Why gold is not a bubble

March 15, 2010
Pattaya, Thailand

I was laying in bed sick recently watching Conan the Barbarian… yes I admit it. Some people eat chicken soup, I drown myself in cheesy Hollywood violence.

If you haven’t see it, you’re not missing much of a plot– Arnold Schwarzenegger at his physical prime wields a big sword and searches for treasure to plunder.

As I watched the Governator decapitate his foes two at a time, I couldn’t help wondering if this was the image that Nouriel Roubini had in mind when he called gold a “barbarous relic” in the highly publicized tit-for-tat argument he was having with Jim Rogers…

In blasting gold and gold bugs alike, Roubini indicated that gold is a new bubble waiting to burst, and that the idea of $2,000 gold is merely speculative fantasy.

To be clear, I am not a gold bug… but I’ve found Roubini’s comments to be off-the-mark. How can there be a gold bubble without widespread gold mania? Wait until the shoeshine boy is having conversations with his customers about Eagles and Maple Leafs… that’ll be a clear sign of mania.

With all the ‘Cash for Gold’ locations I’ve seen sprouting up all around the world, we may be in the very early stages of developing this mania, but for now, the vast majority of people still don’t own a single ounce.

The chief problem with gold is that there is no reasonable way to value the metal, so it will be impossible to quantify when the metal finally has reached bubble phase.

Sure, there are a plethora of technical indicators and moving averages to consider, as well as a comparison between the market value and its production costs… but there is no clear means to define a clear price for gold.

As an example, you can value the balance sheet of a company against very clear, quantifiable assets– cash on the books or dividend yield for example– and determine if the company is undervalued or overvalued.

There is no similar approach for gold… and this makes direct pricing predictions the stuff of wizardry and good headlines.

My suggestion is that, if you want to speculate in gold, it’s probably better to buy shares of gold mining companies instead, which have audited assets and earnings to evaluate.

I view physical gold, on the other hand, much more like a form of cash instead of a speculation… a form of cash that is totally private, uncontrolled by any central bank, and to be used in emergencies only.

To give you an example, I have a euro bank account.  I don’t watch the euro spot price all day, buying/selling the currency based on its fluctuations against the dollar and constantly recalculating the accounts value in dollar terms.

Rather, I only care that the bank holds on to my euros and that I can access the funds to buy things priced in euro. If I have 100,000 euro in the account, I look at it as 100,000 euro, not whatever value it has in dollars at the moment.

I look at gold in the same way. I accumulate gold as money, and I even travel with a bit of it just in case I wake up one morning and find that the global financial system has completely collapsed.

(when you travel as much as I do, this is the best insurance policy, along with a second passport…)

The other benefit to me is that there are no reporting requirements, and no unpaid government spies that snoop over what I’m doing with my ounces. This form of financial privacy is definitely worth considering.

In terms of market value, though, I do not pay much attention to the fluctuations of the gold price in dollar terms, up or down.

I will not cheer if it hits $1,500, nor will I cringe if it drops below $1,000. Just like my other foreign currency holdings, the value of my gold in dollar terms has little significance… besides, obsessing too much about its dollar value defeats the purpose of accumulating gold to begin with: having a private alternative to the dollar.

Tomorrow I’m going to talk about a unique way to buy gold, write-off the storage costs, and hold it overseas in a tax-deferred or tax-free vehicle.

Stay tuned.