Gold: Is it in a Bubble?
The interesting aspect of analysing the financial markets or for that matter the economy is that for every ten analysts (or economists) we invariably will have twenty different opinions. Spotting a bubble is always a very difficult thing, timing it right is a unique art that very few possess. Bubbles reinforce a brilliant observation by Keynes who wearily pointed out that ‘the markets can stay irrational for longer than you can stay solvent’.
The past couple of weeks have increased the number of people who are calling a bubble in Gold. Such has been the ‘noise’ that we have the mainstream media now taking a plunge. A recent spate of articles in The Wall Street Journal are very interesting. The writer quotes Warren Buffett who is stated to have observed sometime back “Gold gets dug out of the ground in Africa, or someplace, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head"
The past couple of weeks have increased the number of people who are calling a bubble in Gold. Such has been the ‘noise’ that we have the mainstream media now taking a plunge. A recent spate of articles in The Wall Street Journal are very interesting. The writer quotes Warren Buffett who is stated to have observed sometime back “Gold gets dug out of the ground in Africa, or someplace, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head"
Unfortunately, Warren Buffett does not live in the developing world and since he is a billionaire, he does not have to bother about accessing credit. Ask billions in the developing world, for them gold is money. Even a beggar can get raise money, if he can pledge gold in most of the developing world. I am sure the day is not far, when the Western world is probably going to be like that for the simple reason, that their own citizens will not trust their currency. Moreover, I really doubt an extremely savvy investor like Warren Buffett will actually tell Wall Street Journal about his personal holdings. The day Buffett defended Moody’s and Goldman, I think we should stop giving much credence to his objectivity.
A number of people may do well to try to remember what has been the best performing asset class in the past decade? Gold has returned 400%, and stocks (probably Buffett’s favourite asset class) have returned less than cash.
There are nonetheless, a number of important arguments that we may have to deal with as a number of other arguments deserve greater attention. The Wall Street Journal article itself raised two important points: (a) high levels of gold production accompanied by reduced demand for jewellery, and (b) the fact that gold cannot be used for anything except as a store of value. Both are valid arguments, but to a certain point. It has been pointed out that since 2002, total demand for gold for jewellery as well as other uses has declined to 22,500 tonnes from about 29,000 tonnes due to increased supply .
A number of people may do well to try to remember what has been the best performing asset class in the past decade? Gold has returned 400%, and stocks (probably Buffett’s favourite asset class) have returned less than cash.
There are nonetheless, a number of important arguments that we may have to deal with as a number of other arguments deserve greater attention. The Wall Street Journal article itself raised two important points: (a) high levels of gold production accompanied by reduced demand for jewellery, and (b) the fact that gold cannot be used for anything except as a store of value. Both are valid arguments, but to a certain point. It has been pointed out that since 2002, total demand for gold for jewellery as well as other uses has declined to 22,500 tonnes from about 29,000 tonnes due to increased supply .
Invariably the above statistics about gold are quite important and should in normal times be a major cause for concern. Reports indicate that there has been reduced demand in traditional consumers like India. However, these are hardly normal times.
It has been pointed out that all the gold mined in the world in human history can fit into four Olympic sized swimming pools. A number of observers claim that it is bad news, but on the contrary, I believe that is good news, probably it may be reason why for centuries people have fought and died to possess it. More importantly, in a recent article, the Financial Times pointed out that the current composition of gold in a person’s portfolio averages about 0.05%, with “investment herd” concurring with the views of the Buffett like claimants. Infact most of the people in the West hardly own any gold, and those who have investible surplus there are in such a state of paranoia that even if they were to move about 5% of the their total cash holdings into gold, it would lead to the price shooting up. Despite all the claims, the Commodity markets are quite shallow when it comes to their ability to absorb huge amounts of cash. It has been pointed out that in 2009 about US$190 billion of new cash went into commodities and the result: most of them shot up by about 100% from their lows.
It has been pointed out that all the gold mined in the world in human history can fit into four Olympic sized swimming pools. A number of observers claim that it is bad news, but on the contrary, I believe that is good news, probably it may be reason why for centuries people have fought and died to possess it. More importantly, in a recent article, the Financial Times pointed out that the current composition of gold in a person’s portfolio averages about 0.05%, with “investment herd” concurring with the views of the Buffett like claimants. Infact most of the people in the West hardly own any gold, and those who have investible surplus there are in such a state of paranoia that even if they were to move about 5% of the their total cash holdings into gold, it would lead to the price shooting up. Despite all the claims, the Commodity markets are quite shallow when it comes to their ability to absorb huge amounts of cash. It has been pointed out that in 2009 about US$190 billion of new cash went into commodities and the result: most of them shot up by about 100% from their lows.
The Wall Street Journal articles cited above had a very interesting chart (given below). If history were to repeat then Gold will have a long way to go when compared to traditional bubbles.
I am personally bullish on gold in the long-term as I have been for the past few years. By long-term the time horizon is over a period of 3-5 years. That reasoning is based on two critical factors. One, is the Sovereign Debt Crisis, which is likely to morph into a currency crisis, sooner rather than later and, two the consequences of millions of people buying a few grams in the third world and in Western world by a few ounces.
The sovereign debt crisis is far from over, on the contrary the worst phase seems to be just about getting underway. It has been pointed out by David Rosenberg, that the global liabilities (private sector as well as public sector) stand at nearly US$220 trillions, about four times the global GDP. These excess need to be washed out. The nature of capitalism and the process of financialisation will mean that this debt will not totally disappear. I assume that the world needs to get rid of at least one-third of the outstanding (if not half) if there has to be a meaningful return to a bull market. This is not to mean that people and companies have no money. Those who have are not willing to spend it, those who need it are not able to get it. That is the inherent nature of the banking system. The age old description of a banker is apt for the present situation. A banker is one who lends you an umbrella when it is not raining and demands it back when it starts to rain.
It is likely to end when there are debt write offs (or defaults on an biblical proportions). However, before we get there, Gold is likely to rise further. But asset prices do not move in straight lines. The sovereign debt crisis will be no different. We are bound to have phases when the policy makers will invariably take up measures that would be provide some hope to investors and speculators. There will be periodic bouts of buying and selling frenzies in the asset markets.
More importantly, the economy is likely to go into a grinding downward move over the next few years – remember Japan. Every year we will witness people who will be excited about a possible recovery and there a slight improvement in the risk appetite. If history is a guide, these hopes will be dashed to the ground, leading to ever larger convulsions in the financial markets. There are a number of events that could trigger a major buying frenzy in gold, including a BP bankruptcy, geo-political tensions, etc. There are sufficient number of innumerable risks that the world faces at this point of time and this is not likely to change in the near future. If the Republicans come to power in the USA in 2012 then we are likely to see another war, this time with Iran. The list is literally endless. But, there is no need to be carried away by such things at the present juncture.
If there are two asset classes that investors are under-exposed then it is Bonds and Gold. Since investors are sceptical, and rightly so, that would leave them with only two alternatives – Gold and its poor cousin, Silver. Both these are likely to witness consistent gradual investment buying, especially in the Western Countries. As far as the Eastern Countries are concerned, it would be a fallacy to think that gold buying will reduce dramatically, considering its solid grounding in the soico-cultural ethos, especially in India. Moreover the collapse of the other investment favourite of Indian (buying land) it is likely that gold will retain its attraction. Millions of Indian get married every year and millions of kids are born every year. In each of those social occasions (even for the poorest of the poor) gifting gold (in whatever form) is a centuries old tradition, which will not only disappear but would instead regain the centre stage because of the rising prices.
Risks:
However, it is imperative to note that spotting a bubble is not only very difficult but is invariably accompanied by multiple risks. Gold is no different. The biggest risk is the gradually running out of the gold de-hedging by Gold Mining companies. It has been pointed out that gold mining companies break-even when they are able to sell at prices from US$400-600 (varies from company to company). It is likely that after a substantial run up in prices, companies are likely to want to protect at least some of their margins and hence, they are likely to re-start hedging their production, though this is only an assumption. The assumption is based on my thinking that as the cost of capital increases because the growing problems of the banking sector, companies would probably find it more profitable to hedge a part of their protection.
When to Invest in Gold?
I really wish I could time the market perfectly and knew the correct answer, because if I could do it consistently well, then I would be a billionaire many times over. But a look at the long-term charts are quite instructive. The long term chart (see the Kagi chart below from 1997 to present) seems to indicate a substantial correction because we find negative divergences building up. However, it is pertinent to note that the 200 day EMA stands at about 1100 and the 500 day EMA stands at 996.
The sovereign debt crisis is far from over, on the contrary the worst phase seems to be just about getting underway. It has been pointed out by David Rosenberg, that the global liabilities (private sector as well as public sector) stand at nearly US$220 trillions, about four times the global GDP. These excess need to be washed out. The nature of capitalism and the process of financialisation will mean that this debt will not totally disappear. I assume that the world needs to get rid of at least one-third of the outstanding (if not half) if there has to be a meaningful return to a bull market. This is not to mean that people and companies have no money. Those who have are not willing to spend it, those who need it are not able to get it. That is the inherent nature of the banking system. The age old description of a banker is apt for the present situation. A banker is one who lends you an umbrella when it is not raining and demands it back when it starts to rain.
It is likely to end when there are debt write offs (or defaults on an biblical proportions). However, before we get there, Gold is likely to rise further. But asset prices do not move in straight lines. The sovereign debt crisis will be no different. We are bound to have phases when the policy makers will invariably take up measures that would be provide some hope to investors and speculators. There will be periodic bouts of buying and selling frenzies in the asset markets.
More importantly, the economy is likely to go into a grinding downward move over the next few years – remember Japan. Every year we will witness people who will be excited about a possible recovery and there a slight improvement in the risk appetite. If history is a guide, these hopes will be dashed to the ground, leading to ever larger convulsions in the financial markets. There are a number of events that could trigger a major buying frenzy in gold, including a BP bankruptcy, geo-political tensions, etc. There are sufficient number of innumerable risks that the world faces at this point of time and this is not likely to change in the near future. If the Republicans come to power in the USA in 2012 then we are likely to see another war, this time with Iran. The list is literally endless. But, there is no need to be carried away by such things at the present juncture.
If there are two asset classes that investors are under-exposed then it is Bonds and Gold. Since investors are sceptical, and rightly so, that would leave them with only two alternatives – Gold and its poor cousin, Silver. Both these are likely to witness consistent gradual investment buying, especially in the Western Countries. As far as the Eastern Countries are concerned, it would be a fallacy to think that gold buying will reduce dramatically, considering its solid grounding in the soico-cultural ethos, especially in India. Moreover the collapse of the other investment favourite of Indian (buying land) it is likely that gold will retain its attraction. Millions of Indian get married every year and millions of kids are born every year. In each of those social occasions (even for the poorest of the poor) gifting gold (in whatever form) is a centuries old tradition, which will not only disappear but would instead regain the centre stage because of the rising prices.
Risks:
However, it is imperative to note that spotting a bubble is not only very difficult but is invariably accompanied by multiple risks. Gold is no different. The biggest risk is the gradually running out of the gold de-hedging by Gold Mining companies. It has been pointed out that gold mining companies break-even when they are able to sell at prices from US$400-600 (varies from company to company). It is likely that after a substantial run up in prices, companies are likely to want to protect at least some of their margins and hence, they are likely to re-start hedging their production, though this is only an assumption. The assumption is based on my thinking that as the cost of capital increases because the growing problems of the banking sector, companies would probably find it more profitable to hedge a part of their protection.
When to Invest in Gold?
I really wish I could time the market perfectly and knew the correct answer, because if I could do it consistently well, then I would be a billionaire many times over. But a look at the long-term charts are quite instructive. The long term chart (see the Kagi chart below from 1997 to present) seems to indicate a substantial correction because we find negative divergences building up. However, it is pertinent to note that the 200 day EMA stands at about 1100 and the 500 day EMA stands at 996.
Thus as long as gold stays above those levels, technically gold is deemed to be in an uptrend – one of the few commodities that still continue to remain in an uptrend. Speculators are best advised to avoid gold if it moves below 1000 as it has the potential to fall to 800 (worst case scenario).
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