Is Gold in A Bubble?
A five-fold increase in the price of anything in less than 9 years invites the bubble analogy; not a few commentators have been promoting this notion about gold.

The chart below compares the price of gold since it was $375 (its 20 year midpoint) until now, against the three largest bubbles of the last 40 years. On the basis of these the move in gold so far looks orderly and almost timid! Past bubbles have shown strong but steady growth for the first 7-8 years before moving into a hyper-growth phase for another 18-24 months. (Each series is adjusted for inflation and smoothed with a 3-month moving average.)

Clearly a 300% (inflation-adjusted) increase in less than 9 years is a heroic move. But if it should happen that the market price of gold gets as much emotional energy behind it as did NASDAQ in the twilight of the 20th century or oil in the opening decade of the new millennium, one could picture it soaring to $3,000 an ounce or more; and it would still just look like your run-of-the-mill bubble. If that should happen, it is probably worth keeping in mind what the downside of these bubbles have always looked like, especially in their first year of correction!

Oil and gold are both mature, established industries. They are both globally-traded, nonrenewable commodities, most often denominated in US Dollars. Their commercial buyers and sellers share the spot and futures markets with an active contingent
of speculators. They have also both seen their market price explode from 40 years ago, and it is widely accepted that currency valuation is a strong influence on their market price. I thought it might be interesting and perhaps even instructive to see how oil and gold have compared over the years.

The nearby chart tracks the price of an ounce of gold divided by the price of a barrel of oil. Said another way, it shows how many barrels of oil you could buy with one ounce of gold at the going market price. The ratio is smoothed using a 12 month moving average.

You can see that on May 4, 2011 an ounce of gold was worth about 15 barrels of oil. That's about where it was 30 years ago when gold was hitting its previous peak. It's also about where it was at the end of WWII. But the ratio is closer to the bottom than the top of its long-term range. In short, gold doesn't look extreme compared with oil.

Here's our final thought on the question of whether gold is in a bubble: it is not gold that is in a bubble; rather it is what's causing gold to go up that is in a bubble. In his Frontline memo of May 14, 2011, John Mauldin opined convincingly, "The biggest bubble in the history of the world is the sovereign debt bubble."

It looks to us like the economy is struggling (1Q growth rate 1.8% real) to provide any meaningful growth even with the tailwind of a huge federal deficit on the order of 10% of GDP. At an annual nominal growth rate of 4%, our GDP is plodding ahead by $600 billion a year. Our government is buying this growth at the cost of $1,500 billion added permanently to our national obligation. Money down the drain... pushing on a string... helium in the balloon. Pick your favorite analogy... it's not working and it is wrecking the national balance sheet and diminishing confidence in the underlying currency.

Will the Federal Reserve keep supporting our patently irresponsible fiscal policy? Our fear and expectation is that the central bank is a one-trick pony. Ben Bernanke is no Paul Volker. Today's central bankers appear smug with satisfaction that QE1
seems to have quieted the credit and liquidity crisis of 2008, and equally thrilled that QE2 succeeded in raising stock prices by 25% from last September and bringing the 10-year treasury rate down to 3%. When the applause dies down and economic sluggishness threatens, QE3 will follow. Runaway debt, runaway money supply; and gold is the investor's most liquid hedge against the inflation surge that lurks around the corner.

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