paper money.
And it is the action of destroying the value of paper money which is increasing the value of gold.
It’s quite simple when you think about it. The more you create of one thing, the less valuable it becomes in terms of another thing.
Providing more paper or electronic money is created than there is gold being recovered from the ground then the price of gold should rise. Of course that doesn’t mean that a bubble can’t be created in gold, it can if the price is pushed up too high too quickly.
The only issue there is at what price is the gold price too high.
Right now, even after a twenty-year 288% increase, it’s still hard to see how that price increase isn’t justifiable when you look at central bank policy actions.
I’ve already mentioned Alan Greenspan and his low interest rate party. Well, that’s continuing under Ben Bernanke. Only Bernanke is doing an even better/worse job of it.
At least Greenspan wasn’t stupid enough to push the interest rate below 1%. Bernanke on the other hand has managed to push interest rates to zero.
Which is quite funny really, because even the mainstream economists you see on CNBC and Bloomberg seem to agree that Greenspan’s low interest rates helped cause the current economic problems. Yet at the same time they laud Bernanke’s courage for taking rates down to zero.
Did I say ‘zero’, I meant to say negative. Take this quote from Bloomberg News:
“Negative Rates… For the first time in seven decades, Treasury bills are paying no interest while stocks continue to appreciate…”
That’s right, in the US investors are prepared to ‘invest’ in government bonds that provide a negative return. Can you believe anyone would want to do that?
In simple terms, investors are paying USD$100 for a bond with a face value of USD$100 with no coupon/interest payment. In other words they’re handing over USD$100 today in order to get USD$100 back in thirty days.
Only, thanks to the transaction costs and inflation, the USD$100 they get back in thirty days will actually be worth less than it is today.
But following on from the quote above, Bloomberg News writes:
“For the first time in seven decades, Treasury bills are paying no interest while stocks continue to appreciate — a divergence that might be perilous if Federal Reserve Chairman Ben S. Bernanke didn’t know all about 1938.
That’s when the Standard & Poor’s 500 Index climbed 25 percent even as bill rates tumbled to 0.05 percent from 0.45 percent. In 1939 stocks began a three-year, 34 percent decline after the Fed increased borrowing costs prematurely to stymie inflation that never materialized.”
The article goes on to explain that because Bernanke is a ‘student’ of the Great Depression he is determined not to make the same mistakes as policy makers during the Great Depression.
The trouble is, he’s destined to make the New Great Depression even worse than the old one.
Continuing to keep interest rates at zero and creating more and more money is inflation. Inflation is already here. The next phase is the rapid price increases which will only cause an upward spiral as more money is created to combat rising prices.
Arguing that keeping interest rates at zero is the best way to prevent a New Great Depression is completely illogical.
It’s like saying you’re better off hitting a brick wall at 200km per hour than at 100km per hour.
That’s what makes the case for gold even more compelling, despite the 288% price rise.
Sure, gold may have risen too quickly in the short term – or it may not – but with the clear signs from the Federal Reserve that it is in no hurry to increase interest rates, and other clear signs that governments here and overseas are in no hurry to stop spending, buying gold, even at the current price of USD$1,164 could be one of the best investment decisions you ever make.
Cheers.
Kris.
60-Second Market Round Up
by Shae Smith
The S&P/ASX200 finished up yesterday, to 4,717, higher by 31 points. After a massive gain in the US the market has opened up.
Not only did the market close up yesterday, but Alex Moffatt an adviser of Joseph Palmer & Sons was quoted saying that he is “…still confident that we might get within a hair’ breath of 4900 by the end of this year”. Learn more here.
The Dow Jones Industrial Average had a rally overnight, closing up by 132 points, ending the day at 10,450.95. This was the highest close since 2 October 2008.
In the UK, the FTSE100 gained just shy of 2% last night, finishing at 5,355.50. The Footsie is up 20.5% overall this year.
The Nikkei closed down 51 points to 9,497.68
Gold has gone to new highs yet again, with the December gold futures reached $1,174.
The price of spot gold in Australian dollars is trading at $1,260.22, while in US Dollars it is trading at $1,164.19.
Currently the price of silver in Aussie dollars is $20.23 and in US Dollars it is $18.59.
Colin Crownover, head of currency management at State Street Global Advisors is convienced that not only will the Australian dollar reach parity with the US, but will push past it to reach $1.02 – 03 within six months. Find out his reasons here.
The Aussie dollar versus the US dollar is trading at USD$0.9239, and against the Japanese Yen JPY82.21
Crude oil remained unchanged overnight closing at USD$77.47
For the biggest movers on the market yesterday click here…
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Jon, anyone who believes that, or worse, tries making a trade on it, might be up for serious disappointment. The fundamentals of gold are what they are, and there are more and more signs that gold do its own thing for a good while yet, and quite independently of the USD.
GB, MATE, what convinced you to buy and hold USD?
Are you planning to travel there and spend it, or are you diversifying your investments? By all accounts, the USD is toast. They are being dropped from helicopters on Wall Street and the Chindia cannot get rid of them fast enough. How long do you plan holding it for?
Jon, I have written a rather long response to your message but seems to have been lost and did not post. So, I will put to you a question first, before elaborating and re-typing the lost one:
You come across as being trade – savvy, and you talk about technical indicators indicating an imminent reversal for the USD and the gold price. Well, I don’t know what your credentials are, but the people I have grown to respect are talking about the opposite where gold is concerned, and that includes the chartists among them. They are talking, to be more specific, about the gold price having been climbing what they refer to as the “swiss stair case.”
Ever heard of it? Or are you one of those plants working for the criminally dumb concentrated shorts who are about to lose their nickers to the Chinese in a fast approaching short squeeze?
http://www.elliottwave.com/freeupdates/archives/2009/11/24/Heard–Seen-A-Near-Term-Opportunity-In-Lean-Hogs-.aspx
Ah, etch, I could also tell a few true stories about the wins I have had at the races. EW have been, and are still predicting, US$680 gold.
How about we judge them by this particular golden measure? Their call on gold.
At this point, with the reserve banks of the BRIC countries, not to mention billions in hedge funds and pension funds being in the open market, sitting on the bid, I struggle to see how gold will manage to dip below 1k, let alone collapse against a doomed currency by some 50%. But, hey, let us give them some more time before jumping to conclusions.
CB and Nick, thanks for your comments. Like I said, I am a little naive when it comes to the value in holding ‘precious metals’.
But I do think there are a few things left for me to say.
1) I never doubted gold was worth something, but is it worth $1100+ an ounce and will it be worth $2000 an ounce in a few years time? So cb, just saying that gold has value because it no one else’s liability is stating the obvious, the question posed by Kris and on a lot of investors minds is what is driving the price of gold to keep rising and will this trend continue (what could reverse it)? I have concerns that whenever something rises so quickly, an adjustment is in order.
2) Maybe its my age and maybe its the 2012 movie being released, but I just have 1000 things I would rather spend my money on then a piece of metal sitting there. If all of a sudden there was a comet heading towards earth – well, you can have your few ounces of gold, I would rather a range rover, a few dozen litres of water and tinned food to last me a year….my point is that gold is just pretty metal and you can only exchange it for cash (which you guys seem so convinced is going to be worth nothing in the long run anyway – so I would rather be ‘doing a China’ with my money (i.e. Using my money to buy commodities and assets that have a utility value and can enhance my productivity (for me, it wouldn’t be stock piling copper and uranium, but it might be upgrading my laptop etc…). That kind of purchase would enhance my ability to increase my wealth and that is better than sitting on a metal hoping it goes up in value.
3) It also seems to be that the value in gold is entirely dependant on people’s faith that it holds value. When you take away its practical uses and aesthetic beauty – its only worth is what others are willing to pay for it and to be that could be a fragile thing to rely on. To me, I actually see some similarities between Oz real estate and gold. The value of these two asset classes seems to be wholly dependant on people’s faith that these goods will always be at least worth their current value and should rise steadily over time. Now the difference being real estate is purchased with debt, but still – I don’t like having my wealth at the mercy of the mob and their irrational decisions.
cb – you say you are lost for words that I have faith in Government’s to not ruin the currency. I have faith in people to evetually wake up to what is going on and realise that inflating our way out of this debt hole will not be the best option and therefore, US policy will eventually change. Say this change is policy is quite sudden and money supply is tightened, then all of a sudden all the reasons to hold gold would evaporate. Not this may seem like a long shot at the moment, but it could happen sometime in 2010.
It might make sense to hold gold for a variety of historical reasons, but I am yet to be convinced holding gold is as safe as everyone seems to think at the moment.
I dont like accusing Kris and DR crew of talking up their own book, but it seems to be something the DR crew have been harping on about for a decade, so obviously they are personally making out well as a result fo the recent surge in gold price. It would therefore make sense for them to talk up the dangers of not owning gold…just like property spruikers talk up the dangers in not holding property ; )
I might be going to america next year and that made my decision to buy easier. However, that is not what made me buy
1. 76% increase in car sales per month in China and no corresponding increase in fuel – explained away by spruikers that the Chinese aren’t driving much at the moment – i mean thats normal isn’t it!! We all buy something new and then dont use it…
2. President Hu of China announced that it may be better if China were to set a growth target of 7.5% GDP – Hint: we are going to have to slow down – i like 3% – 5% GDP
3. Bank regulator in China demanding better capital ratios to cover bad loans
4. Interest rates rising in OZ
5. Employees are selling their shares faster than people are buying
6. Simply mention removing stimulus and markets falter
7. Gold is rising – is it telling us something??
8. Metal stockpiles are racing up – no one seems to be buying anymore but isn’t China booming??? check out copper – stockpiles have nearly doubled in 6 months almost to an all time high – so supply and price increasing while demand is falling – watch out Australia when fundamentals return, there is going to be sooooo much oversupply of minerals that mines are going to close – abundant stockpiles, abundant mines, no demand – priceless!!!
9. The last 6 months the markets actually went up on bad news and down on good news – its upside down but is it transitioning back to the right away up at the moment
10. Example: Harley Davidson released results that revenues fell from over 200 mill down to 20 million and their share price has been rising since then. Their share price has gone from $43 and is now at $29 from a low of $8 – i guess americans are snapping up hogs??
11. the list goes on and on and on……
On the other hand – where is the good news that has driven markets globally by more than 50% etc….
1. Earning are excellent – except revenues have collapsed???
2. Economies are growing less badly or less negatively
3. Unemployment rising but stabilising
4. I have yet to read an article that is actually/truely positive that we are out of recession
so i figure this: Mr Market is a fundamental sort of a fella but his children are a tad excitable and are prone to a touch of chaos. Eventually, like every good parent, he will crack the whip and fundamentals will return which means the kids will flee stocks and return to USD
I dont think it will happen until China etc… start seriously removing stimulus but they have been talking about that in the last week or so. Look at the ASX since we started raising rates.
However, it may all work out and be a-ok, who knows? I dont have a crystal ball
and when China removes its stimulus they wont need bulk Australian resources anymore. Resources kept Australia ticking over.
Reduced demand for resources = reduced employment
Higher unemployment = harder to make interest payments
China slowdown = tough times ahead
http://www.bloomberg.com/apps/news?pid=20601089&sid=au7s7ICxe_hc
Thanks, GB, I understand you better now. But given that the USD is destined to be printed into oblivion, all your reasoning would appear to support going into the hardest of hard forms of money: gold and silver, and not into a doomed currency of which are already mountains and everybody is trying to get rid of it. And, even though you are not alone expecting a short squeeze induced USD rally, by opting to hold USD, you are effectively betting against the overall megatrend, which is considered, I think, a rather dicey form of speculation. You might find the links below of interest for a better, more educated take on this line of thought.
PuntPal – If there one thing that the Bonner – Danning – Sayce trio have got right, it is their megatrend call on fiat currencies vs gold. You might find these links of interest:
Faber: “No decent citizen should trust the Federal Reserve for one second. It’s very important that everyone own some gold because the government will make the dollar (in the long term) useless.”
Mish: No decent citizen should trust any central bank anywhere. The problems go far beyond the Fed and in the long run all fiat currencies are worthless. Fiat currencies do not float, instead they all sink at varying rates.
Reference:
http://globaleconomicanalysis.blogspot.com/2009/11/marc-faber-sees-war-against-invented.html
The link to the original Faber article is here:
http://www.bi-me.com/main.php?id=42214&t=1&c=35&cg=4&mset=1011
cb – i agree completely with you except for one problem. If and i mean if, fundamentals return and their is a mass exodus there just isn’t enough gold for everyone to buy so they have no choice but to go back into USD – there simply is nothing else
gold – i just dont know. if its a speculative bubble which is highly likely because of the way investors trade then it could correct but then again it could hold its gains too
also i bought some USD for the american trip next year so its not a loss (unless the USD comletely collapses to nothing and the AUD becomes a powerhouse)
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