Gold: Just Don’t Call it a Bubble

June 24th, 2010 by

It’s no secret: gold prices are on the rise. But the recent gains that have seen spot prices triple in the last five years, reaching never-before-seen heights, have many wondering if and when increases may turn to precipitous decreases.

The standard definition on an asset bubble, whether it be fueled by the purchase of tulips, tech stocks, or say, houses, is “the condition of an excess demand of some commodity which raises these prices well above intrinsic values.”

This working definition allows us to adeptly identify asset bubbles in commodities which have tangible intrinsic values. Stocks and houses, for example, represent real, usable things. Stocks are valued for the real share of a corporation (which has value) they represent, while houses provide varying qualities of the same service: shelter. As this is the case, it’s a relatively simple task to compare current asset prices to accepted intrinsic values.

Gold, and other precious metals, on the other hand, have a comparatively intangible intrinsic value. While gold is used, among other things, in the production of modern electronic components, the majority of its practical application is in the realm of jewelry. Demand for jewelry, and thus, demand for gold, is affected by a number of other factors, including the price of gold. All other demand of course, comes from commodities markets.

While the “intrinsic” value of gold may be a little hard to pin down, its demand is not. In the past few years, and especially in the past few months, we have observed a marked increase in the demand for gold. Supply is rising as fast as it can, but necessarily lags behind.

So, where does this leave gold’s status? The best course of action, it seems, is to compare this potential asset bubble to those of recent memory. The dot-com bubble of the late 1990’s had its share of speculative buying. There were a number of investors who had no idea what they were purchasing, but did so just to cash in on a rising tide. If we are to learn from this, we ought to be weary of a mass appeal to the public by the likes of TV, internet, and interstate billboard gold-toting snake oil salesmen looking to make a quick buck on a growing trend. Thus far, we haven’t observed anything like this. For the most part, those purchasing gold have been in the market for some time.

Similarly, the recent housing bubble caused a huge upswing in the demand for homes across the country. To finance this increase in demand, Americans took out an unprecedented amount of mortgage and consumer credit. The growth of credit markets is in fact characteristic of many of the most famous asset bubbles in history (yes, for all you economists, this is Minsky). It seems it may be instructive to watch credit markets for the taking on of debt for the sole purpose of investing in gold and other precious metals. To date, we have not seen this become a wide-spread practice.

While there has definitely been an increase in the attention to, and purchase of gold, recent rises, it seems, fail to meet at least some criteria of an asset bubble. Gold is not yet a bubble.