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    Gold Bubble: Final Warning?

    Wed, 11/10/2010 - 02:56 EDT - Seeking Alpha
    • ChartProphet
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    ChartProphet submit:It has led to murder, war, trade, technological advances, and a way to quantify value. We’ve melted it for coins, worn it as jewelry, and invaded countries for it. And it has been one of, if not THE, most sought-after resource throughout human history. But with Gold prices surging almost 500 percent in ten years, can we really say that Gold is 5 times more valuable and important today than it was in 2000 or 13 times more than it was in the 1970s? The reasons behind the Gold surge are understandable:1) Gold has historically been a store of value. Since people will always want more Gold, it can be used as a means of exchange. The more Gold you own, the richer you are.2) Gold is a tangible asset. At a time when the stability of stocks, derivatives, and other financial instruments are in question, Gold offers a tangible and supposedly “stable” alternative. Gold is a hard asset you can actually hold in your hands.3) Gold has limited supply. In order to increase the amount of Gold in circulation we have to mine it. And mines are obviously not limitless; there is a specific amount of Gold in the Earth’s crust, and when we deplete all the earth’s Gold reserves supply will cease to grow. And if demand is continuous while supply is limited, Gold prices are expected to keep rising.4) Gold acts as a currency hedge. As the US Dollar has plummeted and as fears over the Euro escalated due to the uncertain future of the Eurozone’s economy, Gold has been a way to avoid the potential disaster that unfolds if “paper” money becomes worthless. By buying Gold, it is assumed that if world economies fail, Gold would still be accepted as currency.5) Gold as an alternative to equities. The stock market devastation we have lived through with the 2000-2002 Technology Bubble bursting and the 2007-2009 Housing Bubble collapse, many investors have almost completely lost faith in stocks. But with a desperate need to increase their wealth in order to support their own needs, pay for their children’s education, or fund their retirement, investors still continue searching for some form of investment to do so. Out go stocks, in comes Gold – if stocks haven’t worked, maybe a historically-valuable, tangible, limited, and protective asset such as Gold could. But while these reasons are understandable, they don’t necessarily support the extent of Gold’s surge. Yes, they do support Gold prices going up. But who says they support a 500 percent move? Rapid price run-ups tend to diverge from the underlying fundamental reasons for their move. In other words, as people start getting overly excited about a certain investment theme they actually run the price up too far, too fast. Their reasons for excitement may be accurate, but their excitement and the extent to which prices run up are actually getting ahead of themselves. Prices can’t go up forever, and they eventually start to drop. And as more and more people start to realize this, prices plummet faster than before. This marks the bursting of the Bubble that will eventually see prices crash and many people worse off than before. And if Gold is the current bubble, this fate awaits many people now investing in Gold. So why could Gold be a Bubble?1) Rapid price run-up. Prices never run up forever; they always come back to stable levels. Gold prices are up almost 500 percent since 2000 and almost 1300 percent since the mid-70s. At some point they have to come back down. When that will happen is still in question, but they will stabilize at some point. And stabilization may involve a quick plunge in prices.2) “We Buy Gold” everywhere! In the past two years, there have been more “sell your gold” commercials and “we buy gold” stores than ever before. It seems as if everywhere I go or look I see some kind of reference to gold. The prevalence of these stores and commercials not only points to market saturation, but also points to the massive spotlight that has been shining on Gold.3) EXTREME speculation. A bubble requires investors to be so absolutely certain that prices will continue to rise that they actually neglect to protect themselves from the risks involved. By asking “How high is Gold heading?” instead of “Why is Gold going up?” or “Can Gold go higher?” we’re actually ignoring the downside involved, which can lead to severe panic if Gold actually does start to drop. Here is why extreme speculation is here and very dangerous: a. Common investors can now buy gold. With the introduction of the Gold ETF (GLD), any person who wants to buy gold can easily do so by simply buying the GLD. Before 2004 the only way to buy gold was to buy the actual thing. If gold is available to everyone, and becomes the hot new commodity, a bubble is definitely possible. b. No hedging by the mining companies. In order to protect their businesses from a sudden decline in Gold prices, mining companies have generally hedged themselves by owning some put options or other forms of derivatives that would limit their losses in case of such declines. And the higher the price of gold, the more dangerous the price decline is for the miners. But because most of the miners think that gold prices are going to continue rising, they have recently stopped hedging themselves. At a time when protection is actually the most important in the history of their businesses, they’ve joined the gold craze and ceased to hedge. This has to be one of the most counter-intuitive moves I’ve ever seen. Hedges are protections “just in case” prices go down; miners seem to have forgetten that “just in case” is a small bet compared to the potential devastation they may be setting themselves up for.Complete Story »

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