A bubble is what happens when individuals who would generally shy away from an asset or investment become so crazed by it, that they throw all rational and logical thought aside in the hopes of attaining possession of said asset at nearly any price, no matter how over inflated its value has become. In almost all cases the asset is priced well above its intrinsic, or real fundamental value.
Our nine year old son, for example, would never wear pink – ever. He wouldn’t be caught dead in it, for obvious reasons. Nor would he have ever considered wearing a bracelet – that’s something his sisters are generally into.
Last year however, elementary students the country over became crazed over something called silly bands. They’re little rubber bracelets available in a variety of shapes, sizes and colors – even pink. As the craze took off, silly bands became a hot commodity item. Impulse counters at local stores were emptied of any and all silly bands. Silly band value at school was going parabolic, with some shapes in specific colors being traded on the free market at a ratio of 10 to 20 inferior bands to one of the more “rare” models. Even high dollar action figures worth around $10 retail would be traded for a single band that probably cost no more than a penny or two to manufacture.
When we did happen across a package of bands at the store, and refused to shell out the $5 for an 8 pack of what essentially amounts to rubber bands, we got the evil eye and a never ending barrage of protests – even the Slavo sisters got into the mix, hoping that they, too, would be the beneficiaries of silly bands once their parents buckled.
Much to the distress of the Slavo kids, there was no buckling, because we were very well aware that a Silly Band bubble had formed, and a crash in silly band prices and demand was imminent. That didn’t stop the kids from spending their hard earned allowance on them.
It has now been months since the collapse of the silly band bubble, and what was once a high value asset has become just another piece of trash on the carpet in need of disposal. While the girls may still wear one or two from time to time, Mac Jr. won’t even consider accessorizing his daily apparel with a band.
That’s what a bubble being blown and it’s subsequent popping looks like.
When it comes to asset bubbles, kids and adults behave in much the same manner. We are, after all, creatures primarily driven by emotion, as opposed to logic and rationality. As humans we have an inherent need to be accepted, and for most people that means doing what everyone else is doing.
For the last couple of years we’ve heard analysts the world over declare that gold is in a bubble. We can generally spot a bubble when people who would traditionally shy away from a particular trend or investment become experts and die hard proponents of it.
The argument from some analysts, investors and market commentators is that gold is now in bubble territory and set to collapse.
In February of 2010 billionaire financier George Soros was quoted as saying, “The ultimate asset bubble is gold.” The mainstream investment community immediately took this statement as a suggestion that Soros believed gold was topping and would decline. At the time, gold had reached all time highs and was trading at $1080 per ounce. Today, it’s trading just north of $1500. What happened? Didn’t Soros say it was a bubble?
What Mr. Soros said, and what was interpreted by those who hang on his every word were two different things. Within the context of this financial crisis gold is the ultimate bubble. But Soros didn’t say that it had yet reached bubble territory – only that it would be the ultimate bubble within this general crisis. As we know, the crisis is nowhere from being over, and in fact, the economies of the globe are in much worse shape today than they were in 2010.
Another common misconception among highly paid analysts and pundits is that everyone is buying gold. For a time in 2010 this was based on all of the “We Buy Gold” signs popping up on street corners. Everyone, it seemed, was buying – the “signs” were literally everywhere. A little examination would have gone a long way in determining the extent of this gold buying.
A couple of weeks ago, with silver trading at around $37 we decided to have lunch at a diner we frequent in the Houston area. A few doors down from the diner is a “We Buy Gold” business, so we decided we’d stop in to see what type of pricing these dealers had just in case we needed to liquidate our precious metals in an emergency. To our surprise, the gold store employed one individual, had absolutely no gold for sale, no cash register, and quotes were pulled in real-time via a Blackberry. We advised the “broker” that we had 10 ounces of silver to sell and requested a quote. Not only did the broker low-ball the silver spot price using an intra-day low for that day (which was $1 lower than the actual spot price at the time, as we pointed out to him when he pulled up the Kitco web site), when it came time to finalize the deal, the broker made a call to his boss. We were then advised that they were willing to pay $30 for the bar, a whopping 20% less than its value.
Our point with this story is that even though we may be seeing “We Buy Gold” signs all over the place, the dealers are only Buying, not Selling, and when they do buy, they are heavily underpaying the seller. We pointed out to the dealer that he was running what essentially amounts to a scam by taking advantage of uninformed sellers who are probably hard up for cash, which is why they are selling their precious metals jewelry.
Clearly, the “We Buy Gold” signs and commercials cannot be used as an argument that gold has reached parabolic bubble territory. They may be buying gold, but the average American man or woman on the street certainly isn’t. The only thing they can do in these establishments is sell. So the next time someone uses this as an example of how everyone is buying gold, you’ll know they are touting the mainstream line and really have no idea what they are talking about.
When we talk about gold buying, we need look only at what is happening in Greece, China and India. Greek buying of gold, for example, proves to be anything but bubble irrationality. It is emotionally driven, but not in the same sense as wanting to wear a silly band like everyone else, but rather, to protect accumulated wealth and preserve it:
Via The Daily Crux:
In an effort to protect themselves from the collapse of their banks and government, Greeks are rushing to the only money governments can’t mess with: gold.
Greek citizens are emptying savings accounts and buying gold as they brace themselves for the possibility of a sovereign default and runs on the country’s banks.
Gold is again being seen in Greece as an essential store of wealth, hedge against inflation and safe haven asset.
This is not surprising given the scale of the crisis and the sharp falls seen in Greek property and equity markets (see chart above).
The fact that gold cannot default or go bankrupt unlike every single corporation, bank and government in the world is making it the safe haven of choice again.
There is also the important fact that it cannot be debased by bankers and central bankers unlike currencies and bonds.
Greece is the canary in the coalmine and the likelihood is that what is happening in Greece today, people using their cash deposits in banks to buy gold bullion, will be seen in many other countries in the coming months.
Indeed, news from the Perth Mint of record sales of silver coins is indicative that this trend has already begun.
Bloomberg reports that “Silver-coin sales from Australia’s Perth Mint, which was founded in 1899 and processes all of the country’s bullion, have surged to a record as buyers seek to protect their wealth with the metal known as poor man’s gold.
The Greeks are buying gold at unprecedented levels. In the heat of the crisis in 2010, in fact, they were willing to pay $1700 an ounce, over 40% more than the free market price at the time. This was a mini-bubble, as gold prices dropped shortly thereafter, but it was a clear demonstration of how quickly an asset can rise in the heat of panic or market exuberance.
The Indians are also buying gold. Just last month India saw a 222% increase in gold demand, with consumer inflation and wage deflation reported as the cause in personal purchases of the metal.
As the people of the world realize their currencies are depreciating and their governments are further destroying their economies, they are looking to preserve whatever wealth they can.
While we’ve also witness gold and silver demand increase in the US, for most Americans precious metals are still a fringe investment. One reason for this is because financial advisers who have traditionally recommended stocks and bonds have yet to come around to gold as a legitimate investment.
This ever increasing demand around the world, however, is beginning to open some eyes, and the big money on Wall Street is already beginning to shift assets. One recent example is the University of Texas, which is currently sitting on a reported $1 billion gold investment.
As big money takes the lead, the smaller money is starting to notice.
The “ultimate gold bubble” is certainly in progress, but we strongly believe it is still in its infancy. The world may be buying, but we must remember that America has the strongest economy and the most wealth of all nations – and we have yet to begin any sort of significant buying in terms of individual investment.
As financial, economic, monetary and political crises unfold, we can expect to see the value of gold continue to rise. When asset values start crashing, in real terms, and the public loses confidence in our government and The Federal Reserve, the level of buying will increase, eventually leading to a craze.
When the “We Buy Gold” signs turn into “We Sell Gold” signs with buyers willing to pay exorbitant prices, and gold becomes the topic of conversation at the water cooler and your local Starbucks, you’ll know we’re reaching the apex of the bubble. When those who would never consider investing in gold today begin attending gold buying investment conferences together with friends and neighbors, or they start recommending books for you to read about gold investing, you’ll know it’s time to transfer your wealth into a different asset.
Until then, we hold the view that no matter how high the price, dollar-cost-averaging is the best strategy with those who have extra funds available to store and preserve wealth.