Why The Run-Up In Gold Is Not A “Bubble”

0 Shares
Gold topped $1,900 per ounce on Tuesday.

As the price of gold continues to rise (topping $1,900 per ounce on Tuesday), there has been a lot more noise on the Internet and occasionally in other media warning about the run-up in gold prices being a financial “bubble.”

This couldn’t be more wrongheaded.

A bubble occurs when prices get out of line with fundamentals. That is, when there’s an increasing discrepancy between rising prices and the real value of the underlying stock or commodity in question. Typically there’s a pronounced psychological factor involved, properly characterized as a kind of “mania” or mass delusion. Indeed, the first section of Charles Mackay’s classic Extraordinary Popular Delusions & the Madness of Crowds (1841) dealt with famous financial manias of the 18th century like the South Sea Company bubble and the Mississippi Company bubble, as well as the earlier Dutch Tulip mania at the beginning of the 17th century.

A more recent example is the U.S. dot-com boom of the 1990s, when investors became hypnotized by the mantra “the Internet will change everything” and bid up the prices of dot-com companies with unrealistically optimistic financial projections and little or no actual revenues, paying customers or sustainable businesses. Thus the high prices of those companies’ stocks became divorced from reality — from the fundamentals.

So what are the fundamentals right now when it comes to gold? Are the factors driving up the price just a bunch of delusions?

Hardly.

Let’s start with massive U.S. government debt and spending. As I’ve written elsewhere, our government has been like a wino running up a huge bar tab, piling up bills by the billions of dollars. Somebody eventually has to pay them.

But how? Well, the “easy” way (those quotation marks are ironic, because the net result is far from easy) is to print more money. Sure, that covers the bills. But it devalues our currency to the point that the dollar has lost its luster and the confidence required to continue using it as the world’s reserve currency.

Of course, ours isn’t the only government that plays these kinds of games. All over the world governments and central banks are keeping the printing presses going, pumping out more paper money, in a terrible “race to the bottom” that aims to attract more international trade by cheapening their currencies.

In such a world, where can you find value and safety?

For centuries the traditional store of value has been gold and other precious metals. And that’s no myth; it’s reality. And it’s the same reality all over the world.

Take China. Between its populace and Central Bank, it is likely to accumulate about 1,000 tons of gold in 2011. That’s up about 40 percent from 2010 levels. While growth won’t remain at 40 percent, it will continue at a brisk clip for many reasons. For one, gold that goes into personal savings are savings that are well protected from the problem that most troubles the Chinese right now: inflation. There’s no question that China is desperate for gold right now –- and the same goes for other countries like India, Korea and Indonesia.

I could go on. In fact, it would be easy to write a book-length treatise on the subject, and others have. In any event, the bottom line is that all of the factors that have been driving the price of gold higher over the past decade are real factors, and they are still accelerating. So where’s the bubble?

If the market price of an investment went up tenfold while its earnings went up twentyfold, you wouldn’t call that a bubble; you would say it’s an undervalued investment — and an opportunity. That’s what I think gold is today.

So as the dollar and euro deflate like hot air balloons, you are on the right track in emphasizing gold –- even the lagging gold mines, both juniors and seniors.

Among the former, we especially like Pretium Resources Inc. (PVG:CN), which we believe merits a far greater valuation than its current price indicates. As for the latter, we cite our current favorites: NovaGold Resources Inc. (NG), Barrick Gold Corporation (ABX), Goldcorp (GG) and the SPDR Gold Shares ETF (GLD).

Of course, we are also very bullish on silver, which is not only a store of value as a precious metal, but a critical industrial resource. And I don’t use the word “critical” lightly. Unlike gold, there are no substitutes for it in a number of key industrial usages. To mention one example related to alternative energy: Most solar panels require silver, and there’s not likely to be enough of it available to build out the energy infrastructure we need. China is certainly aware of this; it appears to be accumulating silver already and is likely to increasingly do so.

Regarding the investment possibilities here, our current choices remain First Majestic Silver Corp (FR:CN) and the iShares Silver Trust (SLV) ETF.

–Stephen Leeb

Stephen Leeb

has analyzed and identified macro-economic trends for more than three decades. He is a recognized authority on the stock market and commodities, especially oil and precious metals. He is often credited as the first to foresee market-changing events, and predicted the spiraling costs of oil well before others. Dr. Leeb has authored seven books, including the New York Times Bestselling Business Books, The Coming Economic Collapse: How You Can Thrive When Oil Costs $200 a Barrel (2006), Game Over: How You Can Prosper in a Shattered Economy (2009), and the forthcoming Red Alert: How China's Growing Prosperity Threatens the American Way of Life (2011). He is also a frequent contributor to 'Fox Business News,' Bloomberg, ABC, and CNN.He serves as Head of the Advisory Board for Leor Exploration & Production, LLC, as an Advisory Board member of Electrum USA Ltd., one of the world's largest privately held gold exploration companies, and in the same capacity for Sunshine Silver Mines Corp., a privately held silver exploration company. Dr. Leeb received his bachelor's degree in Economics from the University of Pennsylvania's Wharton School of Business. He then earned his master's degree in Mathematics and Ph.D. in Psychology from the University of Illinois in just three years, an academic record that still stands.