Does Gold Live in a Bubble?

It’s hard for many to consider gold an overbought commodity during our current economic conditions, especially after the precious metal emerged from two asset bubbles shinier than ever. Gold is currently trading near its all-time high at $1, 017 an ounce, nearly four times its April 2001 price of $255 an ounce, a decade low. These days, you have every late-night TV infomercial offering to buy all your gold and save you from the sharp bite of the recession. Act now to save your home from foreclosure — melt down your gold “grill!” The fact is that gold has always been an emotional investment; the hype is nothing new. Despite what seems like a golden opportunity for investors, many critics warn that the bubble will burst on gold. Natural curiosity leads us to answer the burning question for fence-riding investors everywhere: Does gold live in a bubble?

In the past, gold has been used to hedge against inflation. However, even as gold has risen 11.9 percent over the past 12 months, inflation actually moved in the opposite direction. In 1983, gold rallied nearly 50 percent as inflation fell. From 1985-1987, gold was up nearly 65 percent while inflation stayed constant. The early part of this decade saw gold up almost 60 percent as inflation fell yet again. Only once, in 1979-1980, has a big jump in gold correctly predicted a rising inflation. The opposite can happen as well. In 1987, gold fell 10 percent while inflation sharply rose and stayed high until the early 1990s. It would seem that gold’s value as an inflation indicator is a little far-sighted.

Investors everywhere are practically throwing their money at gold, despite the low inflation. This should strengthen gold’s case, not weaken it, but most feel that investors are anticipating a sharp spike in inflation sometime down the line caused by the growing velocity of money. It’s not just retail investors buying gold online either. China recently bought 600 tons and Russia purchased 100 tons of gold.

Gold has recently become very attractive for several reasons. On the supply side, the amount of gold worldwide is contracting because gold mining production has been decreasing since 2001. Another reason gold is more attractive is because of its increased accessibility. In 2004, the rise of the exchange traded fund made the process of buying gold as easy as buying stock. With the supply of a natural resource quickly diminishing and the demand increasing, the evolving global economy will grasp tightly onto the only commodity that is always worth its weight. Gold doesn’t live in a bubble, though it appears its critics do.