BUBBLY GOLD MIGHT TAKE A BATH / THE WALL STREET JOURNAL ( VERY HIGHLY RECOMMENDED READING )

HEARD ON THE STREET

AUGUST 27, 2011.

Bubbly Gold Might Take a Bath .

By LIAM DENNING

Is there a gold bubble?

In one respect, gold always is in a bubble. An inert metal in every sense, gold has no intrinsic value as an asset so buyers focus primarily on its resale value. This search for the greater fool is characteristic of bubbles. Yet gold having accelerated this year, the question of whether it is now too expensive takes on new urgency.


Compared with other bubbles, gold's rise actually looks tame. In the 10 years leading up to Aug. 22, when gold closed at a record nominal peak of $1,888.70 a troy ounce, the price had risen 587%. In comparison, crude oil rose almost tenfold in the decade preceding its all-time peak in 2008. But neither hold a candle to Nasdaq: The index climbed more than 2,000% in the tech-crazed decade that ended in March 2000.


Justifying further gains on the basis that we don't yet seem to have lost our marbles to quite the same degree as last time isn't terribly convincing, though. Other comparisons provide similarly unclear results. Deutsche Bank calculates that, in real terms, gold has surpassed its 1980 peak when adjusted for both U.S. producer and consumer inflation. That suggests the price is extreme already. On the other hand, Deutsche also reckons gold compared with the price of oil or the S&P 500-stock index suggests scope for a move toward $3,000.


Another way of assessing gold's bubbliness is to look at the main arguments in its favor.

One is that gold hedges against a falling dollar. Yet gold's 22% gain since April has happened while the dollar hasn't really moved. Another is that gold offers a hedge against rampant inflation. Yet that looks unlikely with weakening developed economies and monetary tightening in major emerging ones. Gold also is touted as a store of value. Yet the history of the past few decades suggests it can be terrible in this regard for long periods of time. Rising price volatility also counts against this argument.


Gold's real underpinning is real interest rates near or below zero, reducing gold's opportunity cost and reinforcing a sense of crisis. Tellingly, the most recent rally since July coincided with a renewed plunge in real rates: The yield on 10-year Treasury inflation-protected securities dipped below zero for the first time in the data series' history.


Gold jumped higher again Friday after its recent pullback. Ostensibly, that's because Federal Reserve Chairman Ben Bernanke's notably bland speech left open the door to further monetary easing. Yet it could be argued, equally, that he spoke little about extra measures and gave a gloomy outlook. That could signal deflation rather than inflation, a scenario in which real rates would be apt to rise rather than fall, hurting gold.


That gold nonetheless staged a rally on the back of this most noncommittal of speeches may be the surest sign of all that prices are frothy.