The Great Gold Bubble

Almost every day that I tune into CNBC I have to listen to someone warn Americans about the potential bubble in the Gold Market.  They have been calling it a bubble since gold was $850 an ounce.  With gold now closing in on $2,000 dollars an ounce, it is making headlines daily.   So what do you think?  Is gold in a secular bull market or is it in a bubble? 

I would like you to try to name five people who invest in physical gold or silver.   Notice I said physical and NOT precious metals stocks or exchange traded funds (ETFs).    A majority of stocks and ETFs mirror the metals’ spot prices but do not keep any physical metal in inventory.   I bet you were unable to think of three or more people investing in precious metals.   That is because almost nobody is buying physical precious metals.  I have noticed dozens of gold shops spawning up all around me but this does not suggest that gold is in a bubble.  This verifies my position, that the masses are still net sellers of gold and silver because they would rather have quick cash. You may be asking then who is buying precious metals that are causing the sky rocketing prices in the precious metals markets?  Answer:  Central Banks.  China, Russia, India, Mexico, and most recently South Korea have been buying tons (or tonnes) of gold at a staggering rate. 

Why do central banks hold gold?  Ben Bernanke said “because of tradition”, but I would say because gold and silver have been money since 7^th century B.C. when Greek city states first started bartering in coins.   Throughout history, gold and silver have remained valuable – serving as both jewelry and money.  Paper currency was first issued as way to exchange precious metals without having to carry the metals around.   Eventually, people became accustomed to exchanging the gold notes instead of physical gold and silver.   The price of gold provided an exchange rate between international currencies prior to 1945.  In 1945, the Bretton Woods System was set up and 29 nations agreed to accept the US dollar as the currency by which international business was to be conducted.  For example, if Britain was to purchase goods from Norway, they would settle in Federal Reserve Notes instead of Pounds.  At the time, the US dollar was a stable currency because it was still on a gold standard.  Thirty-five dollars equaled one ounce of gold.   However, in the early 1970’s the US economy was suffering from stagflation as we found ourselves in a never-ending conflict with Vietnam.  Low interest rates, rising military costs, and increased domestic spending (sound familiar?) paved the way for inflation and a loss in US Dollar confidence.  In early 1971 countries started to cash in some of their paper money for physical gold.  Switzerland traded in $50 million in paper for physical gold and France followed suit by redeeming $191 million for gold.    On August 15^th, 1971 President Nixon took the most drastic response and closed the gold window to prevent foreign countries from emptying Fort Knox.  Since that day, which became known as Nixon Shock, gold has been sky rocketing and the dollar has been weakening as a result of our growing trade deficit and the FED’s inflationary monetary policy.   So gold may be in a bubble, but we are only in the beginning stages!