Do we see a gold bubble?

In times where within less than a generation humankind has seen several asset bubbles come and go (Japan’s real estate and stock market bubbles, the tiger states, the Dotcom bubble and now housing in the US, but equally e.g. in Spain and elsewhere plus one brewing in China and maybe one again in the US) and still left standing albeit on feet of clay,  the recent rallies in gold obviously beg the question if we not only see another bubble, this time in gold. The argument seems to rest on the assumption that any price change with a certain gradient above “what feels right” must be unjustified.

(See more statistical material in our References section!)

To cut a long story short, CrisisMaven believes: no, there’s no gold bubble, he believes the gold “price” has natural causes that can be explained on other merits than just more irrational exuberance. For that I have already tried to lay the theoretical groundwork, albeit still in its nascent state and still to be expanded further:

As I have argued in “What’s wrong with Economics?real bubbles (as against any kind of price hikes in general) tend to be in assets, not in commodities:

“Sometimes it’s commodities as well, however, speculation in these is different – you need to eventually sell or use them up or you lose out in the long run. So there’s maybe speculation in commodities, but real bubbles will be in assets, …
Now, paintings aside, most assets are bought for the “services” they render, e.g. as a return on investment: bonds and shares pay dividends, real estate pays rent or its equivalent in “rent saved” when owner-occupied. That is the reason they exist, to be of use as an investment with a purpose.”

Even the “tulipmania” in the Netherlands was an asset bubble – like factories or other investment goods, tulips were meant to be planted and later produce tulip plants to be harvested or gloated over, like paintings bought with bonuses. Its origin was a widening demand for tulip flowers that turned into madness and only in its later stages it developed the typical traits of any speculative asset bubble: bulbs were bought to be “flipped” like houses or the dotcom stocks. And it even came with the same pattern of moral hazard of an unwarranted bailout mechanism: “The high prices may also have been driven by expectations of a parliamentary decree that contracts could be voided for a small cost—thus lowering the risk to buyers.”

Undeniably there is such a thing as gold speculation, as much as there is always e.g. wheat, oil, copper or pork belly speculation. I’ve also already argued the obvious, man’s life is nothing but a chain of speculations, from the trivial (“if I buy her that valentine, will she kiss me?”) to the most complicated mark-to-myth models which are nothing but a means to get a testosterone-laden yuppie enough of a bonus to blow it on an even bigger valentine …

You see: you can have a glut in houses that have been built due to every beggar getting a loan with no down payment. You can have overshooting stock prices if people not only shift money from their savings accounts into stocks but then begin to borrow against them and set off a vicious cycle. Then, when a real estate bubble bursts, the houses are seen in a more sober light, everyone notices that they pay less rent than would be required to square with interest rates for equally “secure” investments which then brings their prices back in line with generally accepted and expected profitability levels in a society. And that is happening now, albeit distorted by further subsidies that push off the final day of reckoning. In stocks, everyone eventually comes to their senses and sees that price/earnings ratios are way beyond what compares with e.g. interest levels on well rated mortgages and back down those prices come. But with gold (there is an ongoing controversy where George Soros has weighed in amongst others)? No one bought it for its propensity to yield interest in the first place so it can’t be affected by any change in returns on other assets. And no one in his or her right mind should have bought money against credit so any credit squeeze or margin call would not disturb their sleep at night.

What clouds the issue here is, is that gold has two uses (apart from some direct use in dentistry and electronics that don’t count for much):

  • as (a) money (substitute) and
  • as raw material for jewellery.

The latter is a collector’s item, much as paintings are with which I dealt briefly in “What’s wrong with Economics?” also. Ancient gold coins are also collectors items, not assets, while modern coins such as the Krueger Rand, the silver dollar,  the Canada Maple Leaf are money and usually trade for a certain but modest mark-up a large part of it is due the extra cost of minting, quality assurance, handling etc.

When you look at jewellery, that could be classed as an asset along with paintings or antique furniture but its external value (e.g. price per ounce) at the time is always much, much higher than its gold contents would warrant. In fact, as all of you might have learned to their grief when trading in their wedding ring after a successful divorce, gold in the form of jewellery is like a house that needs to make room for another: the proceeds from the sale of undeveloped land would be higher by the amount required for the obsolete building’s demolition. When bringing jewellery to the smelter you also have to deduct the overhead required for parting work plus the time elapsed (= interest foregone) between bringing the object there and receiving sterling gold back.

To carry the analogies even further: in time of need people will sometimes bring their jewellery to the smelter before they go hungry although they realise the enormous loss that entails. Equally so people have been known to use their furniture as firewood, yet in both cases, or even if they did that with their cherished paintings, it would be because they had no better options.

Here’s a litmus test or rule of thumb to decide if an item is rather (a) money (substitute) or an asset: would you rather spend (exchange) it directly for another object you desire, as you are accustomed to with money, and with money only, or would you, given the choice, rather pawn it only to be redeemed later?

Only people who do not yet know the character of money as solely a means of exchange would do otherwise: during the Great Irish Famine some counties laid on public works projects for the starving farmers through which some of them for the first time in their lives earned real banknotes they had never seen nor used before. All they knew was that these pieces of paper had tremendous value but they didn’t, strange as it may sound today where school kids have credit cards (and, may I add, again don’t seem to understand money …) know how to buy with them or how to save them by opening a bank account. So they brought them to the pawn shop! Historians have unearthed several pawn slips from the archives where these illiterate peasants had been given a fraction for their pawned twenty-pound notes only to sometimes not be able … can you believe that … pay ’em back and have their pawn forfeited.

Oh, how much cleverer are we all today in light of a “General Theory”! And still gold puzzles us, when it’s price falls everyone proclaims the end of gold, when it rises considerably it’s a comeback to some (as if it had been in an infirmary in between booms) and to others a bubble.

Now, let’s for a moment assume , since gold can act as money, we give it a currency name, say, the “bollar” or the “mollar”. How convincing would we find talk about a “bollar bubble”, in fact, to generalise, we would coin the phrase “foreign exchange bubble”, a rather unheard of thing. Up to a minute ago I could have sworn that Google would return a complete blank for that expression, but not quite: there are 22 (twenty-two) hits for “foreign exchange bubble” (with the “exact phrase” option of course). But still, look up “housing bubble” (equally in quotes) and you get about 1,310,000 results (and counting no doubt), so that’s a ratio of 0,00169231% or almost sixty thousand as many hits for the latter, so still that’s quite some evidence one doesn’t easily dub rising exchange rates a “currency boom” even outside the realm of academe.

[For epistemological reasons let me stress right here that I tend to see economics as a logical science which, to be practical, should make predictions that are useful and can guide one’s decisions, but which need to be derived through deduction rather than tests through physical proof and from mathematical “models”. Therefore, strictly speaking, comparing the frequency of a term in a search engine is of course no “proof” of the real existence (or absence) of the underlying real-world phenomenon, why, some company or rock band might even call itself the “foreign exchange bubble” an I’d get a billion hits …]

The whole argument hinges on the question if gold is a kind of money and chases goods or if goods chase money. While one can engage in foreign exchange arbitrage and call that (as any other entrepreneurial activity) speculation, but like anticipating or hedging against commodity price swings their nature is entirely different from asset bubbles.

But then why would gold rise (or other currencies relatively fall against it) but not prices in general? Don’t in these hyperinflationary times the “contrarians” always argue just that and try to make us believe those effects are “just around the corner” or are “already here”?

For that, as in prudent economics, there is also a simple explanation: people do not, I repeat myself, speculate in commodities in the same way as they speculate in assets such as shares or houses where one bids up the other and so forth.

When people are desperate to get rid of their money in inflationary times and buy tangibles “no matter what” like they recently did in Venezuela, they do not speculate in, for example, electric heaters or radios or TV sets all of a sudden. Had they planned to become radio wholesalers all of a sudden they could surely have picked a better moment. No, when inflation strikes and people go on such buying binges, they do not expect the value, the real price of their radios to go up tomorrow, all they hope (and even that is in vain!) to hold in their hand a store of value by which tomorrow they hope to  still get no more than the fair value of a radio, only that the nominal value has risen due to price inflation and thus the tangible radio is the hedge against the debased paper currency. In fact, they get even less than the normal real price, because all of a sudden everyone has a spare radio he/she wants to trade which drives down the real price (as against the still increasing nominal price) of any radio for hundreds of miles around.

But if radios are, as we’ve discussed, already a bad store of value, they’re an even worse means of exchange. So when people begin to hoard appliances it is out of sheer desperation. And as with most such items they are subject to fashion trends. Yesterday’s Blackberry is tomorrow’s iPhone, so to speak.

So, when people have time and the resources and some spare (paper) money they look for a general means of exchange which will still keep its value also in times of (anticipated) price inflation (there’s no denying we already have money inflation unless we talk to people who didn’t learn their tables or, as mathematical economists, may have forgotten them) and down the ages they’ve always settled for gold.

So is gold “overpriced”, bubble theory pricked or not?

Certainly not, and that’s equally an easy rule of three: There have so far been about 161,000 tons of gold mined in the entire human history. With 6 to 8 milliards (Br.) resp. billion (Am.) people living on the earth that would mean about 20 to 25 grams or roughly one troy ounce of gold per capita. The US Fed has recently one way or another created a few trillion (Am., billion in original British English) fresh US Dollars. Let’s say, the whole world wanted to go back to a gold standard. Let’s assume, of the 161,000 tons ever mined there were about 60,000 tons available either already in central bank’s vaults or for sale on the market for that purpose. Let’s say the per capita amount of gold would be equal across all countries then with six billion people and sixty billion grams of “free” gold for money purposes and with about 300 million dollar “inhabitants”, i.e. counting not only the US population but also the people in dollarised nations such as Ecuador, Zimbabwe (back to the roots, I say) etc., then that would mean a share of 3,000,000,000 or three billion grams of gold (or 107,142,857 = 107 million ounces) for the US Fed to hold against its circulating US Dollars.

Currently the Fed has issued over two trillion US Dollars:

Amount of US Dollars "in circulation" 1913 - present

Amount of US Dollars "in circulation" 1913 - present

So to get back onto a meaningful gold standard divide 2 trillion US Dollars by 107 million troy ounces and you get (sit down) to get 18,691.5 (almost eighteenthousandandsevenhundred US Dollars per ounce). With a gold price currently (2010-01-22) currently at around 1,100 US Dollars

New York Gold Fixing (

Live Gold Fixing New York

P.S.: CrisisMaven is no gold bug. In fact, he owns not a shred of gold with the exception of his inlays; rather he invests everything into that mass between his ears which, after all, is  the only thing he sees a chance of taking across borders with him should the need arise and the exudations of which he hopes to exchange for his daily bread should some Roosevellian double-speak spin doctor once again get the idea that gold is bad for you.

What’s wrong with Economics?

  1. Michael
    2010-10-30 at 16:48

    Hi everyone
    I am Michael Davis ………….
    I read this forum and is really very interesting…………
    Its really very awesome………..
    Thanks CrisisMaven for leaving your comments and link to your blog on my blog for my readers.


    Cash For Gold Colchester

  2. 2010-03-19 at 12:03

    Jim Roger’s Blog – dated November 2009

    Bloomberg March 6, 2010

    On My Watch…The writings of SamHenry

  3. 2010-03-19 at 11:46

    I meant to place you on my blogroll.

  4. 2010-03-19 at 11:44

    I believe we will. Some predictions take gold to a 2,000 level but you have to be careful. Something could take it much lower. If you get into gold at a level about usual norms, you should watch it carefully. I would also see if it stabilizes at that level for a few months.

  5. 2010-03-07 at 21:57

    I wanted to say that I was impressed with the calculations, but I’m not very convinced that gold will be money anytime soon. In my own blog, I wrote a “creative response:” it treads down a similar path but concludes that the remonetization premium in gold is well below what par would be. The market puts an 8-16% chance of gold being remonetized using my assumptions and figures. It’s not far above the discount that bonds issued by a recently-deposed government trade at.

    If y’all are interested, I spell out my line of reasoning here:

    One more thing, for Crisis Maven particularly: I added your blog to my blogroll. You’ve now been pegged as a “gold and gold-related blog” over at my own. Thanks for the read, and for your own comment on mine.

    • 2010-03-07 at 22:13

      Thanks, Daniel – I found your blog fascinating … and I’m not finished reading 🙂 .
      I put you on my blog roll too: The Gold Bubble – Watching the Gold Market ascend to its Crescendo. Let’s together watch how things are playing out – I am still not fully convinced that the market signals are to betrusted since central banks have a history of manipulating the gold market. On the other hand, if I call them “oafs” in one post I wonder how they can get the gold market under control but fail to interpret a bubble (or is that a “front” too?)? We live in breathtaking times for sure.

  6. Nieel
    2010-02-12 at 12:57

    If you personally like commodities go for wheat and soya.
    I do not think people are ever gonna stop eating, unless we pass a law against obesity. lol

  7. Nieel
    2010-02-12 at 12:54

    I definitely think gold is a bubble, a big one in fact.
    Buying gold is like stashing you cash under your mattress because you think someone is going to rob the bank.
    Its an asset that does not “grow” or give out dividends.Its price is mostly tied up to demand, and the only reason people buy gold so much is because its safe in times of economic uncertainties.
    Investors’ butt a*****e are still sore from the credit crunch and find a safe haven in gold.
    But once the markets start to rally people are going to start to sell off gold and we are going to get a mad rush towards equities, exposing the the true price of gold.
    So if you ask me to buy gold “now” I will have to answer: no fckin way!!
    We will always use gold to trim out the risk that is intrinsic to any equity but its no good on the long term for personal investors.
    In fact if you are speculating that it will rise again, I might answer like the magic eightball : “outlook so so”

    But on a long term 1-5 years : “Definitely no”

    If you cannot see that the bubble is reaching its peak at £1000 then we clearly tackle economics differently.

    • 2010-02-12 at 13:56

      “we clearly tackle economics differently” – well, in the end, it all tackles us, and why don’t we just wait and see?

  8. Rob
    2010-02-06 at 02:22

    Thanks CrisisMaven for leaving your comments and link to your blog on my blog for my readers.

    Keep up the fight!

    Rob Shampine
    Financial Advisor, Investment Advisor

  9. Justizia
    2010-02-01 at 02:04

    In the end Gold will be the ultimate bubble at all, but not in Gold itself. The ultimate Gold bubble identifies all bubbles at all. When the ultimate price bubble is being burst, then new prices will be fixed at the market by human action and their needs.

  10. 2010-01-29 at 02:23

    I saw your comment over on my site and apologize for the late reply. I can’t agree more with your article. Pullback? sure very possible and healthy but long term with all our current problems I think we are a ways off before we can start screaming Gold bubble.

  11. outtanames999
    2010-01-28 at 16:35

    Gold is obviously a bubble that will soon crash. Everyboyd but the goldbug can see this. If in the unlikely scenario that it doesn’t crash from pure economic factors, then it will crash due merely to greed, fraud and avarice in the gold markets.

    Gold is an most certainly asset, not a commodity. While it occurs in the world in some cases as a commodity, its current value is not driven by its commodity uses – jewelry, electronics, medicine. Its current value is driven purely by speculation that the future value of other things (like the dollar) will be lower. So the value of gold is merely a proxy for the value of other things. It is little more than an economic indicator (like the Vix or the Dow Jones) or a thermometer. Its value is not derived from its inherent value as a commodity. It didn’t go up because everybody is buying gold jewelry or because manufacturers are gobbling up gold to put into circuit boards.

    What will trigger a crash in gold? The exposure of the fraud behind gold investing. What is the fraud? That there ain’t no gold thar where you thunk it was – namely in the third party vault to whom you entrusted your gold. When it’s found out that the gold’s gone, the jig will be up. You have been informed and you have been forewarned.

    Oh and by the way, gold is completely useless as a substitute for money (currency).

    • 2010-01-28 at 18:49

      outtanames999 – Thanks for your forceful argument – I was hoping this would start a discussion.
      Gold as an asset – by most textbook definitions you’re right, in so far as a balance sheet is made up of “assets and liabilities“. Even a carpet that’s not been written down completely in that regard counts as an asset. These are all “fine points”.
      In the definition I employed I termed an asset what has the propensity to create “surplus value” by itself, e.g. a rent-paying house, a dividend-paying share or a bond. Commodity on the other hand I termed anything that had its industrial use such as oil or copper or else in more general terms was used in greater quantities in the production of something, like wheat in the production of bread. Since such commodities pay no dividend they are normally not stored for longer and in higher quantities than is absolutely necessary – what would be called (optimised) base stock in business administration textbooks. Quite to the contrary it makes no sense to turn over an asset such as a bond, rather one holds on to it to get the benefit of interest accrued and ultimately paid.

      The moment you begin to hoard a commodity over and above that base stock the interest on capital locked up will begin to eat into your profits. Such “opportunity costs” tend to drive any market participant towards high turnover in commodities while turnover of assets tends to be rather slow, unless there’s a bubble and people begin to “flip” (houses).

      Gold is unique in the sense that it is all three: a commodity (in jewellery and in electronics for example) and an asset (e.g. for the goldsmiths and later the banks issuing notes against their gold stock) and … money.

      The latter is proven by the simple fact that wherever you go in the world if you offer a gold coin in exchange for a good if you shouldn’t have a banknote with you) you ill hardly ever be turned down, but try that with a barrel of crude …

      Alas, whether golds current price is not driven by its commodity uses is, as I believe, hard to determine: if someone chooses to now buy a gold ring for his wife he obviously is quite content with where the price for it is, and to the jeweller gold is a commodity, an area where we are in agreement.

      Now begins the territory of contention: the Austrian school holds forth that anything that acts as money first and foremost has to be a (valuable) commodity and if it then “on top of it” has certain properties that make it practical to use as money, then, and only then, will it eventually become a money. The moment that transmogrification took place it indeed becomes very hard to disentangle the asset, commodity and oney side as well the true cause of its price at any moment. Just as a share rises the moment it gets included into a major index so did gold’s when it was elected as money during the course of history.

      now you are alleging that the gold isn’t there where people think they have it stored for them. While there’s no denying such fraud happens, I believe that most gold “bugs” re aware of that risk and thus choose wisely as to whom they trust. Such a gold store should be in a country, e.g. Switzerland th rule of law and should be audited (unlike the Fed whose money you seem to trust more than gold) by third parties, esp. accredited auditors. plus many, many who now buy gold actually take delivery of the physical gold and if they haven’t been had it’s there for them to inspect.

    • 2010-01-29 at 06:12

      Outtanames999- I’m not going to touch on your whole argument I think crisimaven already has but on your point that the gold is gone or a fraud is actually an argument for an explosion in the price of gold. If people realize there is less gold out there than alluded to people will freak – demand physical delivery and just generally buy. All putting upward pressure on price.

  12. 2010-01-28 at 13:31

    Another perspective on the “gold bubble question”:

    Bubbles are – without exception – the result of greed or, in more friendly terms, the desire to increase wealth. In case of the gold price, the key driver is fear or, in other words, the desire to avoid a loss in wealth. This is a fundamental difference.

    The gold price will fall significantly only if and when the reasons that created the above mentioned fear will have been eliminated for good. In other words: Any “exaggeration” in the gold price will end as soon as the excesses in fiat money have come to an end. The funny thing is: Should this really happen one day, any speculation in gold will end – but the gold price will nevertheless remain high or even climb further for fundamental reasons.

    • 2010-01-28 at 15:30

      I appreciate your clarity of style and vision! Exactly, it doesn’t matter in the last analysis at what “price” gold will be fixed to a currency unit in some hopefully not so distant future – from then on forward the dragon is dead, but only then.

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