Six Myths of the "Gold Bubble"

Anyone calling gold a bubble is talking through their hat or worse. . .

YES, GROWTH IN global gold demand is rapid. No, another decade of quintupling prices isn't nailed on. But neither of those facts makes gold a "bubble" today.

In fact, people calling gold a bubble right now are talking through their hats—at best. Take these jokers, for instance, all holding forth in the last month.

Myth #1: "Gold Is a Crowded Trade"
The finance pages are packed with gold headlines, but actual investment levels remain low. In the early 1980s, private-bank clients were expected to hold 3% of their wealth in gold, many times the 0.5% allocation seen across the finance industry today. Even in the bullion market itself, three-quarters of the 500-plus analysts and traders attending last autumn's LBMA conference in Berlin said they held as little as nothing ("Between 0% and 10%") of their savings in precious metals. Saturation is a long way off.

Myth #2: "Gold Has Madly Rushed to $1,500 Without a Correction"
Compared with undeniable bubbles, gold's recent climb just isn't steep enough. Gold prices rose 70% for dollar investors in the last 3 years, but U.S. stocks rose 160% in that length of time in the 1920s, and Germany's Neuer Markt rose over 1600% starting in 1997. London's South Sea Bubble of 1720 rose ninefold in five months! What makes gold remarkable today is the longevity—not speed—of its bull market, which has delivered positive, inflation-beating returns to U.S. and UK savers every year since 2001.

Myth #3" "Gold Will Fall Hard When Interest Rates Rise"
Only if interest rates outpace inflation, and what are the chances of that? People turn to gold when cash—its major (and otherwise better) competitor as a store of wealth—loses value. Sub-zero real U.S. rates have already cost cash savers over 3% of their spending power in the last 18 months. Rates currently lag inflation by the widest margin since the summer of 1980. Back then, however, the cost of living was rising at double-digits and could not be talked away.

Myth #4: "Inflation Is Set to Fall Back"
How, exactly? The cost living is hurting earners, savers and seniors alike, but mostly because their incomes aren't growing. On the official data, the Consumer Price Index has risen barely 11% from five years ago, its weakest long-term rise since 1967. Anything lower, and QE3 looks certain, thanks to the Fed's anti-deflation fixation. If U.S. inflation is headed anywhere from here, it's not down.

Myth #5: "Gold's Not an Investment, Because It Doesn't Pay Interest"
A desperate claim that was true, at least it was a decade ago at $260, and true evermore unless an investment bank sells you a structured derivative. Gold's lack of income means it has no promises to break, setting it apart from all other asset classes—most notably debt. It's hard to accuse gold buyers of "over-optimism" (Charles Kindleberger's definition of bubble), but this market would only move into "irrational exuberance" (Robert Shiller's phrase) if it kept rising after monetary policy switched from weak to strong.

Myth #6: "Gold Will Burst When the World Economy Settles Down"
You've got to love that "when." But beyond its impact on policy rates, economic growth has little to do with gold prices. Gold fell vs. the dollar during the U.S. recessions of 1980 and 1990, only to triple during the go-go years of 2003–2007. In fact, across the last four decades, gold shows a negative but statistically insignificant correlation with quarterly U.S. GDP of -0.11 year-over-year. Quarterly GDP in China (the world's second-biggest buyers) shows a negligible 0.08 correlation since 2005. Rupee gold prices since 1996 show only a 0.32 correlation with Indian GDP.

People started saying gold was a bubble at $1,000 in early 2008, at $1,200 and $1,300 in 2009 and 2010, and now at $1,500 and above in 2011. Yet still nothing has changed to the core case for gold. If anything, the fundamental reasons for private savings going to buy gold have grown stronger.

Ultra-loose money is locked in by record peacetime debts and deficits. Central bank and private Asian gold buying continue to grow as economic power moves east. Everything else is just noise—the one excess to which gold investing is prone right now.

Adrian Ash
BullionVault

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Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK's leading financial advisory for private investors, Adrian Ash is the editor of Gold News and head of research at BullionVault—winner of the Queen's Award for Enterprise Innovation, 2009 and now backed by the World Gold Council market-development and research body—where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2011

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events—and must be verified elsewhere—should you choose to act on it.