The Gold Rush – is there a bubble in the Gold Market? – A short analysis

As the current gold prices continues to roar up the ladder and on its way to pass the 1,400 USD/t. oz. mark, one might think if this price is justifiable for this precious metal. Could it be possible that there is an economic bubble in the Gold market?

First, what is a bubble? Or economic bubble? Let’s go to good old Wikipedia, I think they didn’t mess this term up so it should be safe to rely on it: “An economic bubble (sometimes referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, a speculative mania or a balloon) is “trade in high volumes at prices that are considerably at variance with intrinsic values”. It could also be described as a trade in products or assets with inflated values.”

I think it’s well known that many investors and traders fell back on Gold and Silver because they are considered safe heavens when the level of uncertainty in the markets rises. What are the uncertainties? We all know them, they include: the U.S. economy and the continues slash of its currency’s worth with the quantitative easing phase one and two, not to mention the 2008 downfall; Europe’s decline with Greece and Ireland nearing bankruptcy, and with other countries on the target such as Portugal; China is also expected to slow down its rise to fight inflation in 2011. Therefore it leaves many of us with commodities to put our money in, and Gold is a good of a commodity as any other.

To refute the existence of a bubble the current prices shouldn’t be detached from the real price, i.e. the demand/supply price. If the asset is priced more then its worth then we have a bubble ready to explode.

In order to check this claim I have gathered information about the total world demand and supply in tons between 2004 and 2010 (Q4 2010 was an estimation) and compared it to the average yearly gold spot price.

If there is no bubble it should mean that the rise in the gold prices should be inline with the rise of demand or the lack of the supply to maintain the demand.

So let’s get started…

In the table below there is the spot gold price in yearly average for 2004-2010 (2010 is up to October), and it is compared with total world Demand for Gold, total world Supply and the supply surplus or deficit (supply minus demand). The last figure shows that if the demand isn’t provided then there is merit for the price to rise because of lack of gold.

The table below presents the year to year change of the demand, supply and gold price (percent change).

spot gold price and supply & demand of gold 2004-2010 percent change

During the years listed above. the gold price increased very sharply the demand and supply didn’t rise in the last couple of years.

Could it be a matter of inflation? I.e. the prices of most commodities rose and therefore the relative price of gold didn’t change much. Perhaps, however I don’t know of any high inflation that we have recently suffered from in the Western world (e.g. Crude oil prices and natural gas prices aren’t higher then they were a few years back).

So what is the bottom line?

I think we should consider that Gold is at a very high price and could be separated from its “real worth”. If it’s true, then it means that Gold is overpriced and its market is a bubble ready to pop any time…

When, if any, this bubble will burst? Good question… I can’t give a good estimate because it’s a tough question…however, I could speculate that it could happen when investors will try to move their funds to somewhere more attractive; nonetheless, this bubble burst could take a long time (even years), because there are no apparent good alternatives as I have pointed out at the beginning, and as long as the trust in the major markets isn’t restored, it will be hard to persuade anyone to move from Gold.

Consider this small story my father told me which could illustrate the point of bubbles in worthless assets:

Back in the 70th there was a shortage of candles in Israel before the Hanukkah holiday, in which there is big demand for candles to light up the menorah. Two guys, however, managed to import several boxes of candles, and storage them before Hanukkah, in order to sell on them on the holiday and profit. One of the guys was short on money, so he asked his partner to buy his cut with at cost+ 10% profit, and persuaded him to sell with this profit margin because he will still make a larger profit margin when he will sell the candles coming Hanukkah. The partner was persuaded and bought the guy’s share. A month goes by and the former partner resolved his fiduciary problem and asked to buy back his cut. This time the partner agreed to sell him back his share but for a 15% profit. The guy wasn’t excited but was convinced that he could make a lot more when they will both sell the candles and bought back his share. Another month goes by and now the partner decides to back out, because he needed the money, the partner asked to sell to the guy his cut with a 20% profit.

The guy said to him: you know what; I just checked the boxes and all the candles don’t have any wicks inside them…they are useless and we won’t able to sell them…

To which his partner replied: Don’t mind the candles, let’s just continue bargaining without them…


Goes to show no mater what the commodity is or its market worth, it only matters what you think it is worth….


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