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While it's always annoying when one's investment moves in the opposite direction of fundamentals, I have not been the slightest bit worried about the recent correction in the precious metals market – and I credit the bears for my lack of anxiety.

We literally have the gold bears divided in half. Half of these critics claim that gold is in a “bubble”, while the other half claim with equal fervor that gold isn't even in a “bull market”.

The bubble-bears have been led by Fortune. There is little sophistication to this argument: gold has gone up in value significantly, recently, therefore it's in a “bubble”. There are two characteristics which must be present for an asset bubble to exist. First, and most obvious, the good/equity must be overvalued.

In that respect alone, gold fails the “bubble” test. A long-term chart of the price of gold, adjusted for inflation clearly illustrates this point. Not only is gold less than half of its all-time high, but the current move higher simply lacks either the speed or the magnitude to suggest an asset bubble. Keep in mind that the following graph uses the phony inflation number of the U.S. government. Using real data, the price of gold would have to rise to somewhere above $5,000/oz to equal its 1980-high.

Can any gold bear point to one other asset class where its valuation is clearly less than half of its all-time high, but a bubble exists?  

The other element which must be present for an asset bubble to exist is large amounts of leveraged debt. In this respect, gold once again fails the “bubble” test. It's common knowledge that a much higher percentage of gold purchased in recent months has been “physical” bullion. Obviously no one buys bullion on margin, since no one trades physical bullion – it's simply not practical to move it in and out of storage for any kind of short-term trading. Thus, if anything, the amount of leverage in the gold market has likely decreased when compared to previous rallies in this bull market.

In short, there is no possible means of justifying the accusation that the gold market represents an asset bubble.

This brings us to the true gold-HATERS. Obviously anyone claiming that gold isn't even in a “bull market” must hate gold to the point of irrationality – since the argument that gold “isn't in a bull market” is even more feeble than the suggestion that gold is in a bubble. While the previous chart shows that gold is not in a bubble, it also clearly shows that a long-term rally (i.e. bull market) is underway. Leading the gold-haters (as always) is Kitco's Jon Nadler. Indeed, only Nadler has directly stated that gold is “not in a bull market”, while the other gold-haters have only implied this.

Joining Nadler in the gold-haters camp is the Korean central bank. A minor official of this institution just referred to the bull market in gold as “an illusion”, which (semantics aside) is exactly the same thing as saying that gold is not in a bull market. Given that the price of gold has quadrupled over the last decade, it's a damn convincing “illusion”, if you ask me. Furthermore, given that the Dow Jones index has gone nowhere over the same period of time where gold has quadrupled, one has to wonder why the Korean central bank hasn't been shrieking warnings at investors to avoid all Dow stocks.

However, the winner of the award for the silliest gold-hater clearly is Bloomberg. On Monday, the rocket-scientists at Bloomberg claimed that gold couldn't even equal the returns of a simple savings account (does this mean that savings accounts are in a "bubble"?). Once again, I'll point out the obvious: gold has quadrupled over the last decade. Put $100 in a savings account ten years ago, and (if you're lucky) you might have $150 today. So how could a multi-billion dollar news organization come up with such an absurd and infantile argument? Simple. Bloomberg chose to compare gold to a savings account by using a starting point of gold's highest price ever.

What Bloomberg fails to mention in its comparison is that this was also the time of the highest interest rates in history. Obviously, if you start this comparison just before gold suffered its largest fall in history and at the same time that savings accounts had their biggest gains in history (and then compounded over 30 years) that Bloomberg is giving the simple savings account a gigantic head-start in this comparison.

Had Bloomberg chosen a start-date for this comparison merely one year later, its argument falls apart completely. Bloomberg's claim obviously has no relevance in the real world today. In the real world many of the people who panicked last fall put their money into savings accounts (or bonds) and many bought gold.

Those who put their money into savings (for safety) earned nothing over the last year. Those who put their money into gold are up nearly 50% - even after this recent plunge. It is surprising that Bloomberg would even attempt a comparison of this nature, given that it has been impossible to make any money in a savings account for many years. During this entire decade, the interest paid on savings accounts has never kept up with inflation – making this “investment” 100% certain to lose money.

While it has been simple to point out that neither of these criticisms of gold has any merit, I prefer to focus on the fact that gold's critics totally refute each other. Obviously, any asset which is not in a “bull market” cannot possibly be in a “bubble”, and any asset which is in a bubble must be in a bull-market – or valuations could never become inflated to a bubble-level, since it's “irrational exuberance” which leads to a bubble.

Thus, gold bulls can sleep easy. When all the critics of gold are simultaneously claiming gold is existing in two, opposite extremes, it would be hard to come up with more convincing evidence that neither of these extremes is credible.

As I have always acknowledged, at some point many years down the road (and after the global financial system has gone back onto a gold standard) the bull market in precious metals will end. One clue that this day is getting close will be when the bears can actually agree on why that bull market is ending. As long as the bears continue their current posturing of insisting that the gold market is simultaneously existing in two, opposite extremes, the bulls have nothing to worry about.

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written by JsJ, December 10, 2009

I find it difficult to make reliable predictions in the current circumstances, in addition to which, I have much less experience than others here. That being said...

As desirous as I may be for a gold standard, I am not certain it is going to happen here in the modern day. Furthermore, I am not certain that the metals ETFs will implode, although it will take criminal levels of deception to preserve them. The COMEX is on shaky ground, but it is by no means a certainty that it cannot survive the coming years.

If there is no gold standard then gold will be a commodity like other commodities, and therefore speculation will be possible. Speculation is the air in a bubble. I believe gold will have a speculative blow-off top, and even if people pay for bullion with cash, that doesn't mean they didn't borrow that cash.

People do a lot of stupid things in bubbles -- like saying they have a $200,000 income to buy a $1,000,000 house when they can barely afford even paying the interest (or even less than the interest). The word "bubble" is in vogue because the ongoing currency vacillations from the world's central banks is causing bubble after bubble after bubble.

My US$.02, anyways.

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written by Jeff Nielson, December 10, 2009

JsJ I know it's "in vogue" to refer to EVERYTHING as a "bubble" these days, but try to resist that temptation. A bubble requires excessive valuations AND large amounts of leveraged debt.

Keep in mind that a few years from now, most of the bullion-ETF's will no longer exist (once they are exposed as paper-shams). At that point, the vast majority of gold and silver purchased will be REAL bullion.

As I pointed out, NO ONE buys real bullion on margin - because it's not practical to engage in short-term trading with real bullion. Thus, most of the gold and silver in the future will be paid for with cash, with only SOME of the futures trading being on margin.

Given those points AND the fact that the CFTC is (slowly) working on REDUCING the size of positions, gold and silver may very possibly reach their long-term "tops" (many years from now) WITHOUT being in a bubble.

Further reinforcing that conclusion, by the time gold and silver come close to their tops, we will almost certainly be on a gold standard (again) by that time.

Not only does the gold standard, itself, suppress the formation of "bubbles" (by limiting the amount of leveraged debt), but once back on a gold standard, gold will not be ALLOWED to go into an asset-bubble - because that would be too disruptive to the global financial system.

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written by JsJ, December 10, 2009

Yes, and the dual-effect of the carry trade (weaker U.S. dollar, excess liquidity) is what will (I should say "may") actually fuel the eventual parabolic blow-off in gold prices. I think we all are predicting that gold will become a bubble eventually -- we just don't think it is a bubble right now.

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written by Jeff Nielson, December 09, 2009

Hi JsJ.

The USD carry-trade serves the gold market best because it guarantees an ever-weakening dollar. Even if the USD was actually worth something, the carry-trade would drag it down. Essentially, this along with central bank buying is what put the $1000-floor under gold.

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written by JsJ, December 09, 2009

Their own fault if they miss this bus.

Anyways, not that it's a major source of leverage at the moment, but the US Dollar carry trade has potential to create the kind of excess liquidity that can flow into gold and other commodities relatively quickly. Although I agree with you that bullion bars are an unlikely way to speculate, however indirectly investing in bullion via GLD could theoretically push the market higher over time.

The carry trade is reported to be about US$500B right now, with probably a very small portion of that going to gold, but since metals markets and miner markets are so small even a significant portion of that sum could cause interesting disruptions.

I agree, though -- if the bears can't get their story straight, it's all the better for the bulls.

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