A Bubble For Fun

I have noticed that my grandchildren love bubbles.  The bigger the better.  I have also noticed that bubbles are not very durable and the bigger they are the less durable they are.

Same durability thing with financial bubbles.

Forty-five years ago my karate sensei advised that in times of danger, the best defense was to be somewhere else.  Same advice for financial danger.

The trick is to notice the danger and then be somewhere else.

Here is one to think about.  Gold.  Probably silver would be similar but as gold is about 60 times the value and there have been many times when it was less, silver may not be as vulnerable.

In my view, gold is a commodity and eventually it will change price in concert with its underlying unit of measure.  A currency.  In this case the US dollar.  If it trades for more, then there is a speculative element, a fear element, an uncertainty element or perhaps just mindless greed.  The objective measure is how many units of currency does it take to buy a unit of the metal.  If the currency is price adjusted and the commodity always behaved the same way, then ratio would be a straight line.  No commodity behaves that way in my experience but they all tend that way.

Here is how gold looks now

price adjusted gold v1

If you do the graph in other currencies it looks similar.  I have tried it with the Swiss franc and it is similarly shaped but not as pronounced because the Swiss franc has not depreciated as much as the US dollar.

If the ratio is to work as a speculative investment into the future, one or more of four things must be true.

  1. The US dollar will inflate dramatically.  This would require about a 40% loss in value just to justify the current price, so you will need much more to make it an investment.  If you do get that, the world economy will be in disarray and maybe by owning gold,  you will be the only survivor.
  2. The price of gold will rise based on factors that are not related to its being a commodity.  If the US dollar stops being a reserve currency for example.  Again, this is very difficult to do.  Recall that the US is still around 40% of the world economy and they owe money to those that might think this a good idea.  They will lose most of their investment in the US.
  3. India cannot lose interest in gold. At some point they will need business capital. When that happens the gold sells and the business begins.
  4. The price of gold will rise because enough people believe it will rise.  Watch how many TV and radio ads there are.  If you spend money to advertise you do so for a reason.  In this case, it is because the intrinsic value is not there and you need to hype it to get people to participate.  Like movies.  If a movie is a good one there is little advertising after release.  Poor ones however get lots.

It is possible that gold can bubble higher in the near term.  If you like speculative investments, possibly you should be there but you do have to get out.  Gold is a two-decision investment.  Be careful.  Be especially careful to notice that just because a price is too high, does not mean it cannot go higher still.

When asked when is the best time to sell an investment, Warren Buffet replied, “Never.”  That will not be the answer for gold.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

don@moneyfyi.com  |  Twitter @DonShaughnessy  |  Follow by email at moneyFYI

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