Bursting The Bubble Of The Gold Bubble Prophets
By: Poseidon One
October 28, 2011
We've all seen them. Every time gold undergoes a significant correction, the gold bears come out of the woodwork to proclaim that the gold 'bubble' has finally burst and we're about to see a massive sell-off.
And, each time, those gold bubble prophets have been proven wrong as gold has continued its uptrend, climbing the proverbial wall of worry to new highs. Fundamentally, this is because the basic drivers of higher gold prices: inflationary monetary policy in the US and the global debt crisis, are still in place. Gold, as the true market money throughout history, stands as the lone alternative to fiat currencies, and stands to benefit when those currencies are being debased - as is the case in the US via the Fed's QE policies - or when there are more political type risks that pose threats to the viability of a fiat currency - as is the case with the euro and the European monetary union. It is also crucial to understand that the global debt crisis goes hand in hand with monetary inflationism; currency debasement is the easy way out for governments faced with either significantly cutting bloated spending levels and raising taxes - an extremely unpalatable political option in a democratic system - or using the printing press to reduce the real value of debts via inflation.
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After today, it seems that the Europeans, after making a good show of holding out against the temptation, have opted to use the printing press themselves. The plan is, apparently, to raise the bailout fund to 1.4 trillion dollars. So, they're coming fashionably late to the currency debasement party, but, hey, better late than never!.
The notion that gold is in a bubble, either from a fundamental or technical perspective, simply does not stand to reason. I define a 'bubble' as a situation in which an asset's price rises to levels that are irrational given the true underlying economic fundamentals, or, as some might term it, 'reality.' That's not to say, of course, that expectations about the future don't come into play; just because a company, such as, let's say, a smaller gold miner, has a high P/E given current earnings doesn't mean that it's in a 'bubble' if the fundamentals of the gold market support earnings increases going forward. The fundamentals of the gold market and the macroeconomic elements that support it, however, do not show a dichotomy with gold's rise.
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If and when the Federal Reserve pulls a complete 180 and embarks upon an exit strategy of raising interest rates and pulling reserves out of the banking system, gold's bull market will have come to an end. This is more or less precisely what occurred during gold's last real bull market in the late 1970s, with Paul Volcker's massive interest rate hikes putting the nail in the coffin of the yellow metal's rise. Until Bernanke (or his successor?) does the same, however, gold will maintain its strength, and it seems at this point that there is little end in sight to the Fed's inflationary policies.
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The basic story is that the recession itself, having been caused by artificially low interest rates and inflationary monetary policy, cannot possibly be cured by more of the same. Fire does not put out fire. Bernanke's expansion of the monetary supply has done little more than delay and prevent the necessary restructuring of malinvested assets that were spawned during the artificial boom; indeed, what the Fed has done, in effect, is to shift those toxic assets off the balance sheets of the major banks and onto its own books, thereby directly reducing the quality of the assets backing its liabilities - namely the US dollar. The Fed has, at this point, put all its cards on the table; if it didn't allow market forces to cleanse the system of the malinvestments back in 2008/2009, it's not likely to do it now, after all its efforts to keep the system on life-support.
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Technically, the July to mid-August rise in gold that many have termed 'parabolic' really was not all THAT drastic from a longer-term perspective. Yes, gold rose very high, very quickly- about 30%- but looking at the 3-year chart below one can see that, while it did move above the top of its long-term trend channel, it did not do so drastically. (Click charts to expand)
Clearly, though, a correction was overdue, and gold subsequently fell back toward its 200-day moving average and the bottom of the trendline channel. It has since moved upward to challenge the 50-day moving average, invalidating a potential bear flag formation that many saw forming over the past several trading days.
I would hardly consider gold's price movement above as indicative of any sort of bubble. In contrast, the REAL bubble out there in the markets today is the bubble in US government bonds. Remember, a bubble, properly understood, is a situation in which an asset's price is at odds with the underlying economic reality. This is precisely what we have now in the bond markets. Despite inflation running at near 4%- 7% if you don't believe the government's fudged CPI numbers, investors in US treasuries are accepting yields of 3.45% on 30-year bonds (and less, of course, for shorter dated treasuries). That means, in essence, that they are paying Uncle Sam for the privilege of being able to loan him their money. This renders treasuries, typically considered 'safe havens' or 'conservative' investments (and I know first hand that this is what mutual fund investors are led to believe) effectively the RISKIEST asset class out there besides money markets or cash, since there is a 100% probability- a certainty- that one will lose value in real terms.
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Flying in the face of this reality treasuries as represented by the iShares Barclays 20+ Year Treasury Bond ETF (TLT) rallied more than 30% from late June to the beginning of October, even as the US's credit rating was downgraded. The rally, though, was never going to be sustainable. A recent article penned by Bud Conrad over at Casey Research shows that foreign central banks, key players in the US treasury market, were actually slowing their purchases as this rally occurred and yields were being pushed down. Indeed, they recently began selling off their holdings in the aggregate, according to this graph.
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As you can see, for many years now there's been, for obvious reasons, a clear correlation between the growth rate of foreign central banks' treasury purchases and treasury yields. The recent rally was at odds with that correlation and therefore with the basic logic of supply and demand. If it continues like this, the Fed is going to be the only one left buying treasuries, especially after private bond investors finally wake up to the reality that they are being fleeced. Indeed, if the chart below is of any indication, treasuries are already starting to breakdown.
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Don't look now, but it seems that the sheep are finally starting to bleat.
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