Gold Prices – Strong Fundamentals or Speculative Bubble?

 

While many market predictors are calling for an end to the gold bubble, gold investors are of the view that we are still in the early stages of the bull market in gold due to overwhelmingly bullish fundamentals.

Amidst growing concerns about a hobbled US economy, European sovereign debt and fears over government money printing, solvency, there is much evidence of growing enthusiasm in precious metals. The shiny yellow metal is more popular than ever. Central banks which disgracefully sold gold (during1990s) at the bottom are now aligning with investors to accumulate it. Besides, noted hedge fund titans like George Soros are loaded down gold exchange-traded funds (ETFs) and mining stocks. The growing demand for safe-haven assets propelled the precious metal to settle a record high of $1500 per ounce while silver reached new 31-year highs of $42.940 per troy ounce on the Comex division of the New York Mercantile. Reports indicate that rise in prices was mainly due to international investors opting for gold as a safe haven for their money against growing political or economic uncertainty and also to protect their wealth from currency volatility, especially the US dollar as a reserve currency. And of course the price of gold is also buoyed by increasing demand from emerging markets.

Goldnomics

It is generally believed that gold protect investors against inflation and deflation and offers protection against financial fight. Thus yellow metal is known as a safe haven asset and an attractive alternative to cash. Gold and other precious metals will continue their bull run higher as investors look to combat inflation. Furthermore, gold is the only major investment asset that does not stand for someone else’s responsibility to repay. Unlike stocks and bonds, whose supply can increase to meet demand, however, there is no enough gold to meet today’s prices.

Global investment banking and securities firm, Goldman Sachs has a target $1,690 an ounce for 2011. Similarly, HSBC forecasts gold will rise by 8% annually for the rest of the decade and recommends a 15% investment allocation to the precious metal. It further adds that gold will continue to attract safe-haven buying from risk-averse investors. Moreover, as the Euro is in trouble amidst sovereign debt concerns and the US Dollar is endangered by Federal Reserve’s loose monetary policies, the yellow metal has become the hottest currency than ever before.

Under-owned Asset Class

While many market predictors are calling for an end to the gold bubble, gold investors are of the view that we are still in the early stages of the bull market in gold due to overwhelmingly bullish fundamentals. They believe that a collapse of the US Dollar will one day cause gold and silver to soar to an unprecedented level. Echoed by US-based Kaplan, a precious metals entrepreneur and suggests that “The attributes of gold are that it is a precious metal without a counterparty or credit risk. It should not trade in as volatile a fashion as oil, copper or other commodities dependent on the health of the economic cycle.

Despite a decade gold bull market, the vast majority of people still do not own any gold. It remains under-owned and as an asset class, it is far from being overbought by speculators. New investment in gold over the last ten years totaled about $250 billion compared to $100 trillion that went into other financial assets over that same time. Bullion experts say as the world is full of increasingly suspect paper money and paper assets where majority of investors are looking for something other than twisted paper. Accordingly, they say that gold not in a bubble, and the price could double in near future.

Speculative Bubble to Burst?

History reveals that no investment asset moves up in a perfectly straight line. Investment themes always go in cycles and each cycle ends with a tremendous rupture of buying attract one and all in near top of the Bull Run. Accordingly, will the speculative bubble burst soon in precious metals markets? According to Yogi Dewan, the Founder and CEO of Hassium Asset Management “Gold is currently in a bubble and investors need to apply some common sense when trading it, as it will likely fall on interest rate tightening.” He further adds “This is a bubble and a fear trade. As soon as the recovery takes hold and the interest-rate cycle changes you will see mass outflows from gold into riskier assets.” Edward Chancellor, author, “Devil Take the Hindmost: A History of Financial Speculation” made an avid case that gold was overpriced and said that gold is experiencing a bubble, adding that bubbles, are defined by valuation rather than investors' behavior. Even though doomsayers expressed over the price of silver, but it is less worrisome due to industrial demand for the metal.

In conclusion, based on the above factors and trends, we believe that interesting days ahead for those investors who own precious metals. If the current trends of geopolitical risks continue, there are chances that gold could double over the next five years.

N Janardhan Rao, Senior Economist.