Is Gold in a Bubble? Will it Burst in 2011?
Nov 9, 2010 Kurtis Hemmerling
Few will dispute that the price of gold has risen rapidly over the past decade. Some are calling it a bubble while others claim it is merely a return to rational levels. What is a bubble? Is gold in one now? Will it burst in 2011?
What is a Gold Bubble?
One source describes a price bubble as speculation in a commodity causing the price to increase, thus creating a self-feeding machine that boosts prices up even higher. The prices inflate rapidly and hit terrific highs. Typically following this is a nasty downward crash.
Another source suggests that a financial bubble is when market prices steeply deviate from an objective analysis of intrinsic value.
It is difficult to pinpoint any one cause to a bubble, but a common denominator appears to be a highly speculative buying frenzy. What is the difference between a sustainable price advance and a bubble?
Sustainable Price Advances
Prices go up to meet demand and inflation. A price jump is sustainable when the demand is likewise stably climbing.
For instance, if you have a limited supply of corn and the population continues to grow, it is probablye that the value of corn will continue to rise with demand. Unless a large portion of the population suddenly becomes allergic to this staple commodity, demand should remain strong. This is one of the benefits that consumable commodities receive. There is an on-going need for more.
Potentially Dangerous Price Advances
A dangerous price advance is one built primarily on speculation. Instead of the commodity truly being consumed and the population needing more as a replacement, the demand comes from an increase of stockpiling with the goal of selling it later for a higher price.
Only a small fraction of gold is used industrially. An article republished by the World Gold Council claims that only 12 percent of gold usage is industrial. A large amount of the buying of gold is related to speculation. Some of these are:
- Gold bought by central banks
- Gold purchased by investors as an alternative currency
- Gold producers de-hedging futures contracts
- Gold as a hedge
- Speculative buying and selling on futures contracts
If the intrinsic value of a commodity is tied into its ability to be consumed or to its industrial use, then it is hard to arrive at a concrete valuation for gold.
Factors Driving Up the Price of Gold
Here are just a few of the factors that are driving gold prices high:
- Global debt fears
- Comments from World Bank president, Robert Zoellick, hinting toward the return of a partial gold standard
- Political turmoil
- Quantitative easing inflating the paper currency
- Speculative buying by central banks and investors alike
Will the Gold Bubble Burst in 2011?
No doubt many will take exception to calling the current gold prices a bubble. Others purport that this speculative climb in prices cannot be described any other way. Whatever you want to name the strong price advance of gold, will it continue on in 2011? Many analysts think so, and call for an average price of $1,500 per ounce. Nonetheless, much caution should be exercised. What might drive prices back down?
- Return to a stable economy
- Gold prices become too high creating doubt of further advance from general public and institutions
As the global economy improves, we should keep a close eye on the high price of gold. This precious metal has a long-term history of volatile change without warning. If enough people lose their belief in the power of gold, it can fall from the sky like a brick! When this will take place is a question nobody can answer with certainty.