Is gold’s rise just another bubble?
To answer that we have to look at not just the prevailing public mood but also at the valuation criteria for gold. Unfortunately, gold – like all other commodities – has no intrinsic value other than what demand there may be for it. As well, it generates no dividend, interest, income, etc. so we can’t use any number of fundamental approaches such as PE ratios and the like.
That leaves only two approaches in our arsenal: sentiment and technical analysis. From a sentiment point of view, it is difficult to claim that an asset is in a bubble when the general media proclaims it as so. It seems that every single month there is an article claiming that gold has been caught in a speculative frenzy and warning investors away from its seductive charms.
The above article from Money magazine is the kind of sentiment data that I like to use because it is geared towards a general audience of retail investors. But there are many similar articles, as a quick google search for “gold bubble” will attest. Even this blog has ventured into the fray more than a few times. So the fact that this question is being debated ad naseum goes towards falsifying the ‘bubble’ moniker.
A Form of Insanity
At the same time, it is undeniable that being long gold is becoming de rigueur not just on Wall Street but main street. I remember people ridiculing the very thought of owning gold just 10 years ago. In those days the sexy investment was shares in technology companies who’s business almost no one understood. Now, we have the advent of gold dispensing ATM’s and the rise of questionable companies like GoldLine preying on the general public’s growing interest.
As well, the rise of ETF’s has made owning gold as easy as owning stocks or bonds. While in 2005 just 16% of demand for gold came from investors with the rest being accounted for by industrial and jewelery demand, today investor demand is almost 40%.
A large number of investment professionals have also switched sides. A recent article by Lorimer Wilson of Munknee, identifies 122 investment advisors who have publicly stated their bullish convictions for gold and provided price targets between $2,500 and $15,000. The majority of those on Wilson’s have a target from $5,001 to $10,000. While Wilson believes this to be bullish, from a contrarian point of view, such wide acceptance and lofty expectations sets a stage for disappointment.
Then you have a recent interview with Robin Griffiths, a technical strategist at Cazenove Capital where he says that “not owning gold is a form of insanity” and those that insist on not being long have “masochistic tendencies”.
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While his rhetoric is colorfully bombastic, I can’t really disagree with him. Gold is still in a linear uptrend and it has yet to show a parabolic blowoff top. Contrast the current gold chart with that of the parabolic crude oil price in 2008.
For this and many other reasons, I continue to look at gold through a pragmatic lens. Taking a trading approach, it is at times a good buy and at times not. My suggestion to you as well is to not get drawn into the idiotic debate of whether it has intrinsic value, is money, should back money, etc. These are false questions and simply draw attention away from the real fact that it is a trading vehicle just like any. As I commented recently, the current trading range is hiding quite a bit of strength in gold.
One thing I will say is that we must also avoid the siren call of pessimists. Even if they have been correct lately. Experts like Nouriel Roubini who have gained a massive following by being correct in their dire predictions should not have our full time attention. A research report prepared by Jerker Denrell and Christina Fang looked at the macro economic predictions of 50 economists in the Wall Street Journal’s Survey of Economic Forecasts.
The found that those who made bold predictions that came true turned out to have very bad track records. That is, the price that they paid for accurately predicting rare and extreme events was that their other predictions for ‘every day’ events was worse off than the average for the group:
The people who successfully predict extreme events, and are duly garlanded with accolades, big book sales, and lucrative speaking engagements, don’t do so because their judgment is so sharp. They do it because it’s so bad.
So if you are continuing to hang on every word that comes from Nouriel Roubini or Nicholas Taleb, etc. you will be sadly disappointed. They are correct one in a black swan.
You can read the complete research report here: “Predicting the Next Big Thing: Success as a Signal of Poor Judgment“.
Speaking of bad predictions, a recent research paper,written based on earlier research methodologies pioneered by Didier Sornette, is predicting an upcoming crash in gold between April and May 2011.
Sornette’s work is based on finding ‘black swan’ events before they happen. The research looks at the gold market as well as the recent crude oil market. Readers of this blog may recall that I argued about oil being in a classic bubble just before it burst. While this is now quite evident in hindsight, at the time it was a contentious position to take.
In any case, the authors of the quantitative research report on gold conclude that “the collapse in gold prices (or the termination of their growth) is most likely to occur in late April – early May 2011.”
I don’t pretend to understand the math involved but from a humble technical analysis point of view I fail to see the same parabolic trend that was clear in crude oil and which is the key characteristic of all bubbles. The report does include this graph which is intended to highlight the parabolic nature of gold’s price rise:
But as you may have already noticed, it is using an arithmetic scale, rather than a logarithmic or semi-log scale. This is an important distinction because a bubble builds and eventually collapses as the slope itself increases. The existence of a persistent price increase is not enough to claim that gold is in a bubble.
Here is the full research report titled “Log-Periodic Oscillation Analysis Forecasts the Burst of the ‘Gold Bubble'”: