Gold’s Magical Climb

November 9, 2010

The relentless rise of gold prices has caught the market’s imagination.  The advance is being fed by a weakening U.S. dollar, bloated paper debt around the world, Fed quantitative easing and fear that debt monetization could create a big inflation problem in the future.  Current inflation is very subdued and still trending lower in many key economies, unlike the high pace that was a key force behind a rise of gold prices from $43.625 per ounce at end-1971 to $850.00 on January 21, 1980.

That earlier rise of gold looked like an asset bubble, behaved like a bubble and, with the benefit of hindsight, was exposed to indeed have been a toxic bubble.  Gold prices settled back more than $250 by the end of 1980 and would eventually fall to $256 at the London fixing on April 2, 2000.

Gold has posted an end-year to end-year rise in every calendar year beginning with 2002, that is for eight straight years.  In six of those years, the yellow metal’s price rose by more than 15%: 24.0% in 2002, 21.7% in 2003, 17.1% in 2005, 23.9% in 2006, 31.6% in 2007, and 27.6% in 2009.  With 7-1/2 weeks left in 2010, gold prices are up about 28% year-to-date.  It took 120 calendar days after first attaining the $700 leve; for gold to reach the $800 level, 70 days from there to reach $900, 603 days to get to $1000, 62 days to hit $1100, 23 days to make the $1200 level, 301 days to ascend past $1300, and just 40 days to surpass $1400.  The start of this cycle of gold appreciation far pre-dated the financial crisis but has risen 89% since the failure of Lehman Brothers just 14 months ago. 

Investors are wondering if the gold market now constitutes another asset bubble.  Demand at these levels for a good with limited industrial use and no dividend or interest return is mostly speculative in nature.  It wouldn’t be the first asset bubble to begin as a fundamentally sensible trend but to evolve subsequently into an unsustainably excessive movement.  Bubbles have a messy epilogue, and exiting in a sufficiently timely fashion is harder than it looks

If gold turns out to be a bubble, the downturn will most likely be triggered by one of three developments.  The first would be renewed recession in the United States and other countries, and the second would be a prolonged period with inflation failing to rise meaningfully.  Neither of these risks is an immediate danger, and the ever-possible geopolitical event could even add a new incentive for the gold buying frenzy in the near term.  In this short time frame, the main downside danger for gold holders is a spontaneous reversal of the markets if investors pull back from the fear that the rising trend is getting too one-sided.

I believe gold will eventually go through a bubble cycle.  But the potential timing and level of the peak remains almost as uncertain as the global economic backdrop.  In the meantime, World Bank President Zoellick’s recommended return to an international monetary system with a central role for gold will go nowhere.  Gold is presently too volatile for that.  Moreover, one lesson of the Great Depression was that countries that abandoned the gold standard before others suffered less pronounced economic contractions.  With sustained recovery not assured and advanced economies saddled with enormous unused productive resources, this is a risky time to attempt going back to the future.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



One Response to “Gold’s Magical Climb”

  1. Jimbo says:

    I think as long as Bernanke keeps printing paper dollars, commodities will rise in terms of U.S. dollars per ounce, including gold. I might be able to buy a car with my 1951 Mickey Mantle card, but if that card was duplicated and 100,000 printed, the intrinsic value of the car remains the same but now my card is one of many and probably buys a used car.

    Gold has other dimensions that other commodities do not have – so it can rise and fall on many other scenarios.