Is Gold in a Bubble?

One question I receive frequently from clients, "is gold in a bubble?" Gold has been the best performing asset class since 2001 with an average 11% annual return and not one negative or down year over this period. So it isn't a silly question, especially considering we have experienced a tech stock and real estate bubble within the past decade. Additionally, many folks remember the gold bubble from the 1970s and 1980s so it is natural to assume this meteoric rise could easily crash.

If you prefer not to read this missive, the short answer is no. There is no bubble. For those who are intrigued as to my call, seven reasons exist why gold is not in a bubble: gold as money, debt relative to gold, gold's ascent relative to the 1980s rise, low portfolio allocation of gold and gold miners, and central bank ownership of gold.

Gold as Money

Since biblical times, gold was a primary means of exchange for goods and services. Merchants, craftsmen, and bakers would gladly exchange their wares for the shiny metal. This is the definition of money. Gold was money. Even in America, our dollars could be exchanged for the metal until President Nixon took the US off the gold standard in 1971. Even though the dollar is no longer backed by gold, its price has been strongly correlated to the US dollar.

Since 2002, the amount of money at the Fed and in the economy has exploded as has the price of gold. As more money circulated in the economy, the dollars you hold lose value, but the price of gold keeps up with the increased supply in dollars. You hold your purchasing power with gold. For example, in 1940, it cost approximately $1,000 for a mid tier car. At that time, the price of gold was $35 per ounce so it cost roughly 28 ounces of gold to buy a car. Today, a mid tier car runs around $40,000, which is close to 28 ounces considering gold costs $1,600 per ounce.

On a graph, one could see its price tracking the global monetary base almost perfectly. In 1984, the global monetary base was around $1 Trillion. It grew consistently until it reached a $2 Trillion plateua in 2002. From 2002 until the beginning of 2011, the worldwide monetary base increased from $2 Trillion to just under $12 Trillion. From 1984 until 2002, gold hovered between $200 per ounce and $350 per ounce. When the monetary base increased six-fold over the ensuing decade, the it's price did the same.

Increase in Debt relative to Gold

The second reason the yellow metal is currently insulated from a precipitous fall is our national debt compared to it's price. This is really a deviation of the first reason as the Federal Reserve will be forced to print money to cover our escalating national debt, but excessive debt reduces the value of the dollar, which means it's price should rise. With $1 Trillion deficits estimated for years to come, gold should avoid a large decline.

From the 1980s until 2006, our total government debt to Gross Domestic Product (GDP) ranged between 40% and 60%. Today, we are passing 100% government debt to GDP. The price of this precious metal correlated tightly with this rise.

Gold's as