As gold prices have been touching ever new highs almost every week for the last few months, the two opposing opinions about gold have hardened as much as the yellow metal itself. Is gold a bubble? To most people, the answer to that question is obvious. Except that there are two separate and opposite ‘obvious’ theories wrapped in there.
To gold’s cheerleaders, it seems obvious that gold isn’t a bubble. These people believe that a gold bubble is almost an oxymoron. There’s no shortage of well-reasoned arguments as to why gold prices will continue to rise. There are many versions of this argument but at the bottom, they are all a variation of the ‘safe-haven’ theory. A large class of investors is skeptical of the future of stocks, bonds, currencies and all other kinds of financial investments. They believe that gold alone will hold value. It isn’t difficult to find apparently well-reasoned arguments as to why gold could rise to twice or more of today’s levels.
There’s no shortage of financial advisors who now advocate that a good chunk of gold plays an important role in every individual portfolio. Even for Indians who don’t hold gold in the traditional way, its common to see it being recommended as a financial asset.
That’s one side of the picture. On the other side are those to whom the question of gold being a bubble is not worth asking because, well, what else could it be? The gold of today is not the gold of the old times -- it’s a paper asset with highly liquid and highly leveraged markets, where derived proxies of gold trade in much larger quantities than any underlying demand. The price of gold is just another effect of the ocean of liquidity sloshing around global markets. Gold is even more of a bubble than so many other commodities have been recently because there’s no consumption story here, and unlike oil, there’s no looming ‘peak gold’ either. It’s the purest of all bubbles.
As an investor, if you think this bubble will continue to grow then by all means go ahead and play it for whatever you can get. Bubbles are irrational and who knows, gold’s price could actually live up to the most optimistic projections that you hear. But please abandon all that old-fashioned nonsense about safe havens. You are riding a trend and how much money you make or lose depends on how accurately you can predict the right time to jump off.
This article was originally published on October 12, 2010.
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