July 13, 2011

Gold – Is it a Bubble?

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 9:23 PM by Robert Barone

Is the price of gold too high?  Too low?  Is it in bubble territory, ready to drop rapidly?  Think about what bubbles are – you know there is a bubble when everyone is trying to participate.  For example, during the dot.com bubble, my tennis pro was buying and selling options several times per day!  I knew we were in a bubble.  I even told him so.  And, during the housing bubble, all of the chatter at cocktail parties was about flipping houses as a side business.  I knew we were in a bubble (just didn’t know how frothy it really was!)  People say to me all of the time when I talk about gold: “I would love to own gold, but its price is just too high.”  Hmm!  Too high relative to what?

The price of gold certainly can be fickle.  After all, unlike other commodities that are essential inputs into some vital process (e.g. the production of energy or food), besides some very minor industrial applications, gold really has few practical uses (jewelry and art excepted).  There is nothing intrinsic in gold to give it value.  There is no cash dividend or earnings.  It goes up and down in value at the whims of investor demand.

Gold does have three characteristics that make it unique: 1) it is rare and hard to find (all the world’s gold is estimated to fit into two Olympic sized swimming pools); 2) it doesn’t change form – all of the gold ever mined is still with us as gold; 3) it cannot be “produced” via the combination of other materials.  Thus, its supply is well defined and increases very slowly and at great expense.  Thus, it is perfect as a medium of exchange or a store of value.

We all know what makes the demand for gold go up – distrust in fiat currencies, and government deficits resulting in paper money printing.  And that, of course, is why gold is rising in value today.  As long as that goes on, the price of gold will keep on rising. So, what could happen to make it fall in value?  I have listed several things below which could happen – I will let you be the judge of their likelihood:

  • The U.S. and the rest of the developed world (Europe) stop running fiscal deficits and stop printing money.  There is an immediate opportunity for this to begin in the U.S. if the GOP and Obama Administration can agree on significant spending cutbacks.  This means entitlement reform.
  • The U.S. economy magically finds its feet and its growth rate increases such that the unemployment rate begins to rapidly fall without additional monetary or fiscal stimulus.  Interest rates would be rising too.
  • As a subset of the above, housing prices find their bottom and begin to rise with home sales and new home construction picking up.
  • The dollar reverses is slide as the premier world reserve currency and becomes demanded because of its intrinsic strength, not just because it is better than all of the other bad alternative currencies (e.g., the Euro). (This requires fiscal and monetary discipline and a reduction in both public and private debt loads.)

As long as gold is viewed as the ultimate monetary unit, its value will increase (decrease) with the debasement (strength) of the fiat currencies.

Robert Barone, Ph.D.

July 13, 2011

Robert Barone is a Principal and an Investment Advisor Representative of Ancora West Advisors LLC, Reno, NV, a SEC Registered Investment Advisor.The mention of gold, commodities, or similar investments in this article should not be considered a recommendation to sell or purchase any commodity or similar investments mentioned.  Please consult an investment professional on how the purchase or sale of such investments can be implemented to meet your particular investment objective or goals.   Investments in gold, commodities, and/or similar investments are subject to risks.  It is important to obtain information about and understand these risks prior to investing.


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