The following is a guest post by Great Credit Score.

Gold crystals. Source: http://en.wikipedia.org/wiki/File:Gold-crystals.jpgAs economic uncertainty dominates the news, the price of gold continues to maintain its high price. In fact gold has spiked so significantly since the 2008 mortgage crisis that most experts think it could be looked at as nothing less than a bubble (especially in the short term). As investors worry more about the dollar, they look to gold as an asset that can maintain its value in case of a severe economic crisis. The price of gold will likely fall or rise depending on what happens in the world economy. Unfortunately we still have some tough economic situations like the European debt crisis to get through, so the price of gold may maintain its value or even rise, until we see positive trends in the economy and job growth.

[Kevin] Gold recently fell from the mid $1700s to the low $1600s after briefly touching $1900… is this pull-back a good time to add to your position, or perhaps a sign of a bubble bursting?

The Recession and Gold Prices

The recession has affected many aspects of the economy and finance including home prices, increasing consumer debt, the drop of formerly good credit numbers, and stock prices. The reason why gold prices tend to rise during these times of uncertainty is that gold is a tangible asset that is unaffected by inflation. As inflation increases, paper money is worth less, but assets like real estate and precious metals are worth more. If an investor placed all of their savings in a bank account, they would be losing net worth as inflation increases. But if they own assets like a home, the price of these assets would go up in value as more paper money is printed.

The Case For The Gold Bubble


Gold prices in 1980 spiked up to $850 an ounce from just over $200 an ounce the previous year. If adjusted for inflation, these prices would be over $2000 an ounce. Two years later (1982), gold lost more than half of its value and plunged to the mid four hundreds.

[Kevin] There are some who believe that this time is different than the 80s. I would recommend searching out the gold posts on my site, or researching posts written by FOFOA.

So what happened to make gold prices rise so significantly at this time?

Certain events took place including double digit inflation rates, an extreme spike in oil prices, the Iranian revolution, and war in Afghanistan with the former Soviet Union. A cluster of negative events occurred simultaneously and uncertainty about the future was high. There is definitely a parallel between what happened in 1980 and what is happening right now. Wars, high gas prices, and instability in the middle east all created a climate of fear which led to a dramatic increase in the price of gold.

Another reason that gold would be seen as a bubble, is that the price of any asset cannot continue to increase indefinitely. Bubbles, crashes, and re-adjustments are a constant with all assets. A bad economy and uncertainty are driving up the prices, so if world events improve, it could lead to a dramatic drop in prices.

The Case For $2000+ an Ounce Gold

The world recession has come as a wake up call to many investors and financial institutions around the world. Due to dramatic increase in gold prices as of late, this metal may start to be seen as a safer place to park large chunks of money compared to the stock market (which has been especially volatile as of late). It could cause investors to begin seeing gold as a type of currency. They may choose to keep their money in gold as an alternative to the Dollar or the Euro.

Some economists see the U.S. entering a period of hyperinflation. As the economy continues to perform poorly and government debt continues to rise, money may be printed to ease the economic problems. If the value of paper currency falls, then the value of commodities like gold will rise even further. Gold can be purchased as a hedge to protect one’s money against inflation.

Summary

Gold prices can be very difficult to forecast because they are reflected in unpredictable world events. I personally think gold is a bubble that will pop when the U.S. economy begins to grow again. Politicians are starting to realize that our national debt is a serious issue and we cannot continue mindlessly on the path we currently are on. If politicians are able to make serious cuts in spending and job growth starts to go in a positive direction, i think gold prices will start to fall. The events that we are going through now mimic many of the world problems that we saw in 1980. I still think that gold prices will hold for a few coming years, but it will drop once this difficult period comes to an end.


Ross maintains the financial website Great Credit Score. It focuses on topics like debt and credit, but will likely start to take subjects like the stock and commodities market.

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18 Comments Guest on Sep 30th 2011

18 Responses to “Why Are Gold Prices Skyrocketing?”

  1. 101 Centavos says:

    I’ve just put in an order for more shares of CEF. :-)

  2. If we want to know what not to buy, we just have to ask the average man on the street what the best current investment is. This would probably be the greatest, most sophisticated barometer and forecaster of future asset prices. If the man on the street thinks it’s the best current investment, it’s destined to be lousy lousy lousy. Hundreds of years of history will bear that out.

    Currently?

    Gold and Australian Real Estate are the hot ones.

    Why? Because they have risen a lot lately.

    And the rationalizations of their stability or continued increase will come from all quarters.

    I’m not a timer, but I think that over my lifetime, from current levels, gold will underperform stocks, bonds, real estate, timber…and whatever other asset class I can imagine.

    The odds are with me. It will be fun to see.

    • Kevin says:

      Hey Andrew,

      The thing is, who really believes that gold is a hot investment? Pretty much everyone I talk to thinks that it’s in a bubble and that you’d have to be crazy to buy at these high prices. People *still* don’t say this about the Canadian housing market, even though prices have doubled since 2000 and debt ratios & income/price ratios are approaching unreasonable bounds.

      I agree with you in principle with gold versus stocks or bonds (depends what kind of bonds we’re talking about though, cause I can’t see this as being true for Treasuries with these yields). I don’t think people should invest in gold expecting to beat the stock market over the long haul; we both know that even with the huge rise in gold and the stagnation of the stock market that one still would have been better off in the market. At least until now.

      I think it makes more sense to look at gold as a currency. Gold is the historical currency of the people and it still is today in a way, even if it isn’t used in everyday life. It is a pure element of the universe and it doesn’t lie to you the way that man-made instruments do. It’s an alternative to holding other currencies, and it helps to keep them honest. :)

  3. CEF pricing often gets 8 to 10% below NAV in times of pessimism…… those are good times to buy if you believe in gold and silver.

    What is the intrinsic value of gold? Can anyone put a number on it? How do you do the calculation of intrinsic value? Is Buffett right when he says: “Look. You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all — not some — all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”

    • Kevin says:

      What intrinsic value? There’s no such thing. ;) The funny thing about Buffett’s quote is that it applies even more to paper money, too.

  4. Interesting perspective. I’ve been investing in gold and silver for months. It is better to be safe than sorry!

    • Kevin says:

      I am personally aiming for 10%. If that balance gets too out of whack I’ll buy and sell depending on fundamentals — i.e. if it’s cause governments all of a sudden become fiscally responsible and interest rates become reasonable, I’ll probably hold off on buying more PMs.

  5. Doctor Stock says:

    Do you see gold maintaining a $1800 plus level til year end? Where do you see it in 2012?

    • Kevin says:

      I am no more clairvoyant than anyone else, but if the recession gets worse then we could easily see a decline of 30% in prices to year’s end — that would affect everything else, too. Nonetheless, so long as interest rates are artificially low and sovereign debt continues to climb, the bull market will continue I think.

  6. At least for those in the United States, until real interest rates turn positive and a commitment to dollar strength returns, I wouldn’t worry about gold peaking yet. There will be additional advances until those two criteria are met.

  7. [...] Kevin from Invest It Wisely said to never give up as part of life’s journey, one of his lessons learned thus far.  Great post Kevin!   He also had a guest post entitled Why Are Gold Price Skyrocketing? [...]

  8. Emile Tanenbaum says:

    More likely than hyperinflation is a simple breakdown in trade due to a collapse in the value in the U.S. dollar. The U.S. isn’t totally bereft of resources, so coal, shale gas, etc… can all be used as substitutes, and the U.S. still has the most powerful military in the world. On top of that, the U.S. has plenty of unemployed people that wouldn’t mind going back to work. I believe what is more likely is that internationally, the U.S. dollar will be worth significantly less, but this doesn’t necessarily mean the end of times for the country itself; it does mean a rebalancing and a lowered standard of living, especially for those people used to a debt-driven lifestyle.

    • Kevin says:

      I don’t think a collapse in value of the U.S. dollar would be the end of times at all, but it would definitely mean a rebalancing of the world economy. Over the long run that might not be such a bad thing.

  9. A collapse in the value of the U.S. dollar would really mess up lots of people’s life! Think of all the hours you put into working. Bills to pay, Retirement Founds, many more! Only the future can tell!