Gold Bubble? Is There Currently One - I Don't Think So

By: Ian Campbell | Mon, Apr 4, 2011
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An article written by Frank Holmes, CEO and Chief Investment Officer of U.S. Global Investors, is in my view well worth reading. Titled, 'The Bedrock of the Gold Bull Rally' - reading time 7 minutes - Holmes' article principally addresses (with underlying supporting charts) the reasons he does not believe gold to be 'in a bubble' from a price perspective. This article has been edited, abridged, reformatted - and from my perspective expanded - by Lorimer Wilson of Wilson has added15 hyperlinks to support comments made by Holmes in his article, and in support of other commentary Wilson makes. Wilson titles his article 'Economic Environment Suggests Gold Not In A Bubble' - reading time also 7 minutes.

Holmes in his article, written in the aftermath of what he saw from his participation in a recent Bloomberg webcast, says he "was struck" by the negativity of some of the webcast participants with respect to the gold market. He then goes on to describe research done by Rodney Sullivan (co-editor of CFA Digest) who Holmes says discovered "three key patterns in the 47 major financial bubbles" going back to the seventeenth century. In shortened form, these are (1) financial innovation, (2) investor exuberance with respect to that financial innovation, and (3) resultant speculative leverage. I assume that one could substitute 'technological innovation' for 'financial innovation'. In any event, like Holmes, from my vantage point I don't see anything about the trend price of physical gold that currently comes close to meeting these three criteria. In fact, as I see things the price of physical gold at any given point in time does nothing but react positively or negatively to its surrounding events. In the past decade I believe many of the uncertainties created by world and country specific events that have occurred and continue to occur can be argued to broadly fall into the three part pattern described. These events, external to gold, include (1) movement of U.S. manufacturing jobs offshore, with the resultant contribution to the build-up of cumulative net trade deficits by the U.S. and build-up of U.S.$ holdings by a number of its trading partners, (2) the massive borrowing against their houses by U.S. homeowners between 2000 - 2007 that lead to the U.S. sub-prime crisis, and (3) not unimportantly, the widely disparate relationship in wealth held by American residents that has evolved over the past two decades in particular.

As I see things, physical gold is inert, and at least in the financial markets price it at any given point in time based on broadly held financial constructs and risk perceptions. Addressing the question of 'is gold in a bubble', I am continuously taken by what I see is the inconsistency of many financial market advisors who take the position that 'the market has priced it in' when that is convenient and suits their purposes. If that indeed is a 'true maxim', then any 'point in time' price of gold ought to reflect whether or not gold then is in a bubble. Fairness dictates that as a practical matter I have always been at odds with the belief the financial markets are omnipotent, and always 'price everything in'.

Wilson in his article discusses Holmes article, and what I take to be some of his own views or the views of others under eleven headings, being:

  1. Standard Deviation Move of Gold Remains Low!;
  2. Private Ownership of Gold Remains Low!;
  3. Gold as a Percentage of Global Financial Assets is Low!;
  4. Institutional Investments in Gold are Low!;
  5. Lower U.S. Dollar Will Mean Higher Gold Price!;
  6. Higher Inflation Will Mean Higher Gold Price!;
  7. Low Interest Rates Mean High Gold Price!;
  8. Rising Developing Countries' Affluence Means Higher Gold Price!;
  9. Money Supply Growth Means Higher Gold Price!;
  10. High U.S. Federal Deficit Means Higher Gold Price!;
  11. How Much Higher Will Gold (and Silver) Prices Go!?

Of these eleven topics, as I read the two articles, Holmes directly addressed #2, #3, and #4. As I read Holmes article Holmes addressed some of the other topics in a more oblique way than Wilson's headings imply. Therefore I recommend that if you hold or are considering holding physical gold or gold exploration or producer company shares that you read the Holmes article first, then read the Wilson article, and then think carefully about what each says and reach your own conclusions. As previously noted, Wilson's article includes a number of useful links.

Holmes concludes at the end of his article that "we believe gold could double over the next five years". In a nutshell I don't believe gold is 'in a bubble', but rather its price is something that reacts to world economic and economic-related (military, societal disruption, etc.) events. That said, I continue to believe that to predict a given price or price range for gold (or silver) largely is meaningless, given that the gold (and to some degree the silver) price is affected by world events that fall into the categories of 'predictable' (e.g. the U.S. is going to run consistent trade deficits going forward for some long time, and may never reverse them), 'somewhat predictable' (e.g. the U.S. housing and unemployment are not going to improve significantly in the next few years); and 'unpredictable' (e.g. events like the Japanese earthquake). However, I do believe it is sensible to discuss the price trend of gold, which I believe on the balance of probabilities will be up.



Ian Campbell

Author: Ian Campbell

Ian R. Campbell, FCA, FCBV
Business Transition Simplified

Through his website and his Business Transition & Valuation Review newsletter Ian R. Campbell shares his perspectives on business transition, business valuation and world economic and financial markets influences on those two topics. A recognized business valuation and transition authority, he founded Toronto based Campbell Valuation Partners Limited (1976). He currently is working to bring his business valuation and transition experience to both business owners and their advisors in our new economic, business and financial markets normal.

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