— “The Financial World According to Inya” Column,
by Inya Ivkovic, MA
With gold trading well past $1,000 per ounce, it is easy to think gold must be in a bubble. For the past six months, the bullion went up over 26%. That kind of return during the worst of recovery years in history is bound to mean an onset of another asset bubble, right?
Well, no, not really. A few years ago, gold was almost universally shunned, laughed at and ignored. That was also the time when my colleagues at Lombardi Financial and I found gold the most attractive, because it meant it was trading for much less than its marginal production cost. Today, however, there is a ton of money in gold, which is why it is prone to sharp declines. Yet, when it soars, it soars, and it does so for a number of obvious and not-so-obvious reasons.
Obviously, gold is trading at historic highs. But what is less obvious is that, when you put it in long-term perspective, gold is actually fairly behind other asset classes, still catching up with today’s price levels. Since gold’s great bull run started in the 1980s, the bullion is up a mere 60%. Inflation, on the other hand, has risen about 175% and stock markets have skyrocketed close to 900%, while money supply in the U.S. is up about 500%. As you can see, when an asset is in a bubble, its price doesn’t just go up 60%; it launches itself into the stratosphere.
Additionally, just because gold is back in vogue does not mean it is in a bubble, too. True, it is one of those things that people started saying as of late, “You have to have gold in your portfolio,” although it also happens to be what many believe. Since physical gold is no longer cheap, turning to the next best thing, exchange-traded gold funds, which have grown to approximately $70.0 billion since shares of the first gold ETF started trading some five years ago, makes perfect sense.
Gold ETFs may very well be the best thing that could have happened to the bullion. Although gold ETFs have demonstrated an unprecedented growth rate within a very short period of time, ETFs are still comparably tiny compared to trillions of dollars worth of gold worldwide. In other words, the room for growth that gold has is enormous.
Further evidence that gold is not in a bubble is investor interest in junior gold miners, as well as institutional interest, or lack of both. For an asset class in a bubble, there sure isn’t much interest in junior producers, even thought their shares are trading well below book value. Granted, it is common knowledge that bringing a mine online is a tough way to make a buck. But if gold were in a bubble, such mining industry fundamentals would have mattered little. A bubble actually can be equated with mindless buying and this is not what we are seeing in gold stocks. At the same time, institutional interest is not all that high either and it certainly hasn’t reached manic prices of real estate and tech stocks, the two bubbles we have had to survive in the past decade.
One of the strongest arguments supporting the thesis that gold is not in a bubble are the bullion’s fundamentals. I think that gold’s price today is all about the relationship between demand and supply. Perhaps the most important part of the equation is that central banks are aggressive buyers of gold. I wrote recently about India buying 200 tons of gold from the International Monetary Fund (IMF). Yet, these 200 tons represent less than 10% of India’s total reserve. As for China, which sits on a ticking bomb/mountain of U.S. dollar assets, bullion reserve represents less than two percent.
Another argument supporting gold’s strong fundamentals is that, even at record-high prices, world governments, particularly the U.S., no longer seem to care how much gold costs. I know conspiracy theorists are going to love this, but, for the longest time, world governments have tried to manipulate gold prices. In a recently declassified letter to former President Ford from former Fed Chairman Burns back in 1975, the latter said, “The broad question at issue is whether central banks and government should be free to buy gold, from one another or from the free market, at market-related prices…The Federal Reserve is opposed.” The letter also says that, “The role of gold in the international monetary system would be gradually reduced,” and “I have a secret understanding in writing with the Bundesbank that Germany will not buy gold either from the market or from another government, at a price above the official price of $42.22 an ounce.”
Lately, however, it seems that world governments no longercare. As I said above, there is a lot of money in gold; yet, gold is still a pariah among asset classes. Decades of contempt for gold have seen to that. Still, that contempt could be gold’s best friend. As long as there are investors who believe that being labeled a gold bug is beneath them and as long as gold remains shut out of the investing mainstream, the true fans of gold will prosper.