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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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The Current Gold Bubble

Posted by Muthu on July 10, 2010

We’ve been writing about the bubbles of the past.

History is of no use unless we learn something out of it.

I want to write today on a current bubble, the Gold bubble.

Gold is a useless asset.

There is no industrial consumption for it.

It does not yield you any dividend or interest.

Long ago, Gold ceased to be an underlying asset for printing currencies of the nations.

Though people may talk about spectacular returns, Gold has given in the recent years, past performance and history tells us that Gold is a mere hedge against inflation, (i.e.) the growth in value corresponds to inflation in an economy or world, over a long period of time. 

If you take last 4 to 5 decades performance, Gold has gone through strong bubbles and burst. Traditionally, Gold has been yielding, on an average only 6% per annum, which is a protection against inflation.

At best Gold protects your wealth but does not enhance it.

Gold has only ‘Social perception value’ and no real utility value. There is no real value to Gold, other than what we socially attribute to.

In a country like India, Gold is considered to be the best of the asset and in occasions like marriages, the value attributed to a family is directly proportionate to the amount of Gold they own or offer.

Right from the poorest to the richest in our country considers Gold as a ‘must have’ asset. For the poorest and middle class, sometime this is the only ‘asset’ they have.

When you attend marriages, you can see that the women who ostentatiously display the gold ornaments they have, are the envy of other women.

Since almost every family in India has some investment in Gold in the form of jewelleries and ornaments, I keep listening to people as to how wise they are in ‘investing’ in Gold, rather than equity or real estate, given the phenomenal increase in the value of Gold during the last few years.

Let us listen to Valueresearch.

“Gold prices seem unstoppable. They’ve reached levels that would have been unimaginable a few years ago and gold cheerleaders say that they are on their way to levels that are unimaginable today.

When investors go and look for information on whether gold is still a good bet, there is no shortage of strong and apparently well-reasoned arguments supporting why gold prices will continue to rise. There are many variations to these arguments, but basically, they all boil down to some version of the ‘safe haven’ theory, viz. that investors are fearful of the future of stocks, bonds, currencies and all other kinds of financial investment. They think that there could be another financial crisis and are thus being smart in rushing in to an asset type that has a historical reputation of protecting wealth in bad times.

Not just the financial media, but even the general media now carries articles recommending gold as a significant chunk of individual investment portfolios. As a mainstream financial investment, gold’s day appears to have arrived. Or has it? Will gold live up to the hype? Definitely, the hype has now reached impressive levels. On the Internet, it’s not difficult to find apparently sane analysts who say that gold could rise to four times today’s price in five years. Projections of two to three times today’s price levels in a year or two are commonplace.

Is this a bubble? The truth is that in any sensible discussion, that question is not even worth asking. Of course gold is a bubble–what else could it possibly be? The gold of today is not the gold of old — a largely physical asset that was a safe haven in troubled times. This is a paper asset; with highly liquid and highly leveraged markets where derived proxies of gold trade in much larger quantities than any underlying demand.

This bubble is like the other commodity bubbles that you have seen over the last few years, whether oil, copper, nickel, wheat and so many others. In fact, gold is even more of a bubble because it is an inherently useless material, earning no dividends or interest. There’s no industrial consumption story like copper or nickel here, and unlike oil, there isn’t any danger of ‘peak gold’ laying waste to the world economy. Gold is the purest of all bubbles — where even the story being told by its proponents is that they expect its price to rise because everyone expects it to rise.

Sure, if you think this bubble will continue then by all means try and milk it for all it is worth. Bubbles are by definition irrational and who knows, gold’s price could actually rise five times in five years. But if you invest in it today, have no illusions that you are putting away money for a rainy day. You are actually speculating that a particular madness will continue for a while. One day this madness will end suddenly, and then you’ll have to run away. When that day comes, how much money you finally make will depend on whether you can outrun the stampede for the exit gate.”

I want to conclude this article with what Warren Buffett has to say about Gold “ Gold gets dug out of the ground in Africa, or some other place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head”.

As it goes without saying, Warren Buffett has refused to participate in the current ‘Gold Rally’. 

(with inputs from Valueresearch)

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