Fresh from winning half a bet about the housing bubble with Steve Keen, Macquarie Bank economist Rory Robertson garnered headlines last week after he sent a research report to clients warning of a growing bubble in the gold price. Since reaching a nadir in 2001, the gold price has risen from $US260 in 2001 to $1240 now (in AUD, the rise has been less pronounced, increasing from approximately $500 to $1440).

In a report headed Bubble Watch, housing bubble denier Robertson told clients that:

It is the very nature of bubbles that drives prices well beyond what most observers see as reasonable. Accordingly, the price of gold over time could jump to multiples of its current elevated price, before reversing … the interesting thing about gold — beyond it being a much-loved “pretty rock” that several generations ago was at the centre of global financial system — is that it has no “running yield”, so there is no anchor, no firm benchmark for valuation.

Fairfax (and former Crikey) scribe Michael Pascoe took a sympathetic view of Robertson’s claims, noting:

When a bubble is on the rise, the number of reasons given to try to justify that rise multiply. Aside from inflation and civilisation’s collapse, ”peak” gold also gets a good run, the idea that the world is running out of gold. It’s not. At present prices, marginal deposits become viable mines and supply increases markedly.

There’s also an element of taking the recent price rise as confirmation of whatever theory was being extolled before the rise, an unfortunate leap in logic. Something like: “Buy gold because the financial system might collapse. Gold has gone up in price, so the financial system must be in danger of collapsing because people buy gold when the financial system might collapse.”

The Financial Review’s David Bassanese also jumped on the gold bubble bandwagon, claiming that “contrary to the claims of noted United States Fund Manager Jeremy Grantham, gold prices look far frothier to me than Australian house prices.” Bassanese gave the same old anti-gold reasoning, stating that “gold offers zero investment yield, so its value is set by what the marginal buyer is prepared to pay.”

That is, of course, entirely correct. With the exception of aesthetic use in jewellery, gold offers virtually no practical use — however, it has been, courtesy of its homogeneous properties, arguably the world’s best store of value for the past few thousand years. As Bill Bonner (who percipiently told investors to “buy gold and sell stocks”  in 2001) noted that last millennium an ounce of gold could buy a man a well-tailored suit — the same applies today.

Or compare the price of an ounce of gold to the Dow Jones index. As Bonner also opined, “you could have bought an ounce of gold on January 18th, 1980, for $US835. On that same day, the Dow was only a little higher, at 867. In other words, you could have bought almost the entire Dow for one ounce of gold.” By 2000, the Dow Jones index leapt to 43 times the price of gold. Now, with the Dow at about 10,000, the ratio is about eight times.

The reason for the gold rush in recent years has largely been investor fear at quantitative easing by large governments, especially the US (and more lately the EU). The Fed’s balance sheet (essentially a gauge of how much money the Reserve has lent to the banking system) rose to $US2.3 trillion in June. Included in that debt are the Fed’s holdings of securities issues by government-owned Fannie Mae and Freddie Mac, which was equal to $US1.128 trillion. As the graph below indicates, before the onset of the GFC, the Fed’s balance sheet was less than $US1 trillion.


What that essentially means is that the US government is lending to US home buyers to prop up mortgage lending (as well as to failed zombie companies such as AIG), and by implication, the US housing market. As the US creates more “money” out of thin air, gold bugs predict that inflation will result (possibly after an initial bout of deflation). The more money that is created, the more valuable gold becomes.

But the Fed is a mere sideshow compared with the US government, which  is shunning austerity measures and continues to run astonishingly large deficits.  US national (public) debt is more than $US13 trillion — or $US42,000 for every American man, woman and child.  For that debt to repaid, the US would need to become astonishingly productive, have remarkably tolerant lenders or undertake an inflationary policy that would make Weimar blush.

The problem for gold bugs is that there is probably more likely to be a round of deflation (as the global private sector continues to repay debt and the government try ham-fisted austerity measures) before the potential onset of hyper-inflation. Therefore, while gold buyers may be proven right in the medium-long term, if global asset markets slump, so too will the price of gold.

Perversely, while Robertson and co warn of the rise of a gold bubble, they mysteriously continue to deny the existence of an Australian housing bubble. Recent data, especially from booming Melbourne, tends to contradict these views. Fairfax’s Domain reported last weekend that Valuer-General releases for the year ending December 2009 indicate some substantial price rises. Most notable, glitzy South Yarra saw its median house price increase by 66% last year (yes, that is 66% in 12 months), while neighboring Prahran (up 37.3%) and South Melbourne (28.3%) were not far behind.

Family oriented suburbs such as Carnegie (up 51%), Bentleigh East (21.5%) and Black Rock (43.1%) leapt, despite their substantial distance from the inner city. House prices increasing by more than 50% in one year in certain suburbs would give pause to even the most virulent of housing optimists.

Meanwhile, an activist group called Earth Sharing has found that Melbourne’s vacancy rate (based on data collected from water suppliers) was almost 7% – well above the Real Estate Institute of Victoria statistics, which allege that the average vacancy rate is 1.6%.

The author does not have any interest in gold but has a “short” position on the S&P500 index.

Peter Fray

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Peter Fray
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