Gold: Bubble or Long-term Bull Market?

The majority of market commentators believe that gold is in a bubble, but there are others, myself included, that believe gold to be in a healthy long-term bull market. So who is right?

Gold’s performance so far

Gold has been rising for over a decade and has returned on average 18% with no down years. The low for gold was made back in July 1999 at $252 an ounce. Since that time gold has appreciated 511%.

Not well understood

As an asset gold is not well understood. The vast majority of analysts still treat gold as a commodity like oil or copper, but gold is not a commodity it’s an asset and this makes it very hard to value.

Unlike commodities that are produced in order to be consumed, almost all the gold ever mined still exists, either in the form of jewellery or bars and coins held by investors. In theory this means that the market could be flooded with gold if the price were high enough, but a large part of the gold in the jewellery category is in the form of religious artifacts and will not come to market at any price. Also since gold is held as an asset it is typically held for the long-term. Investors have only been net sellers of gold once in the past 30 years.

So why are investors turning to gold?

The majority of investors buy gold in order to protect their wealth – as the old saying goes: Gold won’t make you wealthy but it will keep you wealthy. Gold offers a safe haven and protects investors from a number of economic, fiscal and monetary ills, including: inflation, currency crisis, debt default and even deflation.

It seems clear that western governments have chosen inflation as the ‘solution’ to their massive debt burdens. If the inflation rate here in the UK can be kept at 4% for 7 years the government will have eroded nearly 25% of its debts.

Buyers of gold understand that negative real interest rates combined with government money printing is destroying the purchasing power of money and the value of their savings. This is giving the illusion of rising prices at the supermarket and petrol station, but what’s really going on is the destruction of the value of paper money.

All currencies are being devalued in a kind of ‘race to the bottom’ but investors do have a choice: Hold their wealth in increasingly worthless paper, or seek protection in gold which has a history of maintaining its purchasing power over long periods.

Not in a bubble

Gold is far from being in a bubble. In the last bull market gold rose from $35 an ounce to an intraday spike of $800 in 1980, a 23 fold increase. So far in this bull market gold has risen just 6 fold.

This chart shows the current bull market in gold and compares it to both the gold bubble of the 1970’s and the technology bubble on the 1990’s. As you can see the current bull market, looks very modest and orderly in comparison.

Today the percentage of gold held by investors and fund managers in their portfolios is very low indeed when compared to the peaks and panics of the past. In the 1930’s gold made up around 20% of investment portfolios worldwide. At its peak in 1980 gold represented 26% of assets. Today the percentage of gold held by investors is less than 1%.

In many ways it’s a good thing that the mainstream is still negative on gold. It’s when they are consistently bullish that we will know the bull market is in its final stages. Personally I believe that is some years away and I stick by the prediction I made back in 2006 that gold will reach $3,000 an ounce.

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