Archive for January, 2010

Beware the 4 new asset bubbles” by Shawn Tully (January 25, 2010, Fortune).
Coming down with gold fever” by Stephen Gandel (January 7, 2010, CNN Money).
The Coming Bubble of 2010 and How to Avoid It by Adam J Wiederman (November 6, 2009, The Motley Fool).

Are all the recent articles about the untenable gold asset bubble an indication that it is about to burst?

Shawn Tully, writing in Fortune, says this:

Since early 2009, the price has jumped to $1,100 an ounce from $875, triple its average price between 1990 and 2004. Yet the supply of gold is far more fluid than the gold bugs admit, partly because mining companies are investing heavily to increase production.

The real threat: Prices are so high all over the world that people who once treasured their gold jewelry are now rushing to sell it. Swiss refiners are offering irresistible prices for bracelets and brooches, “cash-for-gold” stores are in Chicago malls, and suburbanites are hosting Tupperware-style parties where neighbors show up to hock their gold teeth.

When this happened in the early 1980s with silver, prices plummeted from $50 to $15 in less than a year. Look for gold to end up below $500 an ounce within two years.

Stephen Gandel, writing in CNN ¬†Money, dispels several popular “fairy tales” supporting gold investment:

Tale No. 1: Inflation is a looming threat, and gold offers you better protection than stocks or bonds.

The reality: The price of gold is the only thing that seems to be rising.

… The investment management firm Research Affiliates studied the last period of sharply rising prices — the late 1970s — to find out what was the best investment to own back then. The answer: not gold.

In fact, the study found gold prices and inflation had very little correlation. Between January 1977 and April 1980, small-company stocks were actually the best-performing asset, outpacing gold and other commodities by 4 percentage points a year during that stretch.

Tale No. 2: Unlike stocks, gold is real and tangible. So it will hold its value.

The reality: Gold prices fell for a quarter-century before the recent rally.

But isn’t there a limited supply of gold around the world? And doesn’t that mean prices will have to go up?

Not exactly. The truth is, no one really needs gold. Besides its use in jewelry, gold serves very few functions. In fact, industrial demand for the metal has been falling for years.

Tale No. 3: Despite its spectacular run, gold is still cheap by historical standards.

The reality: Gold isn’t that inexpensive. And who says it’s guaranteed to return to old highs?

Tale No. 4: As the world sours on the U.S. dollar, the demand for gold will take off.

The reality: Even China is wary of gold prices rising too much.

… governments don’t act like pure currency speculators. They hold dollars for economic and political reasons that go beyond the day-today value of the buck. Even with its recent purchases of gold, China still holds 20 times more of its reserves in the greenback than in gold.

And as this metal gets more expensive, central banks are becoming price-sensitive. A deputy governor of the Bank of China in early December said higher prices might slow that country’s gold purchases.

Tale No. 5: The “smart money” is buying gold. So you should too.

The reality: Only a small number of sophisticated investors are getting in on the action.

… you’d do well to heed the warning of economist Nouriel Roubini, who was ahead of the pack in predicting the credit crisis. People who argue that there’s economic justification for gold prices continuing their rise, he wrote recently, “are just talking nonsense.”

Adam J Wiederman, writing for The Motley Fool, believes that the gold bubble will burst this year, and says that “foolish” investors in gold are overlooking the following facts:

1. When gold demand rises, supply does, too, which brings gold prices back down.
Fortune magazine reports that gold miners invested more than $40 billion into new projects since 2001, and they “are now bearing fruit.” Bullion dealer Kitco “predicts that these new mining projects will add 450 tons annually — or 5% — “to the gold supply through 2014, enough to move prices lower.” The demand also brings out sellers of scrap gold, which adds even more to the supply.

All this while demand for gold has dropped 20% in the past year.

2. Gold is not just dollar-denominated.
Unlike oil, gold is bought and sold in local currencies throughout the world. The Wall Street Journal reports that “gold remains well below last winter’s peaks when priced in pounds, euros, yen, or Swiss francs.” This indicates that it is solely Americans speculating on gold’s rise.

3. Gold is historically a poor investment.
Perhaps the most damning fact is that, from 1833 through 2005, gold and inflation had nearly perfect correlation, according to Forbes. This means that, after taxes, you would have actually lost money in gold.

Warren Buffett once quipped, “It gets dug out of the ground … 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.”

In fact, the only way to make gold rise is to get other investors to buy into the idea — like a giant Ponzi scheme. And as we know from watching the unraveling of Bernie Madoff’s empire, this can’t last forever.

Which is why buying gold today is a horrible decision — and why investors would be better off looking elsewhere.

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