In my opinion gold (and silver) is the next big bubble to burst!

Take a look at this chart which illustrates the price of an ounce of gold over the past 20 years:

20 Year US Dollar Gold Price (courtesy goldprice.org)

The meteoric rise in the price of Gold over the past three to four years is clear.  Indeed the price of Gold between about 1980 and the early 2000s averaged around US$350 per ounce.

The price now is just under $1500 per ounce.  Why?

As with most of our discussions about pricing being determined by ‘supply and demand’ – the demand for Gold is very high and this has been driving up the price.  My argument (and the argument of many others), however, is that the logic underpinning the demand for Gold is seriously flawed.

The demand for Gold is primarily driven by fear.  Fear about the state of the world economy, increasing inflationary pressures, the large fiscal deficit in the United States etc etc.  These fears are perfectly rational, but the conclusion that investing in Gold as a consequence of that fear is irrational.

People aren’t investing in Gold because the Gold is needed by industry, or to produce goods, or even because they like looking at it.  If miners were to stop producing gold today, current stockpiles would last at least 10 years.  Massive stock piles of Gold are sitting in bank vaults around the world because people believe that owning that Gold will provide financial security.

Why should Gold provide financial security?  This thinking is seriously outdated, and yearns back to a time when these prescious metals were indeed synonymous with ‘money’.  Up until 1971 the value of money was directly linked to gold (known as the ‘gold standard’), but those times are no more, and there is no fundamental justification for the current demand for Gold, i.e. the current price is not linked to any true ‘value’ of Gold.

In some ways this is reminiscent of the ‘.com’ bubble where companies were given ridiculously high ‘valuations’ because of the number of ‘eyeballs’ a particular website received… completely irrational, and completely unrelated to any fundamental ‘value’.

This is clearly a bubble.  It’s inevitable that this will unravel and that the Gold price will tumble, it’s just  question of how rapidly.