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Tuesday, September 21, 2010

The Gold Bubble

Ah the price of gold. As of when I posted this , it's topping out at $1,300 an ounce. Can you believe it?
The problem is, that precious metal prices, especially gold, are showing the classic signs of being in an economic bubble.
Whats a bubble you ask? An economic bubble is purely driven by human emotion. It starts out when the price of an item (could be anything) starts to increase at a higher than normal pace. Investors see this, and jump on board, betting the price will continue to rise at a fast rate. With new investors spending money, the price goes up even faster, attracting even more folks. The price shoots threw the roof in a relatively short amount of time, and the investment game of "who is the biggest fool" starts. Folks pay more and more money for the bubbled item, until there is no one with "more money" to spend. After a period of time, people start to get the idea that maybe the item is not worth as much as they thought, and begin to sell off. Very quickly panic selling hits, and the bubble pops, bringing the price of the item threw the floor, and in most cases, a lot lower than when the bubble started.
There is no known prediction of what can bubble, or how long the bubble can last. Some bubbles form, and pop the same day. Other bubbles can take many years to pop.
The most famous bubble is the European Tulip Bubble. Before that bubble popped, the price of a single tulip bulb was higher than the price of a house.
The most common place to find bubbles, though, is the stock markets.

Now you know the basics of a bubble, lets get back to gold. The price has risen sharply in the last few years, but there is no economic shortages. Most of the price movement has been caused by a mixture of fear, and speculation. If you watch television now-a-days, there are all sorts of grossly misleading ads encouraging you to buy -buy -buy gold.
Maybe I should pop some of the misinformation out there.
One of the misleading ads tells you that the price of gold steadily goes up.While it's true that the price rises, historically gold prices go up so slow, it does not make a good investment. From 1791 to 1967 the price of gold chugged up a whopping .... $15 on the free markets. That works out to a price increase of $0.08 a year for 176 years.
Another is that gold is a hedge against inflation. Do I really have to explain to you 2/10th of 1% yearly historic increase is grossly behind national inflation? In 1791 $20 could buy you 15-30 acres of land, depending on were you were. Now-a-days, it could buy you less than an acre of land on the moon, or about 1/4 acre of virtual land in Secondlife.
The biggest lie out there, in my opinion, is the prices of gold is stable. Ha-Ha-Ha-Ha. Gold has bubbled in the past. The first major bubble happened in 1864. Gold went up to $42 an ounce. In 1866 it hit a low of $29 an ounce. From there it took 107 years before the price worked it's way back to $42 an ounce. The last major bubble happened in 1980. The price hit a record of $612. By 1982, the price went threw the floor to $375 and took 26 years before it made it's way back to $600. Gold does not rebound fast at all.
From what I see, all the red flags are flying that gold is bubbled. In my opinion, it's very risky to have investments in precious metals right now. According to my calculations, Gold is about $800 over valued at the moment, and when this bubble bursts it could shed as much as $1,000 in value.
I know when this pops, the media will find some rich couple, who are sobbing their eyes out, because they "lost it all" due to overleveraging their investments in precious metals.
You want a safe investment that is inflation proof? Buy US government I Bonds or Treasury T.I.P. Securities.

If you want to do your own gold price research, here is a great site to do it.

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