Is the gold bubble about to burst?
October 8th, 2009 · Greg Atkinson · 47 Comments
Recently you have probably noticed that gold prices are getting plenty of media coverage and we are often hearing predictions that gold will hit $2000 USD an ounce in the not too distant future. Sadly what is often not highlighted is that gold is rising mainly because the U.S. dollar is falling and that the demand for gold is largely being supported up by investors.
Earlier in the year I said I believed that gold was trading at prices that were too high to be sustained over the longer term and at bubble-like levels. Since that time nothing has happened to change my view and even though a weaker U.S dollar has helped gold shine in some people’s eyes, if we look at gold in Australian dollar terms we can see more clearly how it has fared.
Gold 1 Year Spot Price in Australian Dollars (Oct 2009)
As you can see gold in Australian dollar terms has been falling since it peaked in March and has seriously underperformed Australian stocks in 2009. Unless you were extremely lucky with your timing then the chances are if you bought gold using Australian dollars this year then you are now sitting on a loss.
At this point let me make it quite clear that I am not offering any form of investment or financial advice, I am simply outlining my view of where I think gold prices are headed in Australian dollar terms.
Also if you have not already done so may I suggest you read: Investing in gold: a basic guide for investors as this provides some background on gold supply and demand fundamentals.
Knowing that I will most likely end up with egg on my face in some months time let me say that I think gold is NOT the place to be in 2009 for Australian investors and is overpriced at current levels.
I am also sticking by the comment I made in April this year in Are we in a gold bubble? Could gold prices fall?
“My own personal view is that the gold price will fall back just as oil prices did last year, probably not a big fall, but I think the people saying gold will reach USD $2000/ounce soon sound a lot like those calls that oil would reach USD $200 a barrel last year”
Since I wrote that gold prices have slipped back in AUD terms, but I still feel they have further to fall this year.
As much as people try to pretend otherwise the demand for gold is somewhat elastic in nature. In other words as gold prices rise, overall demand falls. This is not a theory, it is a fact and is confirmed by the World Gold Council:
“Investment demand for gold remained very strong in the second quarter of 2009, rising 46% on year earlier levels as investors continued a flight to quality. Overall demand for gold fell back from recent high levels as weak economic conditions and high gold prices combined to impact demand, according to the Q2’09 Gold Demand Trends report published today by World Gold Council (WGC). Although gold demand remains very high on a historical basis, total demand in Q2’09 was down 9% on the levels of a year earlier, a 6% decline in $US value terms to $US21.3b.”
What should concern investors is that gold demand is being held up by investors and this means gold is being dug up, stored in a vault and at some point one would assume the people who own the gold will want to sell it, hopefully at a profit.
So for gold prices to remain at current levels or go higher in U.S. dollar terms two things basically need to happen:
- The U.S dollar needs to keep falling against other currencies.
- Investors need to keep buying gold or the demand for gold other than for investment purposes needs to pick up.
Let’s put the first point aside for now as it involves getting into the complex world of exchange rates and focus on the second one.
The second point is where the gold catch-22 comes into play. Investors put money into gold because they believe that the global economic outlook is not looking good, but if the global economy is struggling then the demand for industrial & jewellery gold falls.
So as investors increasingly head for the safety of gold their actions actually make gold less safe, because the pool of potential sellers (those who own gold) will at some point be greater than the pool of potentials buyers. Of course the point at which this will happen is almost impossible to predict because it is subject to so many variables.
For example if the global economy continues to show signs of recovery then the number of potential buyers could drop quickly and thus the point where sellers outnumber buyers would be lowered. (i.e. a lower price point would result)
But don’t take my word for it, have a look at the table below from the World Gold Council and you will see clearly how the overall demand for gold is falling, but investors keep buying nonetheless.
Identifiable Gold Demand
Source: World Gold Council (www.gold.org)
I guess there are basically two ways you could look at the data above. The pro-gold crowd would point out how gold for investment purposes is soaring and that if that trend continues gold prices will soar.
When I look at the data I see a bubble forming. The only thing putting a floor under demand is investors whereas the demand for gold for practical purposes is falling. At the moment the point at which sellers outnumber buyers has not been reached, but for how long can investor demand keep growing?
I could be very wrong, however I will not be joining the rush towards gold and much prefer oil as a long term investment play. However I stress that investors need to do their own research, consider a wide variety of views and seek professional advice (if needed) before making any investment related decisions.