Monday, March 8, 2010

The Gold Bubble

This represents my personal opinion, not the views of the SEC or its staff.

I am not going to spend time here talking about how the price of gold is off-the-wall, that it is not just a bubble in the making, but a bubble waiting to burst. I don’t want to waste your time on that point.We all know it is a bubble.


George Soros has said “The ultimate asset bubble is gold”. Many of the top asset managers, such as Tudor and Paulson, are piling on; Paul Tudor Jones recently said gold “has its time and place, and now is that time.” The banks are echoing this view with their research. Goldman has a research piece that looks for gold to approach $1,400 in the next year. The more ebullient Charles Morris of HSBC has said, “I absolutely believe it’s heading into a bubble, but that’s why you buy it. ” He, along with a number of other professional and otherwise rational managers, looks for gold to move as high as $5,000 an ounce.


More interesting than this almost universal agreement is what that agreement tells us about the dynamics of the market.

The Naked Bubble

Usually the markets have the courtesy of giving cover for bubbles. We adorn the bubbles with some justification. Even if a guy is just after sex, he at least has the decency to act like there is some substance behind his interest. For the Internet bubble, it was that fundamental analysis based on the brick and mortar world did not bear relevance in the New Paradigm. For the Nikkei bubble, it was that the crazy P/E ratios were not considering one subtlety or another in the Japanese accounting system.

But with gold, no one seems even to care about giving a justification, other than “gold has been a store of value throughout 5,000 years of monetary history”. Which is fine as far as it goes, but that doesn’t say anything about what the price of that store of value should be.

Pump and Dump

Given that “hedge fund” and “highly secretive” are usually said in the same breath, don’t you get suspicious when so many of the top managers are so vocally out there about their gold investments? And when their positions are structured in a way that make them open to view? Paulson and Soros have huge positions in gold ETFs. We know that, because if you buy ETFs, they show up in your 13-F filing. Granted, with an equity investment you can’t help putting that information out into the market, but with an asset there are plenty of ways to take the position without signaling it.


That they are taking a highly visible route to their positions suggests the game that is being played is one of leading the herd. The 13-F reports positions with a big lag, so no one will notice if they quietly slip out the side door while the party is still hopping. And how about when the view is backed up by none other than Goldman Sachs? Will they let everyone know when they think it has gone too far before they get out. Or before they go short? Maybe they already have.

Herds, crowds, mobs, and the Top Ten

And yet, we follow the herd, as we have countless times in the past. Herding is a timeless and universal market behavior, but one that seems less than rational. It is broader than markets; think of the Top Ten phenomenon. We feel better if a lot of other people think that our favorite artist or actor is The Best. We like a song better if we know a lot of other people are liking it as well. Thus our love affair with lists. Magazines featuring the Ten Sexiest, the Five Best, the 100 Whatever are all best sellers, even if the list is the product of a story meeting between an editor and five reporters.


Herding can be explained as an artifact of what was rational behavior in earlier times, when we were running around as hunter gatherers. Back then, mob and herding behavior made sense. Mob behavior if attacking a competitive group or killing a large animal; herding behavior if protecting against predators or uprooting to a new location. Whatever it was that got started, you could be pretty sure there was safety in having a crowd on hand to finish it.

The very notion of mobs and herds evokes a certain spontaneity.
But with the gold bubble, we are moving on to a concept of herding by appointment. Everyone seems to be happy in agreeing that this is a bubble, and we are all going to participate in this bubble in a rational, genteel way. We have all decided that this is going to be a number one hit, a Top Ten. Though we might want to ask who is leading this herd, because my bet is they will be stepping aside and cheering us over the cliff.