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19 Jun 2021 5:51
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  •   Home > News > Business > Features

    How Bubbles Form

    Investments tend to go through three phases during a bull run. The first is when the smart money and the contrarian investments get into a particular sector or type of asset and prices start to creep upwards.

    Investment Research Group
    Investment Research Group
    After a while, and this can take years, the sustained rises attract the attention of institutional investors and prices begin to rise sharply. Finally the general public gets excited about the asset and pile in, eventually creating a fully-fledged bubble.

    Eventually this crashes and the asset spends a good deal of time in the investment wilderness, while investors concentrate on the next hot class.

    Gold has just reached stage three in my opinion and the price is going to go a lot higher over the next few years.

    One sign of this is the amount of positive media commentary being devoted to the metal.

    Where once it was derided as an archaic form of money whose safe haven attributes could better be replicated by futures contracts, now everybody seems to like it.

    Phase one began in late 1999, when the price of gold began to pick up after 18 years of decline. Stage two probably began around November 2004, when gold was around US$450 oz. This is when the Gold Shares exchange-traded fund was launched on the New York Stock Exchange (US: GLD). This invests in bullion and gave mostly institutional investors a tradeable security tied to the physical metal.

    It claims to have more than 275 tonnes of gold, making it the 7th largest holder in the gold after the world's largest economies.

    While public interest in gold has been building in the past couple of years, I am picking this quarter as the start of stage three based on the remarkable uptick in interest from non-financial quarters.

    The New York Times has just published an article entitled "Inside the Global Gold Frenzy" while on the other side of the country the Los Angeles Times had article with the headline "Why gold is shining brighter".

    International website, which is a general interest site on topics ranging from arts to writing, also ran an article entitled "Physical Gold Investment".

    Most of the world's media have also carried items about the venerable Harrods department store in London beginning to sell gold bullion to customers for the first time and India's massive purchase of gold from the IMF.

    So how high could gold go?

    Nobody knows of course, but it is worth noting that for gold's popularity to reach the same level as its last peak in early 1980, adjusting for US inflation, it would need to be US$2300 oz.

    At the extreme end are some 'gold bugs', who thinks the metal is the only true source of money and all paper equivalents are doomed to go to zero.

    One bug has added up the value of all the paper money in the world and divided this by the total amount of refined gold. This gives an intrinsic of gold at US$20,000 oz.

    Legendary commentator Marc Faber believes the fair price is two to three times the S&P500 index. That suggests a price of US$2,000 – US$3,000.

    © 2021 David McEwen, NZCity

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