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Gold BubbleOmics Revisited

Commodities / Gold and Silver 2010 Jul 23, 2010 - 06:28 PM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticleThe recent gyrations of the Gold price are rather typical of a bubble about to pop, with lows coming in lower than the upward trend-line of lows. Although figuring out exactly when a bubble will pop is a bit like figuring out when a volcano will blow…there are rumblings, false alarms…more rumblings…and everyone says “don’t be a scaredy-cat” then….BOOM.

George Soros says Gold is the ultimate bubble, that’s why he bought in a while back, what we don’t know is when he sold (did he?) or when he will sell? But either way if the King of Bubbles says it’s a bubble, that’s good enough for me.

Long-term the best driver of a model to predict the price of gold is the price of oil; that gets you a 74% R-Squared on annual data since 1971:

By that marker Gold is 55% over valued right now if oil is priced correctly, which I think it is.

The black line on that chart is what the price of Gold (in this case the ETF GLD because the data is easier to download), “ought” to be if it followed oil prices.

This is my explanation of the “story”.

  • In 2008 there was a bubble in the price of oil (manufactured probably by the combination of Clueless George buying oil for America’s Strategic Reserve plus Goldman Sachs “doing God’s Work”).
  • Then there was a bust, and the pivot point (the square root of the peak multiplied by the trough) which gets you to the “fundamental” then, was at $72 GLD (interesting how they both coincided on that day).
  • Then GLD which was not mispriced before, chugged along and did not follow oil down its trough (no reason why it should have), but then there was uncertainty about “the banks”, and a flight to the safety of the “ancient relic”.
  • Oil found its “fundamental” quite quick – and that was a mite lower than in 2008 thanks to reduced demand, and the “trough” lasted about as long as the previous bubble (classic bubbleomics).
  • Since then, according to that logic gold has been pretty much 50% over priced.

What that says is that at some point it’s going to bust down to the “fundamental” divided by 1.5 = about GLD = $50 or thereabouts. When is anyone’s guess, although the lower lows, is like a sort of rumbling of the volcano.

The fact that the ECB has produced a hilarious set of smoke and mirrors to trump the Geithner Stressed Clown Tests (and thus draw a line in the sand saying that if anyone wants to speculate against European Banks they are going to turn on the ECB printing presses (no one thought they had any but they do))…that’s the important message, don’t be fooled by the red-nose that Jean Claude is wearing… means that “stability” has returned.

So if indeed the lousy “assets” held by European banks are not worth the paper they are printed on, no one is going to find out just how lousy they are for quite some time.

And that might mean that Gold’s place as the refuge from lunatic central bankers, may not be needed for a while, the central bankers have flexed their muscles and defended the integrity of their fiat currencies, and if you want to mess with the ECNB or the Fed – well you will need to be sharper and to have bigger pockets than Soros.

Remember, a drop in the price of gold would make the central banks ecstatic, their scorecard is measured in the price of Gold, the higher it is, the lower their score.

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2010 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Andrew Butter Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


24 Jul 10, 03:57
Gold and Oil correlation not valid in a systemic crisis


The main difference between gold and oil is that gold is easily portable, durable and most importantly it is money. Gold is neutral, no nationality, not a liability of anyone. It is safe, it is physically demanded and it is the most marketable good in the world. (world financial assets close to $200 trillion, the value of gold worldwide only $6 trillion) Everyone wants to own gold, noone rejects it. On the contrary, oil is not portable, you cannot say "let me buy some physical oil for investment" cos many people don't have a large tank to store "physical oil" with their $100,000 purchase for example. Also it is not durable, not a very marketable good and not of a standard quality. The only options are futures and oil stocks which are highly sentimental and vulnerable to manipulation whereas physical gold market is of course much less vulnerable.

30-40 years ago, almost all speculators had been residing in Western countries. Today we have tens of thousands of speculators (some may say "investors") from emerging market countries whose cash or cash-like portfolios are worth over $5-10 millions. If half of those speculators allocate 10-15% of their portfolios to physical gold, not to make profit but as an insurance policy, I think it will be impossible to find even an ounce of precious metals at the "paper gold" price. Make no mistake, gold is a "vote against US Foreign Policy or monetary policy", I am sure Asians, Russians, Arab countries have already been voting against US policies by buying gold.

For the past 40 years the main driver of gold prices is real interest rates (nowadays negative), not the price of oil. In 1980-82 Volcker broke the waist of the gold by bringing real interest rates to 5% in a matter of weeks, but this time do you think this is possible? I don't think so. It means outright depression. Short term interest rates of 6-7% for banks mean extra $300-350 billion cost a year, for government $500 billion. They cannot cope with that.

Andrew Butter
24 Jul 10, 12:05
Gold/oil correlation

"Real" interest rates rely on the US Government's analysis which is widely suspected to be wrong - they are after all produced by the Bureau of Labor and they have quirks like "owner's equivalent of rent".

The correlation between oil and gold is just that, a good correlation historically, granted we may be entering a new age, and sure in Roman times an ounce of gold would buy you a top-of the line toga, now it will buy you a top of the line Saville Row suit.

But you can't gas up your Ferrari with gold.

24 Jul 10, 17:07
Gold and Oil correlation

According to my humble calculation gold/real interest rate correlation is 0.52 for the period between 1971-2010. I think it is a somewhat reliable correlation, it is highly probable that market watchs it. As long as people have confidence in banking system and government, real interest rates reflect the cost of holding gold. I must also say that the correlation broke between 2005-2006, both real interest rates and gold did go up. To calculate real interest rates, I have used 3 month treasury yield and y-o-y official CPI (all items) To smooth out volatility I have also figured out 12 month average.

P.S. I am neither a newsletter writer nor a professional economist nor a hedge fund manager, so I don't have a Ferrari. I am an ordinary man interested in markets.

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