Monday, May 10, 2010

Why Potential Is Bulding For Gold To Enter Into A Major Boom

Brian Hunt discusses why he believes that gold has a strong potential right now to enter into a mania phase similar to the dot-com boom. One of the key criteria for a pending mania is a widespread belief that "this time it's different" from past conditions. See the following post from Daily Wealth.

On February 18, 2009 the Financial Times published one of the most important articles nobody read.

The article's headline was Gold primed to become "mania asset."

The gist of the article was something I've been telling people for a long time: Gold – more so than any asset right now – has the potential to experience a mania phase... one like we saw in Internet stocks from 1997 through 2000.

A mania phase is a period in an asset's lifecycle marked by leaps of 10% or 20% in a month... 100% or 300% in a year... and 500% or more over the course of several years. Get in early with a big position on a mania phase, and you'll make a fortune. Remember one Internet-mania darling, JDS Uniphase, climbed more than 30-fold in about two years... which would have turned a stake of $20,000 into $640,000.

As that little-read article mentioned, an asset must have one key ingredient to enter mania phase: It must have the "new era" factor... a set of conditions folks can point to and say, "This time is different... The old, conventional methods of valuing assets are useless in this case."

Take Internet stocks. In the late '90s, Wall Street analysts chucked classic valuation measures – like price-to-cash flow and price-to-book – out the window. The Internet was growing too fast for these old measures, they figured. Instead, they used crazy metrics like web traffic (and often pure fantasy) to justify valuations. Companies with little chance of turning a profit sported market caps of hundreds of millions of dollars simply because they had good stories... and because that time was "different."

Now let's get to gold. As we've noted many times in DailyWealth, you can make a good case that this time is different. Never before has the nation with the world's reserve paper currency – which is backed by nothing but faith in a bankrupt government – promised so much to so many people (Social Security, Obamacare, unlimited military commitment).

We're funding many of these promises with borrowed money... so crushing interest payments are on the way. The U.S. government could pay as much as 20% of its tax revenue to service the national debt in just three years. Imagine working your tail off just to pay the interest on your credit cards.

For a picture of what could happen, consider that Europe – which in aggregate has made the same crazy promises... and is under a similar debt load – is watching its paper currency union experience a slow-motion train wreck. The chart below shows what gold's action looks like in the eyes of a European. It's looking a lot like a mania phase.

How high can gold go? I can't say. Nobody can.

Despite what many gurus will tell you, we simply cannot properly value gold. It's not a stock, so you can't say, "I'll pay 10 times cash flow for this." It's not a rental property, so you can't say, "I'll buy this for eight times annual rent." Gold's chief use isn't in the manufacturing process, like copper and iron ore.

Nope... gold is the odd man out in the asset family.

Gold represents real, intrinsic wealth. Greece can't debase it. The U.S. government cannot debase it. There's no way to know what people will pay for gold in a big crisis. This is precisely the reason it is a candidate for mania phase. People can tell themselves, "This time is different. It's a new era of currency crisis, so gold can and should trade for $2,000... $3,000... or $6,000 an ounce."

I'm no "the world is going to hell in a handcart" guy. I simply look around for assets with extraordinary potential to rise. I'm indifferent to whether it's gold, stocks, homebuilders, uranium, or Malaysian palm oil.

I'm not saying a gold mania will happen next week... or even six months from now. I actually believe gold needs to pull back and "catch its breath." I am saying gold is an asset folks can justify paying any price for.

The same sort of analysts who claimed the Nasdaq would go to 50,000 are the same sort of analysts who will claim gold will go to $25,000 an ounce. The sober among us will be shouted down... because "this time is different."

This is the chief requirement of a mania. It is in place for gold.

Good investing,

Brian Hunt

This article has been republished from Daily Wealth, a contrarian investment analysis site.

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