Let me start by answering the question posed. Yes — there is almost certainly a serious bubble inflating in the gold markets.
Now let’s step back a moment and take note of the irony of this. Why did this bubble inflate — or, more precisely, what actions set the stage for the inflation of a bubble? Well, it would seem that ‘gold bugs’ are two a penny these days. People don’t understand how modern monetary systems work — and, since ignorance invariably breeds fear, a lot of people are spooked in these days of QE and large government deficits.
This flight into the gold markets was originally undertaken by the fearful, the cautious and the confused. And this is where the irony comes in. This flight by those hard-headed folk who think they ‘know better’, has now led investors seeking profits to bump up the prices of gold (and silver). The gains are record-breaking — gold hit $1,500 the other day — and the rhetoric is absolutely typical of a bubble. Consider the following, from a Guardian article the other day:
Jollie believes the silver price is unsustainable in the longer term, but says it’s possible the price could first exceed $50 if the speculation continues.
You can almost see the investors rubbing their palms. Hence, the irony. People in search of a safe haven have, by their actions, led to the inflation of a bubble. And if we take the last major historical example of a bubble inflating in the gold markets — that of 1980 — we can see just how quickly gold prices can come crashing down to earth:
See the spike that took place at the time of the Afghanistan war (the Soviet one…)? Now do you see how quickly the bubble crashed out? That’s right it topped off at over $800 — and quickly saw its value plummet to just $500. Ouch! I’ll bet some of the more zealous investors got their fingers burned in that particular venture.
So, will this bubble continue? It may. The fears that led to this bubble are all based on the unfounded — yet very real — anxiety that most have about almost all of today’s world currencies. People seem to think that all high government debts and QE policies are going to lead to the apocalypse — they won’t, but that doesn’t matter, the perception is there. In the near future these debt-burdens will not decrease — indeed, there’s every chance that even if these countries impose austerity programs on their populations, the deficits will either grow or remain the same due to ‘automatic stabalisers‘ kicking in. This will ensure that the gold bugs will continue to think that gold is the only ‘real’ store of value.
However, if there are investors piling into the market, this may take the shape of a classic bubble. So — as happens in a Ponzi scheme — when there are no more people available to get in on the action the price will stop rising. A slight decline will then take place. And, finally, a rush to sell and a major crash in prices.
The irony of this is far from slight. In their delirium and lack of understanding, those in search of a mythical ‘permanent store of value’ are, in fact, giving rise to ever more ‘value disequilibrium’. A holy man once said: “Forgive them, for they know not what they do.” Amen to that.
UPDATE: Here’s an excellent historical survey of the gold price hike and subsequent crash in 1980. The author’s survey strongly supports the thesis that gold prices — like those of any commodity — can be extremely volatile.
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