Gold. Dumb Money. Bubble?

Quotable

“A man that hoards up riches and enjoys them not, is like an ass that carries gold and eats thistles.”
                              Richard Burton

Commentary & Analysis
Gold. Dumb Money. Bubble?

I think the title is clear. I ask because we’re starting to get wind of bubble-talk from the financial press et al. It is very similar to the talk we heard on silver earlier in the year when its price increases began looking parabolic.

While gold seems to have gotten ahead of itself, I tend to lean towards the idea that gold is not officially in a bubble. And while at this stage I tend to shy away from the forecasts that shout of $5000 and $10,000 an ounce, the current environment could persist long enough to warrant much higher gold prices over the course of 12-24 months.

I found this line on a blog post and thought I’d share it:

The dumb money continues to warn that gold and silver are bubbles.

I suppose it comes down to semantics here. First, this is the type of rhetoric used by gold bugs the world over; so by their definition dumb money pretty much means anyone not buying in to the long-term bull market in precious metals. Second, many people define bubbles differently, so it’s tough to actually decipher individual forecasts from mere mention of a bubble.

By most generally accepted technical measures, gold had become overbought somewhere between $1,800 and $1,900. The pace of its price rises relative to its longer-term trend (back to 2009, and then even further back to 2005ish) became much sharper. And despite the precious utopia in some investors’ imaginations, not all who dabble in the precious metals market buy up physical metal or hold paper positions longer than a handful of months.

So, does gold’s overbought status equate to a bubble? I would say no.

The argument put forth by the same blog (an argument that has driven long-term gold bugs for years and years) is found in this chart showing the inflation-adjusted price of gold:

Does this argument have any merit? Sure.

But it is not to say that gold is an inflation-driven asset; it is also not to say that a return to the inflation-adjusted highs should be expected.

It is to say that a sustained distaste for global government and monetary shenanigans can be a driver regardless of the nominal dollar price of gold.

But again – do not ignore the potential for sharp, near-term price declines in the neighborhood of 10% or more. Yesterday was a prime example of how quickly and sharply these corrections can occur.

I have two friends who have recently come to me asking for my opinion on gold (and silver):

Friend #1 specifically asked if I thought gold was in a bubble. I told him ‘No, not yet.’ He just took a job out in Nevada as a geologist for Barrick Gold Corporation; he was concerned that he was taking a job that could be irrelevant soon if gold prices collapse and his project is not worth the time and money for Barrick to develop.

Friend #2 asked for my opinion on physical gold and silver as a long-term investment. I told him it seemed to make sense but was sure to identify the risks to the story in the near-term. This friend is a casual investor, at best, and is not normally tuned in to the markets; he wanted to be validated on his expectations for gold and silver.

Friend #1 has valid concerns. With the time it takes to get a new mine online and producing, gold may have climbed too high and too quickly for its own good. I don’t think gold is in bubble mode yet … but two or three years down the road could be a completely different story.

Friend #2 is similar to the shoe shine boys giving out stock tips. The fact that this mostly uninformed investor has now been driven to act on physical metal makes you think that there is some near-term hysteria that needs to be worked off before gold and silver can make the advances that the bugs and hard-moniers believe imminent.

I’ll leave you with a couple charts:

Gold: 50-day moving average with 2 and 3 standard deviation Bollinger Bands suggests overbought; 14-day ATR skyrocketing suggests the pace of gold’s climb is perhaps unsustainable in the near-term.

While I think we are due to see a correction as deep as $1,700, some longer-term perspective on gold’s average true range may help. As you can see below, the ATR has gotten nowhere close to where it is today, except for in 2008:

But the ATR is measured in dollars per ounce. If you compare the ATR percentages from the 2008 peak and today, you’ll find that gold was moving on average nearly 5% per day during October 2008; in the last 14-days it has moved on average 2.6% per day.

ATR is a non-directional indicator of volatility. Perhaps we’ll first start to see consistent large daily moves (to the upside) in the price of gold before we truly can start calling it a bubble. Keep this indicator handy as we watch the direction of future price action.