Tuesday, August 23, 2011

Gold bubble?

Take a look at a 1 year gold price chart in USD.

As you can see the price of gold is going parabolical and this, in fact, is a proof of a bubble forming especially considering we don't have hyperinflation in US. If you don't believe me take a look at the following two charts - first is a yearly price of silver where you can see a decent correction after parabolical rise. The second chart displays Nasdaq index during the famous dot.com boom in the beginning of the current century.

And here's Nasdaq

The most difficult question with all bubbles is this - will we see even higher prices or are we heading for a top. Since this is impossible to answer, I would recommend the following. Set a target price for your investment which for you is fundamentally justified for some reason. When this price level is achieved, sell and be happy that you made profit. Even if the price does goes up after you sold this is all speculative and it might as well go down and eat your profits.

The price of gold will come down at some point. The question is how far can it fly. What is your target price for gold?


  1. Great post Allan!

    I do agree with you on the notion that gold is more expensive than it's intrinsic value is. However, I do not agree with you on the reasoning behind that argument.

    Saying that "gold will come down", because both NASDAQ and silver once did is like argumenting that a drunkard starting to drive home from a party will definitely make a crash just because a few drunkards have done exactly this in the past. Well, he might get home safe, just as I'm sure that there are also a lot of examples of prices with parabolic rises which did not burst. In addition to that, you are giving examples of NASDAQs 10-year period and silver's 10-months period - hardly a comparable base..

    However, like I said, I believe that gold is overpriced. The metal just does not have intrinsic value to justify that price. Well, yes, gold has been used as a money substitute for years but I cannot see the reason why does it necessarily have to be this way forever. But I digress.

    As far as I can see, the price of gold will indeed go up until the sky over the world economy starts to clear. At that point we have a moment when there is unprecedented amount of people (and entities ets) who own gold and sooner or later want to monetize it to buy things they actually need. The problem is, there will be pretty much nobody buying the gold. And in addition to that, there will be some countries who keep *printing* that *money*.

    When will this happen? Go figure. However, I'm convinced we will see a remarkable price increase (that is, from today's levels) before that.


  2. Thank you, Lauri, for bringing some fundamental background to this post!

    Fundamental reasoning behind the rise of gold price is definitely uncertainty about world economy and turbulent times on the stock markets. Gold is perceived as a safe haven for money, until we realize that there's money to be made elsewhere.

    Coming back to the technical picture of a bubble - when there's a drunkard who's driving home from a party, it is not certain that he or she will crash. When he's doing that party after party the probability that he will crash will rise exponentially. So from a technical point of view exponential rise of a price might also lean us to understanding that we might have a bubble in our hands.

    I also heard of a speculation that Fed might be selling their gold reserves at some point since the value of their gold reserves has risen considerably. With an intention to buy it back cheaper. I'm not sure how possible this is but as they say - everything's possible in America.

  3. What is your target price for gold?

    Historically looking at the Dow/gold chart the ratio should come down to 2:1 since we are on a downward trend that will bottom out in the next years (http://2.bp.blogspot.com/_N2wseLMIbtE/SgBoh6Jw-3I/AAAAAAAAAVg/E-YU1B2UMUM/s1600-h/Dow+Gold.JPG) so when Dow now at 11,500 and gold at 1,800 they should end up somewhere dow 6000, gold 3000. Considering that in 2009 dow was 6670 this is more than just a possibility.

    You have to look what is money - object accepted as payment of goods and that holds 3 functions: medium of exchange, unit of account, store of value. Some paper currencies (notably dollar) lack the last one - store of value - because their supply is limitless, where for gold it is limited. It is the basic laws of supply and demand that will maintain gold as money.

  4. Interesting theory and thanks for sharing!

    I think it would be pretty dangerous to predict the price of gold according to that ratio. First of all stock markets are mainly driven by profit expectations. When profits are rising quicker than inflation then we see fundamentally justified up-movements in stock markets. I think that at rapid growth times we should see this ratio increasing and vice versa. Claiming that fundamentally the ratio should be 2:1 is like saying that stock markets and gold price have the same direct causal outlier which is difficult to agree with.