Gold Never Has Been (And Never Will Be) In A Bubble

The Daily Reckoning ^ | 10-30-2010 | Nathan Lewis

[blam]

Gold Never Has Been (And Never Will Be) In A Bubble

By Nathan Lewis

10/30/10 Binghamton, New York – Most serious gold investors follow a basic principle: that gold is stable in value. Changes in the “gold price” represent changes in the currency being compared to gold, while gold itself is essentially inert.

This is why gold was used as a monetary foundation for literally thousands of years. You want money to be stable in value. The simplest way to accomplish this was to link it to gold. Today, we summarize this quality by saying that “gold is money.”

From this we can see immediately, that if gold doesn’t change in value – at least not very much – then it can never be in a “bubble.” There may be a time when many people are desperate to trade their paper money for gold, but that is because their paper money is collapsing in value. It has nothing to do with gold.

Let’s take a look at some of the great gold bull markets of the last hundred years:

* From 1920 to 1923, the price of gold in German marks rose from 160/oz. to 48 trillion/oz.

* From 1945 to 1950, the price of gold in Japanese yen rose from 140/oz. to 12,600/oz.

* From 1948 to 1967, the price of gold in Brazilian cruzeiros went from 648/oz. to 94,500/oz.

* From 1970 to 1980, the price of gold in US dollars went from 35/oz. to 850/oz.

* From 1982 to 1990, the price of gold in Mexican pesos went from 8,000/oz. to 1,025,000/oz.

* From 1989 to 2000, the price of gold in Russian rubles went from 1,600/oz. to 8,120,000/oz.

Each of these situations was an episode of paper currency depreciation. Today is no different. The rising dollar/euro/yen gold price is simply a reflection of the Keynesian “easy money” policies popular around the world today.

We can also see that, if gold remains stable in value, then the supply/demand considerations that affect industrial commodities do not affect gold, which is a monetary commodity. This is why gold is used as money. If its value was affected by industrial supply/demand factors, we would not be able to use it as money.

Thus, “jewelry demand” or “peak gold,” or any other such factor, has little meaningful effect on gold’s value. Day-to-day money flows will affect the price at which currencies trade vs. gold, but this ultimately affects the currency in question, not gold.

None of these historical “gold bull markets” resulted from jewelry demand or mining supply.

Any attempt to attach a valuation to gold is mostly a waste of time. Concepts like the “inflation-adjusted gold price” or the “gold/oil ratio,” or a ratio of outstanding debt or currency to a quantity of gold bullion, are a distraction. An item that doesn’t change value is never cheap or dear. That’s what “gold is money” means.

The “price of gold” may reach five thousand, ten thousand, a hundred thousand, a million, or a billion dollars per ounce. The gold bubble-callers will be frothing at the mouth, until they finally have the realization that there was never a bubble in gold, but only a crash in paper money.

Gold is money. Always has been. Probably always will be. This time it’s different? I don’t think so.

[RegulatorCountry]

Probably best not to judge gold with dollars in that period.

Why, because it's disadvantageous to those who are encouraging people to buy gold? It's just as real as judging gold by the weak currency that preceded it.

Look, it's a safe haven, I don't dispute that. I own precious metals myself, but I'm not going to get so caught up in the matter that I lose my *** when it inevitably starts back down again, as it has again and again. It's bought during times of economic upheaval and sold in times of prosperity. That's the driver of the currency strengthening as well. It does not serve any argument about a looming hyperinflation.

We have not even come anywhere near hyperinflation, ever, in the history of this country, unless you want to delve into the very uncertain currencies present during the Revolution (have an ancestor whose Rev. pension application details his trials when his pay in Continental money had depreciated to worthlessness) or during the latter stages of the Civil War with Confederate money doing likewise (ancestors who lived through and endured that as well).

If you want to buy and hold gold by all means do so. I've told you that it's not an historically good thing to buy and hold long term, and even your own graphs show you that. But, it's your money. Have at it. Me, I'll hold it until the trend is clearly downward, I bought in early enough to afford that luxury and still have a very nice return. Certainly didn't get in at $250 or whatever as so many here brag, more like twice that in the wake of 9/11. It's been good to me but it's delusion to think it always will be.

[RegulatorCountry]

The events of which you speak were anomaly of such short duration that they are not even a blip on the long term curve.

... but this time it's different, right? This isn't a blip and it's not a bubble?

Please show this long term curve that demonstrates the correctness of the author's argument, then. I'm interested in learning something new.

[bert]

Here is one such curve. The spike indicates an over reaction to the increase from the artificially low prices in the seventies. When Nixon broke the tie, gold was trading abroad at about $40. After that is looked for and found a higher average level. That is what is happening again now.

When the tie was broken, the price in US$$ varied but the peak was of very short duration

I have looked but can't find the chart dating from 1793 that illlustrates the point well. There is also a chart for hundreds of years that is pretty much flat and the spike is barely noticeable. This one shows the very short duration of the spike as well

[justa-hairyape]

Why, because it's disadvantageous to those who are encouraging people to buy gold?

Not at all. That time period actually illustrates the volatility of the US dollar. It is the dollars volatility that corrupts the price of gold in dollars during that time period. But if you want to use a time period where the dollar doubled in value and then dropped half that value again all within 5 to 6 years, fine. But some might think you are illustrating the authors point. Gold rose in dollars during the Jimmy Carter years. Seems like a reasonable response to me. Then it fell and slightly recovered when the dollar went on its hyper roller coaster ride. Then from 1988 to 2000, gold was fairly stable. Starting rising again in dollars after the dot com crash, 911 and the War in Iraq and Af/Pak. Now we are setting absolute high gold records after the Financial Sector collapse in 2008. Followed of course by the Mortgage Crisis and now the potential currency and trade wars. All seems like reasonable behavior to me.

[ExGeeEye]

Good catch. Thanks.

[GOPJ]

The rising dollar/euro/yen gold price is simply a reflection of the Keynesian “easy money” policies popular around the world today.

True - but what if the Chinese decide to artificially prop up the dollar...

[Atlas Sneezed]

I’ll let the charting wizards do it, but overlaying the 10 years prior to now, and the 10 years prior to the 1980s peak (it was a bubble), with the present and the peak adjusted to the same level, on a logarithmic scale, will make it clear that our current steady rise is nothing like the brief 1980 spike.

[Atlas Sneezed]

Here's the past 10 years, which looks like a gradual inflationary climb:

Here's the 5-year runup to 1980 (note that the peak in 1980 was well above the end of this chart):

So, after years of trading in a range where peaks were double the minimums, gold quadrupled in a year (then lost most of that quadrupling to return to something above the prior range). Currently, we have seen a tripling in 5 years, but smoothly occurring over that period. In any year, the increase has been at most 50% gain.

This makes the current period look like the gradual runup we saw in 76-79, when gold tripled. I'm not convinced that this means that history will repeat, but it seems far less likely that we are currently in a bubble, than at the point before a bubble even starts to build.

When gold has quadrupled in a year, I'll be ready to accept that it may drop by half or more, but we're nowhere near that.

My most likely scenario is that gold rises to $4000 sometime in the next 3-5 years, and drops back to a stable market price of about $2500.

Or maybe we have hyperinflation, and the price of gold in dollars becomes meaningless. Or we may have restored fiscal sanity in 2012, and gold settles out where it is. Or maybe it drops to below $1000, and I buy more after picking my jaw up off the floor (because the foreclosure mess and entitlement obligations still point to serious inflation).

[Atlas Sneezed]

To put the 1979 bubble in perspective:

In August of 78, Gold broke through the $200 barrier after years of trading in the $100-200 range. (Paper bugs were worrying that it was a bubble).

By September of the next year (1979), gold doubled its record, hitting $400 (one-third of that gain coming in the final two weeks of the period).

In the following 15 weeks, gold doubled AGAIN (with half of that rise in the last two weeks of the period).

THAT, my friends, might be an indication of a bubble.

Note that the price stabilized in the $300-400 range for years to follow (with ample opportunity to sell at over $500, so unless people bought in the final month (after gold had more than doubled an all-time high in a year), they enjoyed ample gains.

[Atlas Sneezed]

Here's the comparison:

I'll leave it to others to overlay these, but it's pretty clear that the past pattern is not being repeated presently.

I got these from a very handy charting site:

http://quotes.post1.org/historical-gold-price-chart/

[Atlas Sneezed]

If we want to see plausibly similar, compare the last three years to 1976-79:

Today's price is 5.7 times the price back then, so if history repeats, you can expect gold to peak at $4869 in July of 2011, be at $3360 a year later in July 2012, and bottom at $1635 in 2016, before it begins another climb.