The thought in this post may be obvious (I wrote something similar about a year ago when I was a complete gold newbie), but it struck me as fresh and relevant today.
Here's a quote from LeMetropoleCafe: "If Gold can continue this week’s outperformance of all other asset classes, investment demand for Gold should continue to accelerate."
What happened when there was an Internet bubble? It was ultimately extinguished by the supply of Internet Stocks (in the form of IPOs) exceeding the demand for stock. Then the bubble popped.
What happened when there was a real-estate bubble? Home builders ramped up home building and the bubble was ultimately extinguished by the supply of houses exceeding the demand for houses.
Now, let's consider gold as a potential bubble. Suppose "investment demand for gold continues to accelerate". There is a limited amount of gold in the world. Wikipedia reports that there has been roughly 158,000 tonnes of gold over all history. At $1000 / oz and 33.1 grams / troy oz that is 4.8 billion oz and 4.8 trillion dollars.
By comparison, Global GDP is around 48 trillion dollar / year. US household financial assets (as of a year ago) were roughly the same size.
The supply of gold (mine production) is increasing at the rate of around 110 million oz / year or 2.3% of all gold ever mined per year. Again at $1000 /oz that is 110 billion dollars / year or roughly .2% of global GDP.
A key observation here is that even a dramatic increase in gold mining (say a 50% increase) would not significantly change the amount of gold in the world. A gold bubble, unlike the Internet and Real-Estate bubbles, cannot be extinguished by a dramatic increase in supply. The European and USA central banks, with their allies, have been suppressing the price of gold for years by selling their stores of gold into the market. Should that Cartel be broken, either by various members getting cold feet and refusing to sell (as seems to be the case with European central banks) or by members running out of gold to sell or by investor demand, from a flight to safety, simply overwhelming this central bank selling a genuine gold bubble could begin.
The western investor psychology is momentum investing. So, if the price of gold should rise, western investors will not want to sell their gold while it is rising. If we model gold price as existing holders not selling and a fraction of GDP or US household financial assets moving into gold (say 1%) we have roughly 480 billion dollars chasing 110 million oz of new gold and a price of gold of 4,400$.
Similarly if we see 5% of financial assets moving into gold (in a mania or panic) with our model we see a price of gold of 22,000$. That would be a genuine gold bubble as all the gold in the world would then be valued at roughly twice global GDP (110 trillion $). This is not sustainable, but a shift of a significant fraction of financial assets into gold could definitely kick off a gold mania pushing prices to extravagantly high levels.
The point is, that if a gold bubble takes off, there could be quite a parabolic rise in the price of gold.
Of course, a negative momentum could similarly kick in. This could happen at that point, whenever it is, when the global economy is suddenly considered "saved" with low inflation. As momentum turns a significant fraction of "all the gold ever mined" could be sold driving the price of gold down to rediculously low levels.
The more likely event that could create such a negative momentum would be the coordinated outlawing of gold ownership by the USA and EU (and allies) where confiscated gold would be sold into the market pushing the price down (way down, potentially). I am certainly not underestimating the likelihood of this happening. This is not seriously addressed by gold pumping analysts even though it happened at the beginning of the FDR's administration in the great depression.
I expect you've heard Ghandi's famous quote: "First they ignore you, then they mock you, then they fight you, then you win."
If any serious confiscation rumors surface I'll be jumping out of gold miners. I'm expecting that the demonization of gold and gold mining as an ecological disaster and a waste of precious resources will precede such a move. I expect that hearing that kind of buzz on the mainstream news media will be a warning sign that the jig may be up. That will only occur after gold has made quite an extravagant move, in my opinion, as the central bankers and G7 governments remain in the "they mock you" stage of fighting gold bugs (with central bank selling and other manipulations as a hidden form of the "they fight you" stage). The demonization of gold mining and gold will mark the beginning of the open "they fight you stage".
So, even though many think of gold as a safe-haven, I conclude that it is certainly not completely safe. I'm watching it closely to see what happens. If I knew of any other businesses generating profits with a sub-3 price to operating cash-flow at current market prices, I would certainly be diversified into them. For now, I'm in Jr gold producers because they appear to be the best money-making businesses open to passive investors.
MontyHigh, www.worldofwallstreet.us
Yes, the amount of Gold on (in) this planet is limited, but the amount that we Humans have recovered is probably less that 1% of this total. We are held back due to our recovery technology, but at $4,400.00 per oz. New Technology will come to life. The Worlds Oceans have more Gold floating in the tides, that would more than equal what has been found in the ground to date! Gold is only limited at this point by the means used in recovery!
Posted by: RC Vickerman | February 01, 2009 at 03:35 PM
When the real estate bubble was inflating, every RE agent was claiming that "they're not making any more land".
Gold's current inflation is speculative, largely owing to low interest rates.
Jewelry demand has plummeted, as has its marginal industrial uses.
I find that the price of gold is becoming more and more divorced from the fundamentals and that yes, it is a classic bubble. Every comment on every newspaper article on gold seems to be 'where can I buy some' and all the prognostications are for it to go up in perpetuity.
Posted by: none | February 04, 2009 at 10:04 AM
Haha, there is no conspiracy against goldbugs. Your yellow metal is pretty to look at, but has no real value as it has no industrial use where it can’t be substituted. The only reason it was ever outlawed was because we were on a gold standard that we had to suspend because of WWII. We are not on a gold standard at all anymore. No normal person cares about gold. It has zero impact on the economy. Oil is a different story as it has a major impact on the economy – but, I wouldn’t recommend investing in oil either.
Posted by: Kirk | September 05, 2009 at 01:32 AM