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When Will the Gold Bubble Burst?

February 15, 2009 (Last updated on May 9, 2011) by

The gold seems to be becoming the favorite investment around as the traders are afraid of the crisis and the fiat currencies seem to be in a great danger when all those anti-crisis measures will induct a massive wave of inflation, reducing the money’s buying power. In such an environment gold looks like a good investment to save one’s assets and to multiply them if you trade with a considerable leverage. Forex traders may also decide to capitalize the expected upward gold trend as many Forex brokers provide the gold vs. dollar or gold vs. euro pairs.

There is one problem with investing in the gold now — it’s already way overbought. For almost ten years — from 1995 to 2005 the gold has been trading between $250 and $420 per troy ounce. The gold began its rally in 2005 and peaked above $1,030 in March 2008. Now it’s trading not far from that level — near $940 per troy ounce. Gold’s «bubble rally» accompanied the similar rallies in carry trade (GBP/JPY, EUR/JPY, AUD/JPY currency pairs, etc.) and in oil. Both the carry trade and the oil rallies ended with the bubble bursts as the financial crisis reached its apogee in September 2008. The gold bubble lived through that period falling to is local minimum of $680 in October and that minimum was far above the recent average trading range for this commodity. You can compare a carry trade unwinding with the drawdown in the gold prices during the crisis time from these charts:

Gold Chart

Gold Chart

AUD/JPY Chart

AUD/JPY Chart

The gold is praised by many as the real investment in the world full of the paper money and the bills that go default or the shares of the companies that may just vanish. Gold is seen as some kind of a standard of value compared to other assets. Average Joe might even hope to use the gold as the method of payment during the harshest times when the fiat currencies won’t be considered as anything worthy. In reality gold has almost no real value. Of course, it’s nice and makes a good jewelry but its value has nothing to do with its current price. The current price was raised by the investors, traders and the short-time speculators. Investors opt to gold as the safe haven investment, traders buy it because they can get an almost risk-free ROI during the time of the near-zero interest rates; the short-time speculators just find a good opportunity in riding the wave and gaining from the daily or weekly pull-backs on the gold market.

But the bubble will continue to grow until one day it bursts. So, when will it happen? It will happen only when two conditions become true. First, the financial markets should offer something else for the investors to get in — the higher interest rates by the major central banks is a good indicator that the investors now have better ways to multiply their funds than sitting on the piles of gold. Second, stability should rule the finances — not many investors will go investing into South African or Russian papers (which still offer more than 10% ROI) if there is a high probability to lose their money. Gold offers safety and the new investments should be also considerably safer. When the traders will have something new to invest in and the safety of their funds will become satisfying they will start to move out of the gold gradually. When the short-time speculators realize that the gold is falling they will start to bet on the short side, pushing the gold down faster, which will trigger the major stop-losses of many long-term investors forcing them out of this asset. As the oil fell from near $150 to $40, the gold will probably fall from $1,000-$1,200 to about $400 in a period of a month or two.

It can’t be known exactly when the right time for the burst comes. For now gold is still a good buy — central banks maintain the near-zero interest rates, the risks are high and the risk-aversion is the general trend. The gold should flourish at least for the next several months, bellying the bubble even further. I’d watch closely for the U.S. interest rate and if it comes close to 3–4% (and they will eventually have to increase the rates because of the budget deficit-induced inflation) that means the major part of the gold investors will start to slowly move out of it. But for now, selling the gold probably won’t be a good trade.

Update: You can also read my February 2010 technical report on the medium-term state of gold bubble.

35 Responses to “When Will the Gold Bubble Burst?”

  1. Yohay

    Looks like it’s not going to burst soon.

    Reply

  2. Pierce Randall

    I disagree with many assumptions in this article — I don’t think inflation, today, is on the radar, and I disagree that, today, gold is a good long play.

    Gold is definitely in a bubble. It’s toxic. Maybe it collapses tomorrow, maybe next year. When I saw real signs of a gold bubble collapse, I’d get into DZZ — an inverse gold ETF — and I’d hedge by going long on oil.

    Reply

    Andrei Reply:

    So, why do you think the gold bubble will go down tomorrow or in a year? If you don’t spot an inflation on the radar, what else can push gold down?

    Reply

  3. Solbama

    You have proven yourself dumder than a box of rocks

    Reply

    Andrei Reply:

    Right! I am just the mere shadow in the light of your wisdom and omniscience.

    Reply

  4. Jon King

    This piece is right on. When every housewife and neihbor is holding gold parties and buying gold coins it is just another bubble.

    Reply

  5. Ducktales

    PLEASE DISCUSS THIS POINT
    If the dollar/ euro loses much of its worth due to inflation, even if people start selling gold after the wave of inflation, gold will still have kept much of its real value, or at the very least its value in euro/dollar. Historically, gold has proven the best protection against inflation. Furthermore, I think that after the massive wave of inflation we may expect in some time, the culture will be biased much more in favor of gold which may gain back its former status of world currency.

    Reply

    Andrei Reply:

    The problem is that the gold is very bad substitute for money. Even if you use the gold standard for the usual currency the gold limits your monetary policy control. But the greatest problem of gold-based money is the limited value of the currently available gold. Either you won’t be able to price everything in gold or you’ll have to inflate the gold value which differs little from giving the paper money the value greater the the paper’s value. As to the possible growth of gold during the inflation wave – yes, that’s possible; but if the inflation wave will be accompanied by the growth of the stock markets and real estate, investors and traders will favor the latest ones before the gold.

    Reply

    AUX Reply:

    Gold has been used as money for centuries. A lot longer then any fiat currency. Gold has a longer history as money then anything else. It is surprising to me the way people talk about this comparitively very short time in history of the fiat currency is so grand that it can never fail and gold is not worthless. That is so laughable. Gold and the dollar were only decoupled in 1971. I sure hope your not basing all your assertions about gold having no value as money on this 30 year period are you? That would be pretty poor science. Gold is used as currency right now in Zimbabwe and has always been used during currency crisis as money. Anyone claim that gos against all of history is ridiculous on its face. Fiat currncy always returns to zero. Prices have risen quite dramatically since 1971. You think we pay so much more for everything because of supply and demand, or the inflation in the supply of money since 71? Gold is and always will be valuable and used as money.

    Reply

    Andrei Reply:

    1. The fact that the gold has been used as money centuries before the introduction of the paper currency and for few centuries as the standard for the paper currency, doesn’t mean that it continues to be good as a currency or a standard for a currency. After all, pre-modern medicine was used for thousands years before 1880s but that doesn’t mean that it was better than the modern medicine, which is used for only little more than hundred years.

    2. Gold has no value as money because currently you can’t use it as money. You can’t pay in the supermarket with gold. You can use it as an investment. And there are reasons outlined in the previous comments that make gold an ineffective standard for the currencies.

    3. Zimbabwe currently uses USD, ZAR, GBP, BWP and other local currencies. Where did you read about gold? But even if the gold was used in Zimbabwe as the only currency that wouldn’t mean that the gold could be used in other more developed countries. Zimbabwean economy would need only 53.1 tons of gold to cover its yearly GDP.

    4. The inflation is the result of the credit-based economy. Supplying more money “in advance” is required for faster development of the economy. It’s quite a basic concept of the economic theory.

    Reply

  6. Gator

    “Even if you use the gold standard for the usual currency the gold limits your monetary policy control.”

    That is what makes gold the perfect currency.

    Reply

    Andrei Reply:

    Gator,
    Actually, it makes it unusable as a currency.

    Reply

  7. Gator

    Monetary policy control has been such a global success!

    Reply

    Andrei Reply:

    Gator,
    Eh? That’s like blaming a shovel for that you’ve dig a hole instead of a mound.

    Reply

  8. AirGibson

    Andrei, no, it’s not at all the same. Monetary policy can be a very noble concept with excellent intentions. The problem is that greed and power-mongering is just too prevalent among mankind for it to succeed.

    The powers-that-be in a Representative Republic will always be concerned with being re-elected, and will thus have every incentive to stave off a recession by any means necessary even if it just means they’re just pushing it off to the future and making it worse. Likewise, a debt-riddled population (like most US citizens) will have every incentive to vote for candidates who will “enable” their reliance on a continuous flow of cheap credit as opposed to actually foregoing current luxuries in favor of dealing with our problems and saving rather than spending.

    Fiat currency / monetary policy will simply be leveraged to these ends as opposed to what you are hoping it would be used for. A gold standard helps prevent things like hyper inflation, which is why the founding fathers of the United States explicitly prevented the various states from making anything other than gold or silver coins legal tender in the Constitution. Eventually, more recent governments decided to shun this idea and “get around it”, and here we are.

    I do believe gold is overvalued currently, though. But to say it is a “bad substitute for money” is totally wrong. Gold is THE historical definition of money. In fact, historically speaking, gold had most all of the qualities desireable for a currency: It was actually worth something in that it was a beautiful metal which doesn’t rust and is highly conductive, it can be easily transported and stored in general, it is malleable and easily divided, it can be measured easily, it serves as a medium of exchange, etc… It has *plenty* of the qualities you’d like to have in a currency.

    With modern internet technology, it would actually be pretty easy for someone to set up a “Paypal” based on gold where the bank stores our gold for us and we simply carry around our “gold debit card” just like we use our current debit / credit cards. Long story short, “enabling monetary policy” is not a part of the definition of the “perfect currency” where man-kind goes.

    Reply

    Andrei Reply:

    You wrote a lot but you don’t seem to understand that gold has a lot of disadvantages as a currency standard, not saying that it fails completely as an actual currency. The talk about gold being “THE historical definition of money” is clearly sentimental as we can go into saying that shells and stones are historical definition of money. As a currency standard the gold has 4 major problems:
    1. It’s limited in supply – “Hello deflation!”.
    2. Sometimes huge geographically concentrated deposits are discovered – “Hello inflation!”.
    3. Gold speculators will have the power of the central banks (and they won’t be elected or appointed by the elected authority).
    4. During recession/depression periods government won’t be able to use “cheap money” to stimulate economy.

    The problem that you’ve mentioned in the 2nd paragraph of your comment is important but it’s a problem of application and a current financial system, not of its basic principles.

    Reply

  9. AirGibson

    – Nobody has said “gold is perfect”. I’ve simply refuted your claim that it is “unusable as a currency”. I agree 100% that gold has shortcomings and potentials for issues (as does virtually any currency candidate).

    – Ah, the government-created spectre of deflation. I love when people throw around deflation as if it is something awful to be avoided at all costs or as a means to justify inflation. Just like inflation comes from expanding our money supply, deflation is just a contraction. The only way deflation is truly “bad” is when demand for the currency drys up due to a collapse of income (e.g. the Great Depression). If that is not the case, then there exists demand at some level of prices, and deflation just means that supply exceeds it (making prices fall). It is the limited supply of gold that makes it excellent. I have no idea how you are trying to twist that into a “bad” thing.

    – Gold speculation (if it were a currency) would be no different than the current currency speculation prevalent across the world. In fact, currency speculation in general is losing its appeal simply because the reward does not tend to be worth the risk taken. No idea what you’re reaching for here.

    – Recessions are a *necessary* part of any economy. “Lessening the blow” by printing more money and lowering rates to make money cheap to borrow are both simply lessening the blow via inflation. So we inflate the currency a lot in the hard times (just like we’re seeing now), yet in the good times we also continue to expand it. There is never a contraction. This is exactly what forced the US to basically declare bankruptcy under Nixon and close the gold window: It could no longer back up all of the currency it had printed in effort to stave off a recession. Again, enabling “monetary policy” is NOT a desirable quality of a currency. I’m not sure why you are pretending it is. In fact, an initial draft of the Constitution gave the federal government the ability to issue bills of credit (read: paper money), but the founding fathers struck it down for this very reason: They did not want the federal government to have the power to create inflation. Enforcing a gold standard puts a drastic (if not total) damper on their ability to do that. I personally think they were pretty smart guys and I agree with their assesment. If you think they are misguided on this topic, I’d be interested to know why.

    Reply

    Andrei Reply:

    – Nobody has said “gold is perfect”. I’ve simply refuted your claim that it is “unusable as a currency”. I agree 100% that gold has shortcomings and potentials for issues (as does virtually any currency candidate).

    The only reason because I’ve said that gold is “unusable as a currency” is because I believe that its disadvantages make it unusable. Of course we can use anything as a currency or even abolish the currency. But currently fiat currency is the only effective type of currency, in my opinion.

    – Ah, the government-created spectre of deflation. I love when people throw around deflation as if it is something awful to be avoided at all costs or as a means to justify inflation. Just like inflation comes from expanding our money supply, deflation is just a contraction. The only way deflation is truly “bad” is when demand for the currency drys up due to a collapse of income (e.g. the Great Depression). If that is not the case, then there exists demand at some level of prices, and deflation just means that supply exceeds it (making prices fall). It is the limited supply of gold that makes it excellent. I have no idea how you are trying to twist that into a “bad” thing.

    Deflation isn’t something more evil than inflation. They are both quite harmless if kept in the reasonably low level. But both inflation and deflation are equally bad if go out of control. I guess that you haven’t read anything on deflation and why it can be bad. No only it’s bad when the income decreases (like in Great Depression) but it’s also bad because it actually causes income to decrease. Not to say that it can do in the credit-based economy (I hope we won’t get into the discussion about the “evilness” of the credit-based economy).

    Gold speculation (if it were a currency) would be no different than the current currency speculation prevalent across the world. In fact, currency speculation in general is losing its appeal simply because the reward does not tend to be worth the risk taken. No idea what you’re reaching for here.

    Governments have almost full control over the currency speculation (print money, liquidate money). With gold – it’s quite impossible.

    I don’t get the idea of your last paragraph. I am not going to argue with the argument that refers to the authority of the U.S. founding fathers. That’s not a real reasoning to me. But what’s wrong in decreasing the recession period or its severeness by increasing an inflation? There is nothing bad in a moderate level of inflation if the economy continues to grow. In fact, I am quite surprised to hear complaints about the inflation from the U.S. residents, where inflation is almost absent compared to the emerging economies. Actually an elevated level of inflation (say 10-12%) would help many of the issues U.S. economy has.

    Reply

  10. AirGibson

    – “The only reason because I’ve said that gold is “unusable as a currency” is because I believe that its disadvantages make it unusable.”

    I would have to say that thus far, you’ve given no viable reasons that it is “unusable” other than a variety of incorrect assumptions (e.g. the potential for deflation somehow makes it bad) and you saying so. Again, gold has several potential issues (just like any other currency), but you’ve offered nothing substatial in the way of proving it “unusable”. It’s a bit of an absurd argument anyhow since history has already proven you wrong. With modern technology (again, imagine a gold-based Paypal of sorts), it is very easy to see how it could be easily used again. You’d be better seved by simply conceding that yes, it is usable, but you think there are better alternatives. Until you actually offer up proof of it being unusable, I don’t see the need to continue debunking the statement. Or perhaps you never realized that this was against their wisdom?

    – “I guess that you haven’t read anything on deflation and why it can be bad. ”

    Considering I gave an explicit example in the very discussion of how deflation is bad, I’m not sure who you’re even talking to now. Please keep up :)

    – “I don’t get the idea of your last paragraph. I am not going to argue with the argument that refers to the authority of the U.S. founding fathers.”

    Well that is quite the cop-out. The point is quite salient and relevant. Just because “you don’t want to address it” doesn’t mean much. The founding fathers did NOT want the federal government to have the ability to control inflation (read: monetary policy) and *explicitly* struck down giving them the ability to do so. They also required gold backing for the money used by the states to additionaly combat inflation. You apparently disagree with their logic in doing these things. I would like to hear you describe why you think their logic is flawed since your stance is in *complete* contrast to theirs.

    “But what’s wrong in decreasing the recession period or its severeness by increasing an inflation?”
    Nothing. That was one of the noble ideas behind fiat currency in the first place. Nobody disagrees that fiat currency / monetary policy CAN be used for good in some cases. The point that seems lost on you is that humans are simply greedy and that the power can be easily abused to other not-so-noble ends (like we see now). Much like communism, it’s a noble idea that just can’t stand in the face of our tendancies toward greed.

    Reply

    Andrei Reply:

    OK, I see that we’ve got ourselves into a vicious circle here. You say that the gold is usable as the currency as you think that the currency shouldn’t allow monetary policy regulation (like the U.S. founding fathers made it so). On the other side, I say that gold keeps the disadvantages of the fiat currencies and also doesn’t allow flexible monetary policy regulation, which, in my opinion is one of vital parts of the currency in the modern economics. So, we’d better go into discussion of the necessity (or vileness) of the monetary regulation if we want to move forward from this point.

    If I understand your argument correctly, you state that the monetary regulates makes government to provide cheaper credit (and higher inflation), while the people is being stimulated to re-elect this government and get those cheaper credits. That’s the inevitable and a bad consequence of having a government regulating a monetary policy. Please, correct me if I misunderstood your point.

    I say that the monetary policy is required because it provides a way for the government to halt deflation and stimulate demand during recessions, halt inflation during the period of growth, while at the same time it regulates the availability of the credit (and actually provides quite a cheap credit) during all times. The problem of the government using the monetary policy to make potentially harmful populist decisions is the problem of itself and, in my opinion, it shouldn’t be solved by removing this tool. That’s like fighting a corruption by removing the ability of the government to make any decisions.

    By the way (it’s not about monetary policy), if the world would decide to move for the gold standard today it would encounter one serious problem. At the current price (about $1,000/ounce) there are just about $4 trillion gold available in the world, while the world’s monetary base is tens times bigger. Assume it’s only $40 trillion. Then the gold price will have to be artificially increased to $10,000 to back all the money we currently have. $10,000/ounce means goodbye to the jewelry industry and industrial usage of gold. But that’s not all. Assume after we have some currency backed by the gold at $10,000 value. And some good or supply is produced, the monetary base should be proportionally increased by the value of the produced goods/services, while the value of gold mined during the same time is less than the value of the produced G/S (and it will always be less), we have to increase the value of the gold in relation to the currency. And thus we’ll have a constantly depreciating currency.

    Reply

  11. Rick

    I developed charts showing gold & oil divided by the M1 money supply for every year from 1968 on.

    The theory being that M1 to gold or oil prices over time should remain a constant. It turned out they are except both are declining by just under 2% per year compared to M1 growth probably to to increased productivity.

    It turns out that there has been a 28 year cycle that peaked in 1980 and appears to have peaked at about the same level above the mean in 2008 for oil and what appears to be a peak for gold in 2009. Gold has not quite turned negative as oil has but has stalled. Looks like a quadruple top on the charts for gold? Based on May 2009 M1 levels the mean value for gold would be about $430 and $37 for oil.

    I recall the 1979-1980 bubble in oil & gold and today’s market coditions look similar to me. I thought it was bubble back in 79-80.

    Expecations of runaway money growth are unrealistic for our economy (the beaurocrates know they would lose their jobs and therfore won’t do it!).

    Reply

  12. Mike

    Yes, there will be a gold bubble. But the gold bubble will not burst until well after the USDollar bubble bas burst. And that is the point.
    Inflation will come in the USDollar and it will Devalue. Confidence in the USDollar will be lost, people will initially switch to other currencies such as the Euro but as the Dollar crumbles, confidence will be lost in all currencies and funds will flow to gold. There will be a Gold Rush and capital will flow to mining. Gold will reach an absurd level and then, in the midst of a recovery, funds will switch to productive assets such as land and that is when the Gold Bubble will Burst.

    Reply

    Andrei Reply:

    Ummm… The problem is that there is no bubble in the U.S. dollar now.

    Reply

  13. Tom

    Gold has already reached what is historically an absurd level. I think it could continue to drift higher to around $1200, but it appears to be nearing a peak.

    Reply

    Andrei Reply:

    Actually, it can go a lot higher than $1,200. But farther it goes, deeper it will fall, when the bubble bursts. Though, currently I am not quite sure about the exact reason for burst.

    Reply

  14. Josh

    gold will climb to levels unimagined. government is killing the dollar….but the real story is rhodium. it dropped from 10,000 oz. to $800 oz. and now has begun its rapid recovery. now at 1900 oz. will climb again past 10,000. rhodium climbing faster…worth paying ridiculous kitco fees.

    Reply

    Andrei Reply:

    Is rhodium liquid (financially)? I’ve never though about it as an investment commodity…

    Reply

  15. Josh

    yes can be bought and sold through kitco pool acounts instantly. they hold it till your ready to sale back to them. it show buy and sell prices. wish i got in at $800. i got in at $1400 recently and paid $1700 with fees but its already past at $1850.

    Reply

  16. JOSH

    MAKE THAT $2400…KITCO SALE $2900 NOW IN A WEEK UP LIKE THAT.
    WILL IT CONTINUE???

    Reply

    Andrei Reply:

    Josh, no need to scream. Yes, it will probably continue for some time.

    Reply

  17. Rationalist

    I appreciate Andrei’s arguments, yes gold will probably go to 1500-1800 with all the hyperventing going on…then a fairly rapid descent to 700-900. I suppose a short at 1500-1800 would be a opportunity. Did everyone miss the $140 oil to $75 oil move? Gold is a big tinker toy that you can’t even heat the house or drive the car. The US has about 261.5 million ounces in the treasury, maybe they should unload some of it at these prices….

    Reply

  18. vico vico

    Sorry Andrei but you should really pull your head our of your ass and really read what AirGibson is trying to explain to you. I can tell you’re the type that hears but doesn’t listen.

    Reply

    admin Reply:

    Sure!

    Reply

  19. torben

    Just read this article. The date is 12th of May, 2011. The price for an ounce of gold in AU is $1401.04. AUS dollar is trading at $1.0695 with US $1. Gold is always good, in respect to buyingin it with the Bear. I have no formal education in Economics, but any twit can speculate with accuracy that gold will go up up UP with a retaliation terrorist attack looming. Not to mention the ammount of natural disasters screwing up civilization. The time is 8017 Gold Coast, Australia.

    Reply

    admin Reply:

    So, you believe that it’s still a good time to buy gold?

    Reply

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