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

August 24, 2011 by  

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

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.

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  • Lookout

    Not just you, but generally Fresnillo never gets a mention? I am heavily invested there and not concerned but I recognize that I might be missing something?

  • Vern Holford

    This looks like yet another reason for canning the solar energy subsidies.

  • David

    Who can afford to buy gold? I can’t afford food.

  • Jyrine

    David, I’ve gone to silver. It’s cheaper and easier to use as cash.

    • PMS

      That’s what I’m doing Jyrine. I belong to a monthly accumulation called Independent Bullion.That’s my retirement fund!

  • ONTIME

    As gold lunges upward because of the deterioration of fiscal policy and lack of economic leadership, it is bound to slide once in a while, at those times should you be able to utilize those fallbacks, you will increase your position and wealth. At the present time silver a much more used metal for money and industry application is also on that same climb on the scale and still affordable, you may want to look into a ETF that deals with precious and industrial metals for a investment but be careful and get a well known broker to assist you.

  • Lawrence

    So now how do you explain that it is now back in the 1760 range.

  • bob wire

    I admit that I know little about gold or it’s value.

    But I do know the people that encourage you to buy gold and sell you gold expect to get paid in greenbacks.

    I smell a rat.

  • CharlieO

    My reasons for buying gold are all simply self preservation. I have very little life savings and no assets available for “growth investments.” All I seek is for my life savings to retain it’s current purchasing power under ANY circumstance. We are certain to experience hyper-inflation, see our dollar devalued to pennies, and that’s the best case scenario. I also fear that total economic collapse and even the failure of the US Government is likely at best and probable at worst. Whatever “world currency” becomes dominant, the conversion from US dollars will consume at least 70% of all US wealth, both public and private. My little stash of gold should give my family a chance at survival. and maybe even a leg up when all this transpires.

  • s c

    If anyone feels obligated to smell a rat, look no further than the PPT That band of false gods has but one job, and that is to depress the price of gold (so people who still believe in fiat dollars won’t get spooked and bring to an end the immoral, totalitarian schemes of central banks).
    Sure, gold will go up and down on its own, but as long as the PPT still exists, they’ll be doing their worst to keep the price artificially low.

  • Mike

    Funny money will be toilet paper soon. End the FED. Ron Paul 2012.

  • Ridge Runner

    The man says get rid of the fed reserve whike you are at it get rid of 75& 0f the feds period.Put strong restraints on what is left.

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