Is Gold in a Bubble?
Gold has long been revered as an inflationary-proof form of alternative currency, particularly favoured in periods of economic turbulence and uncertainty. Throughout history, it has been used as a relative standard for equivalent currency and indeed Europe implemented the gold standard in the nineteenth century as a mark of measure. Battles have been fought, communities grown and cities built all on the basis of gold and its enduring allure.
How Do Investors Hold Gold?
Traditionally, investors will hold gold by purchasing bullion gold bars. In some countries, such as Canada, Argentina and Switzerland, these can be traded at major banks and other bullion dealers provide similar services, with bars being sold at different sizes and weights. Gold coins are another common way of investing in gold. Bullion coins are priced according to weight. Gold bullion coins tend to sell at the largest price premium but bars bear a higher risk of forgery, as their appearance isn't governed in the same stringent way. Other investors will also hold gold in its jewellery form, particularly rare and high value jewellery, which may also hold precious stones.
Gold and the Economic Crisis
Certainly, since the banking crisis and subsequent recession of 2008 onwards, many investors have been deserting the equities markets and other more complex financial instruments in favour of solid gold investments and those bars of glistening pure gold that have long captured public imagination as the ultimate source of visible wealth! This drive to acquire gold has been magnified in the current crisis, as even 'safe' financial vehicles such as government bonds and bank shares have been proven to be less reliable and safe than in recent history. It has acted as a safe hedge against a range of threats including weak currencies, inflation and a failure in the banking system and global turmoil and rises in its value have been double digit over the past ten years.
The Role of Economics and Gold Prices
The market largely dictates the price of gold and the economic forces of supply and demand, as well as speculator activity, which can drive prices up or down significantly. However, with gold, its disposal and saving plays a larger role in determining price than its consumption, making gold different from other commodities. Much of the gold that has ever been mined in the world still exists today in accessible and reusable forms such as jewellery and bullion. This means it can potentially return to the market. Central banks also play a key role in gold prices, along with the IMF. Traditionally, central banks have held gold reserves as safe investments.
Finally Falling Out of Favour?
However, gold seems to be falling out of favour rapidly in some circles, with some investors claiming that its bubble is about to burst. But is this the case and what does it mean for investors desperate to find somewhere to place their assets in an ever turbulent market?
The Attraction of Gold
Gold has been popular as an inflationary-proof asset. This meant that large numbers of investors rushed into the gold market and the price rose rapidly, peaking in March 2008 and not dipping significantly since, let alone reaching the pre-rise levels. It is also a 'real investment' in a world of digital numbers and paper bills, where a company might go bankrupt and disappear overnight, taking its investors' money with it. Gold is reassuringly present and visible. Its weight is literally measured in gold. In the most extreme cases, when economies crash and currencies become worthless (such as during periods of civil unrest or war), gold becomes one of the last remaining true currencies. Investors love it because it's safe, speculators enjoy the daily changes on the gold market and riding the waves of opportunity and traders know they will have a near risk-free return on investment during a difficult time of historically low interest rates. In the EU, gold also can attract more favourable tax treatment than other forms of investment, making it even more popular for investors.
However, gold's rally makes some traders nervous, as they know that other high-profile bubbles have burst with disastrous results in the past, dot-com and tech industries as one example. The crucial thing is that gold's real price has been elevated to potentially excessive levels by traders, speculators and investors. At some point, the price will rise too high for the market to bear and the bubble will burst. The question is - when?
When Will the Gold Bubble Burst?
Market analysts believe that two conditions need to be satisfied before the bubble bursts. Firstly, the markets will need to offer something as equally attractive to gold for investors to pile into. Higher interest rates offered by major central banks will be a good indicator that investors have alternative routes for growing their funds, other than sitting on gold piles. Secondly, stability is a factor. Even if potentially high returns are offered by investing in the paper markets of turbulent or emerging economies, only the investors with the highest risk appetites are likely to be swayed. Low or medium risk investors will still be attracted by the stability of gold. The danger, of course, is that investors and traders will naturally move out of the gold market gradually, as new investment vehicles emerge that are attractive and suitably 'safe' but the effects may be magnified by speculators betting on gold falls and pushing the price decreases down more quickly (as happened with oil). This could see the value of gold more than halving in just a month or two, based on historical evidence.
Timing the Market
Of course, market success is largely down to timing the market and analysts are watching market movements carefully. For now at least, gold remains a wise buy, particularly whilst the central banks keep a low hold on interest rates, whilst wider economies are still experiencing great turbulence and the mood remains wedded to risk-averse investments. Many analysts believe that the shift away from gold will happen when interest rates start to rise, back to 3-4%, keeping a rein on the rising levels of inflation.
In the meantime, opinion on what will happen and when, remains divided. George Soros, one of the most renowned fund managers in history, has warned that policymakers are risking creating unsustainable bubbles in assets such as gold, which will later crash. He has pointed to their policies of low interest rates and the potential dangers of sticking to this strategy whilst gold prices continue to rise.
Meanwhile, gold prices do seem to be falling, suggesting that the bear market of the last ten years is finally ending. Continuing volatility in the gold market will only contribute to this trend. It's worth harking back to the last bull market in gold too, which ended in 1980 and saw prices falling by 60 percent. For twenty years after this, owning gold was seen as a 'dead money' decision and highly unattractive, a historical fact that savvy investors are no doubt bearing in mind today. Meanwhile however, the market remains strong and the tide is yet to fully turn, although the early signs have been picked up by some. The market watches and waits, as it always does and stakeholders of all kinds wait for the next twist and turn in the current economic turmoil.