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The Gold Bubble Debate: Four Differing Views

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Metals analysts and one of the world's most famous gold critics outline what a bubble would look like -- and whether or not gold is heading there.

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Although gold prices have been climbing over the last decade and reached a record in mid-2011, and investment demand is expected to stay strong in 2012, assessing the metal's real value can be a challenge, say analysts.

Recently market watchers have been weighing in on the question of whether or not gold may be heading into bubble territory, and the debate has been heated. Here are a few key views -- from one of the investment world's most famous gold critics, to analysts, to a portfolio manager behind the largest gold ETF.

1. Quantitative Easing = No Bubble

Charles Gibson, director and mining sector head at Edison Investment Research in London, says that in his view, something is a bubble when it goes back to its pre-bubble price or lower after it bursts.

"I would say that the gold bull market started in 2001 (when the price was c $250/oz). I'd say it was a bubble if, having gone to US$1,900/oz, it then retreated back to $250/oz. However, I see no chance of that whatsoever, given all of the quantitative easing in the US in particular," he says.

As long as US interest rates are negative, says Gibson, upward pressure will remain on the gold price, which he doesn't see changing in the short to medium term.

"Gold is roughly where we would expect it to be at this point in the cycle. Based on a correlation with the US monetary base, we have a long term price of gold at this stage of $1,350/oz. We deem it extremely unlikely that it will ever go below $1,000/oz again. On that basis, I wouldn't call the gold price a bubble," he says.

2. "Bubbles Blown Large Enough Inevitably Pop"

Not exactly known for being a gold bug, in a recent Berkshire Hathaway (BRK-A) letter to shareholders, Warren Buffett named gold as the major asset in a category of investments "that will never produce anything" and are purchased with the hope that someone else will pay more for them in the future, which he compares to the tulips in the 17th century.

With gold, he says, purchasers are often motivated by the belief that the ranks of the fearful will grow. Extra buying enthusiasm, sparked by higher prices, also attracts those who see the rise in gold prices "as validating an investment thesis".

"As 'bandwagon' investors join any party, they create their own truth – for a while," says Buffett.

Referencing the tech and housing bubbles, Buffett writes that "an army of originally skeptical investors succumbed to the 'proof' delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling." But, he notes, "bubbles blown large enough inevitably pop."

3. No Bubble Now, but the Potential Aftermath of One Could Be "Monumentally Bad"

In a filing with the Securities and Exchange Commission for the SPDR Gold Shares (GLD) ETF earlier this month, Chris Goolgasian, senior portfolio manager with State Street Global Advisors, responded to Buffett's comments. He agreed that while gold has no earnings, yield, or way to return cash to the investor, that doesn't mean one can't make money in the metal. "While Berkshire Hathaway has gone up a very respectable 105% since January of 2000, gold has increased nearly five-fold during the same period," he writes.

At the same time, Goolgasian sets out the criteria for being in "bubble territory." These include: the asset must become widely owned, there must be few naysayers, and there must be a number of ways to access the asset.

Goolgasian says that Main Street is not yet fully engaged in the gold market, with ETF asset growth concentrated in hedge funds. "When the gold cycle ends, it will end with everyone owning gold. We are not there yet," he says.

He adds that he believes gold is difficult to own, and the proliferation of gold assets is nowhere near the tech-related products available in the late 1990s and early 2000s.

While the conclusion may be that we are not yet in a bubble, Goolgasian noted that someday we could have a "true gold bubble" on our hands, with the aftermath of such a bubble being "monumentally bad."

"If investors decide to flee gold as an investment, then gold the asset class will be crushed. There are no offshoots that investors can transition to which will cushion the asset class fall. Furthermore, without any valuation support to cling to, investors may have a hard time rationalizing holding on if a freefall begins. The end of gold could be quicker and more severe than the technology or real estate bubbles," he writes.

4. Analysts: No Bubble Here

Edward Meir, senior commodity analyst with INTL FCStone, says that while the gold price has been going up sharply in recent times, it has also posted notable gains over the last decade.

"If there is a bubble, it would have burst a long time ago," he says.

"People are looking to gold as a historically tested measure of value that can hold its purchasing power and protect the investor from inflation, which is quite a serious problem, especially in emerging markets. So I think gold has kind of carved out its own role in the portfolio and it has a pretty loyal following and you know, there's going to be corrections here and there but I think for the most part, the gold story is intact," he adds.

For example, while gold has yet to climb back up to its highs, the pullback seen on February 29 didn't lead to a series of $100 declines for days in a row, says Meir.

Similarly, David Jollie, an analyst at Mitsui & Co. Precious Metals says he is not seeing a lot of bubble-like behavior in gold.

"It's possible to argue that gold is overbought, that it might be at a higher price than it should be, but I don't think that of itself makes it a bubble. I think you have to be a long way above reasonable territory in price terms for that to be a bubble," he says.

"Prices are still lower in dollar terms, US dollar terms at least, than they were in August last year. So certainly, the behavior short-term is not bubble-like, simply because the price isn't higher," he adds.

As well, gold still has underlying value. This makes sense to some people, who, because of today's prices, may also be buying for diversification. Essentially, he says, if it's still worth it without having to sell it on to someone, then it can not yet likely be described as a bubble.

"If you saw people holding positions for shorter periods of time, that would look more like a bubble than today. I think most people buying gold today are doing so with the intention of holding onto it for a considerable period of time," he says.
No positions in stocks mentioned.
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