When Will the Gold Bubble Burst? Someday, perhaps soon.

The recent spike in Gold Prices is no doubt a bubble.  But predicting then the bubble will burst is always tricky.  Remember the Real Estate Bubble?  That went on for about two years past the date most people said it would collapse.  As a result, the collapse was worse than expected.

One ironclad rule of investing - in anything - is that speculative bubbles always collapse, always, always, always.

And the gold bubble is no exception.  Driven by fears of inflation, devalued currency, economic crises, global instability, as well as the outright hyping of the mineral by several popular right-wing media talk show hosts, the price has gone from about $300 an ounce in 2000 to nearly $1400 today.

Was this a good investment?  If you could go back in time and buy it in 2000, yes.  Anything after the big gains, well, less so.  For example, if you bought at $1000 a ounce in 2007, you would have been upside down until 2009 and only making money just now.  As I noted in an earlier posting, the gold-bugs like to look at price charts that start in 2000, but rarely look back to 1980, as the price shows more signs of volatility (read:  little guys losing their shirts).

Buying Gold, like any commodity, was probably not a good idea for the average small investor.   And when the bubble bursts (or deflates) the small investor will be the one who "hangs on" to his "investment" until it drops down to an artificially low dip, at which point he will panic and unload it (as many did with stocks in February of 2008) and thus lose even the hope of a rebound.

These gold-bugs will get creamed.

A year ago, many folks thought the bubble would burst, and advise short-selling gold.  Bad idea.  Why?  Predicting when a bubble will burst is hard to do.  I thought the Real Estate bubble would deflate in the early 2000's when I sold a $95,000 property for $285,000 after owning it only five years.  But the bubble kept rising for another two years.  At the height of the market, that property could have sold for $450,000 or more - nearly a half-million bucks.

In the cold, hard reality of today, we realize that a duplex like that is not a half-million dollar mini-mansion, and moreover, the supply of Real Estate more than meets demand.  The valuations of just a few years ago seem, well, alien to us now.  What were we thinking?  Was it even us?  Or was that some sort of alternative history timeline?  Most of us just try to forget it all happened, frankly.

The gold-bugs are mostly right-wing crackpots, and when they lose all their money in gold, I will not cry too much for them.  But the problem with those folks is that they blame all their personal failings in life not on their own actions (or inactions) but on minority groups, the government, in short, anyone but themselves.  It is lazy thinking, at its worst.  When the gold bubble bursts, they will lose their life savings and no doubt blame President Obama for all of their woes.

But I think the bubble may be getting close to bursting.  How can I tell?  Well, it is 1929 all over again.

1.  Average Schmucks are Investing In It:  I believe it was one of the Rockefellers who said that he got out of the market in 1929 when he heard a stock boy at a grocery store talking about his investment portfolio.  When people with no skill or sophistication in investments get into a market, they tend to drive prices wildly higher.  The same happened in Real Estate  in the last decade - people without the skill or knowledge to make money in Real Estate got into it, bid prices up through the roof (to the point where properties had negative cash-flow or were cheaper to rent than own) and then all got creamed.  When listeners to Glenn Beck's program buy gold, the end is nigh.

2.  They are selling gold out of vending machines:  This recent article tells how a mall in Boca Raton has a vending machine that sells gold bars.  Again, this is selling to unsophisticated investors, who are buying gold more out of fear, than knowledge of the market.

3.  People are buying out of FEAR:  Fear and Greed are the worst ways to invest, and many gold-bugs are fear driven - and driven by fear-mongers like Glenn Beck and Rush Limbaugh.  Buy Gold Now! they say, or you will be priced out of the market!  Funny thing, the same argument was made with regard to Real Estate.  Fear is the worst reason to buy anything.  Gold has no inherent value other than for use in electronics, and the like, so if Armageddon comes, well, you can't eat it.  You'll wish you bought bullets instead.  But the end of the world is not nigh, and when people figure that out, well, the price of gold will drop - again.

4.  Gold Prices Have dropped dramatically in the past:  In 1982, the price of gold peaked, and every Joe and Jane tried to buy "Gold Krugerrands" - remember?  Then the price tanked, and stayed tanked for more than a decade.  People who got caught up in the hoopla and fear surrounding Gold back then ended up losing a lot of money on their "investment".


5.  The Economy Will Turn Around:  Just as in 1982, unemployment remains high, in this economy, the recovery will be slow - and a lot of people making six-figure salaries will remain unemployed or underemployed for a long, long time.  As I have noted before, it is very likely that you will get laid off at age 55 and never work again.  And this is happening to a lot of people today (it happened to my Dad back in the 1980's).  It will take time for them to swallow their pride and start a second career.  But the economy already shows signs of a turnaround and growth.   And once Joe Lunchbox realizes that, he will stop panicking and stop buying gold.  Prices will plummet.

6.  Gold costs only about $450 an ounce to mine:  A recent article on gold mining stocks mentions, in passing, that the company is wildly profitable, as their cost per ounce is only about $450.  Re-read that last sentence again and again, until it sinks in.  Even assuming a 100% retail markup through dealers and the like, that still means that Gold isn't worth anywhere near $1400 an ounce.  Once people figure this out, well, the price will fall like a lead balloon.

7.  The Price of Gold is Volatile: In recent weeks, months, and even days, the price of gold has gone from a little over $1300 an ounce to over $1400 an ounce and back again.  A sure sign a bubble is about to burst is when prices fluctuate wildly.  This may be due to people trying to "cash out" of gold investments, while others are still buying in.

8.  All the Pundits Have Called this a Bubble Early On:   Few, if any, financial experts have said that the price of gold is rational.  In fact, it is just like the Real Estate market, where pundits warned for years that a bubble was taking place.  Every day the bubble didn't burst seemed to "prove" that the pundits were wrong.  But in a way, it is like predicting when a volcano will explode.  Ignorant tribesmen will say "well, the volcano hasn't exploded in my lifetime, so that vulcanologist doesn't know what he is talking about!".  And vulcanologists, like economists, cannot predict, with exact certainty, when these types of catastrophic events will occur - with precision.  But they can point to the signs of an upcoming event and say "She's gonna blow!  Run for cover!"

9.  The Supply of Gold is Increasing:  Some of the most profitable stocks these days are gold mining companies.  With $1400 an ounce as an incentive, they are pulling as much of the mineral out of the ground as they can.  And there is a lot of it to pull out of the ground, all over the planet.  So every day that goes buy, ounces, pounds, even tons of gold are being produced.  Every year, over 80 million ounces are produced (that's nearly SEVEN TONS a DAY or nearly 600 POUNDS an HOUR, nearly TEN POUNDS a MINUTE or nearly 3 ounces a SECOND!), and production is on the rise.  And at current prices, people are melting down inventories of old jewelry and the like, and selling.  When supply increases, eventually it will outpace demand, and when that happens, prices will drop - and not by a little, either.

So when will the bubble burst?  If I knew that exactly, I could short-sell and make millions, if not billions of dollars.  Some lucky investor will surely make this bet and be a "winner" and tell everyone, after the fact, what a genius he was to see it coming.

And that is the problem with these types of market instabilities.  They make a LOT of people a little poorer and a FEW people a heck of a lot richer.  You cannot become a billionaire very easily in stable markets.  But irrational markets, where prices see-saw all over the place?  Where uninformed investors are buying based on irrational criteria?  Well, the informed investor can make out like a bandit.

For that reason, I am sitting out the "gold rush" and just watching from the sidelines.  While I can't make money from this coming debacle, I can surely avoid losing money by not getting involved in it.

Such speculative bubbles are little more than gambling operations, where the prices are inflated through fear and intimidation, and when the bubble bursts is not something that the average Joe will know - so that they can sell out in time, or bet against the market.

It is just gambling, pure and simple, not investing - which is why the types of people who get suckered into this are idiots - the type of people who listen to Glenn Beck and think he makes coherent sense.

Walk away from gambling.  It is not a form of investing!

UPDATE:  January 17, 2011:

CNN is starting to call the bubble at this point.  And while, like myself, they are not willing to say when, they believe it will pop soon.  Whether gold can continue to achieve 23% annual gains is anyone's guess.  One problem with bubbles is, that in order to sustain such gains, the prices have to go up exponentially over time.

CNN noted some of the same things I have here - that people who bought at the peak of the last bubble, in about 1981 (the last major recession) are just now breaking even - and still behind if you calculate inflation.  I suspect then, that gold is near or at its "recession panic level".

The other problem with Gold, as CNN notes, is that the high price is based on End-Times scenarios.  If horribly bad things don't happen, well, the price will go down.  Each day that good news is posted will hammer the price of Gold.

So, when the parties show signs of bi-partisanship and reach a budget agreement that lowers the deficit, that's bad news for Gold.

When unemployment drops another tenth of a point, that's bad news for Gold.

When the stock market goes up another 10%, that's bad news for Gold.

I would be hard pressed to say when the bubble will burst, but I think I can say that the best time to buy was in 2005 and today, you'd be hard pressed to make much more.  Selling now, if you bought a year or two ago, might lock in some gains, even if it means you miss the "peak" of the market.

And I can tell you personally that I am glad I sold out of Real Estate before the "peak" than after.  I made a lot of money, but not the maximum possible.

Pigs get fat, hogs get slaughtered.

My prediction is that by the next Presidential election, the economy will have turned around enough that the price of gold will be dropping.  It could occur before then.  But I don't see a long-term sustained price rise at this point.  Perhaps a plateau, but that's it.

For all you gold-bugs, I hope I'm wrong.  But history says the same thing again and again - bubbles always burst - and the supply of gold is not finite!  In the time it took me to type this, another 20 pounds was pulled out of the Earth.