Monday, December 14, 2009

How To Spot A Gold Bubble

Moses Kim discusses some of the warning signs to watch for when a gold bubble is forming, such as the large bubble in 1980. Currently, most of the signals of a gold bubble are absent, such as the participation of 'average' investors, very high rate of growth, and a disconnect between price and the supply and demand dynamics. See the following post from Expected Returns.

There is little doubt in my mind that gold will eventually reach bubble valuations when the average guy on the street starts buying. I just hope I will be smart and disciplined enough to sell when the signs of a bubble start emerging.

In order to successfully exit a bubble market without being wiped out, one must be aware of some of the characteristics of bubbles. First of all, the price of the given asset must be totally disconnected from supply and demand dynamics. For example, if prices continued to rise in the face of quickly rising supply, I would question whether the given asset was really in a sustainable bull market.

In terms of price action, I've provided the chart below so that you can visually see what a bubble looks like. Notice the parabolic upswing in prices in 1980; in effect, the price of gold doubled in a matter of weeks. I would say 99 times out of 100 when you see an asset rise this much in one year, it is a bubble.

After the peak in gold prices at $850, it took almost 30 years for us to see those levels again. Looking back, it was clearly a time to get rich off of paper assets like stocks and bonds. Now the pendulum has clearly shifted to "hard assets" like gold.

You can see from the chart below that the last 2 years have been very good for gold. From my standpoint, this chart does not look like a bubble at all; in fact, it is quite a bullish chart. The price of gold in this 2 year time span rose 70%, which is hardly what I would consider a bubble. Even this latest intermediate term move that has everyone calling gold a bubble has only brought gold prices up about 25% in 5 months, which is a far cry from the 100% move we saw in 1980 in a much shorter time frame.

As a gold bull, I love to see people bashing gold and calling it a bubble. When even the casual investor suddenly becomes an expert in gold bubbles, you know that we are still early in this bull market. Why? Because these so-called bubble-spotting experts have yet to buy, which means there is still tremendous potential buying pressure at the margin. Trust me, all bubbles end with the public participating. Until then, the smart money will continue to add on every correction to ride the wave of investor euphoria in gold when it comes- and believe me, it's coming.

This post has been republished from Moses Kim's blog, Expected Returns.

1 comment:

anna Coulling said...

Gold has now broken above the previous top of $1225 per ounce and now looks set to soar. Many are worried that it cannot possibly go anyhigher. My own view is that on an inflation adjusted basis $1200 per ounce is still only 50% of the 1980 high - so there is still some way for it go and with all the short term technical indicators pointing sharply higher the recent sideways consolidation will provide a solid platform for any pullback.