So farewell then…

 Recall what the agenda of this blog was: to critically analyze the theory of bubbles, and whether there might be one present in the gold market – as claimed by the experts in the video.  A blog cannot hope to cover all of the nuances and different theories of bubbles, and so the studious reader will have noted that the theory I have used comes from the realm of behavioural finance: specifically the work of Robert Shiller (for it is he).  Other theories of bubbles are surely of merit, but the work of Shiller is intuitively appealing (for a sociologist, at least).  Indeed, this blog has only scratched the surface of Shiller's work; the aim has been to have a few key premises and then scrutinize them in detail.

For it is he... (photograph permitted under the Creative
Commons Attribution Share - Alike 3.0 Unreported License)

So, as Lloyd Grossman would say, “let’s look at the evidence”.  Two things are needed to trigger a bubble (remember, there are no doubt more conditions, but for brevity we are concerned with just two key events): an exogenous environmental shock, and a positive feedback loop.  Are these factors present in gold?  It has been suggested that in the recent economic downturn, the price of gold as been justified due to its “safe haven status”.   However, the “current economic crisis”  initiated in 2007/8, yet gold had been on the rise since the year 2000.  If there was an exogenous shock present, it cannot have been the “safe haven” hypothesis.

There has been the potential for a positive feedback loop to form: investors need not invest in the physical gold, or its futures contracts.  Instead, SPDR and ETC funds allow greater access to gold, and investors are flocking to these new opportunities.  Once again, there is temporal discontinuity here: the first gold ETC was started in Australia in 2003.  The start of the rapid rise in gold occurred three years before this.

Based on this evidence, it seems difficult to conclude that a bubble has been brewing in gold as an asset class.  Granted, the “safe haven status” might have contributed to the increase in gold prices, and the formation of ETC’s might aid a positive feedback loop, but these factors are triggered after gold experiences a rapid increase: they did not initiate the price move.

Looking at inflation adjusted gold prices, the price of gold was higher in 1978 than it was in 2011.  In terms of a 30 year investment, gold hasn’t been that attractive.  Gold has been rising (admittedly, rapidly) since the year 2000; but this increase might have been predicated upon gold being at its lowest price for 20 years.  Billionaire commodities hedge fund manger Jim Rogers (2005) observes that increases in prices from their historic lows is not the sign of a bubble, rather it is the market realizing an opportunity to invest in an asset that has been undervalued for some time.  In Rogers’ opinion, this is the definition of a so called “bull run”, not a bubble.

So were the “experts” in the video correct in their appraisal of the gold market?  Or were they simply foolish?  Well, stay hungry, and decide that one for yourselves.  When listening to their rationales, just remember the saying “free advice is worth exactly what you pay for it” (and remember that applies to this blog as well!).

Blogging off.