The “Gold Bubble” and The Litany of Risk

Yet another friend has recently admonished me for my foolish affection for the “barbarous relic”.  It’s clearly “in a bubble” you see and, like any bubble, will soon crash.

And, of course, today, we’ve all become completely inured to the bubble phenomenon, having cycled through so many.  So common are they now that the one thing that everyone imagines that they understand is the bubble.   To most now, the “surest sign” of a bubble is:  anything that is rising when everything else is falling.

Well, here’s a test for all you “bubble-heads”…..can you spot the gold bubbles in the following chart?  Look closely.

So, those huge spikes in the Dow-Gold ratio, which are clearly obvious to any blind man, they must be bubbles, right?  Well, of course they are.   To some, however, those are merely periods of “real growth and expansion”.  And, naturally enough, most politicians try to spin history in just that way. 

“Oh, if we could only return to the policies that fostered such expansive growth in the 1950s, or the 1960s or the late 1980s and 1990s.  Now, those were the days.”  And, yes they were, assuming you had access to credit and you were lucky enough to get out of the market in time.

OK, let’s get real here.  Anytime the Dow-Gold ratio rises much above the range of 3X-4X or so, you can be sure that:  a) either the stock market has begun to be greatly overvalued (or over-inflated by excess debt and money in the system) and/or, alternatively, b) that gold has become greatly undervalued and underappreciated and, in a word:  forgotten. 

Now, as it happens, I do believe that we’ve had “gold bubbles” in the past 100 years:  twice, to be exact.  They’re a bit hard to see in the above chart since, by comparison to the huge stock market bubbles, they are virtually invisible.  They would be those very brief periods in which the ratio actually dropped below, say, around 3X or so.  Can you spot them?  Do you need a magnifying glass?  Hint:  The first one flashes quickly by in 1932 and the second one briefly zips past in 1980.  In both, the Dow-Gold ratio declined to roughly 1X (1:1 or Dow = Gold Price). 

Amazingly,  to these “barbarian” eyes anyway, each of the above were fairly quickly followed by yet another massive, debt-driven build-up in excess stock valuations, fostering, yet again, the delusion that inflation=growth, only to crash again, just as we are in the process of doing RIGHT NOW (if you hadn’t noticed).

Side note:  You may also notice that these massive distortions just didn’t happen before about 1920 or so.  Let’s see, what could have happened way back then that might have changed the equation?  Oh, that’s right, we created the Federal Reserve and started the wonderfully “scientific” process of inflation and the undermining of the value of the dollar.

More amazing still, is that gold ceased having any official role, first as a circulated money in 1933 and, then, as even a tenuous backing to the dollar in 1971.  Despite these measures, gold has continued to periodically reassert itself as the single-best measure of the “real economy”, but only after all the non-real, inflationary fluff in the system was fully exposed and understood.

Every time the Dow-Gold ratio has returned to it’s historic benchmark levels, I would contend, the market was merely rediscovering and remembering (however briefly) just why gold has always been useful as money.  It doesn’t have to be….but it’s properties are universally suitable in that role.  When nothing else makes sense, you hold cash, and when even cash doesn’t make sense, you hold gold.  It’s just that simple.

Today, we might expect to see a growing impetus to consider other commodities, such as oil, as money, but let’s just leave that discussion for another day.  Even casual examination of the above chart should tell you that the market is now, once again, rediscovered the monetary role of gold and, just as important, it’s a process that is not yet finished.   Why?

Well, from here (today’s ratio = 8.4X), it would seem that we’ve got quite a bit of road yet to travel.  A return to a 3X ratio, assuming stable stock prices, would suggest that gold could easily rise to nearly $4,000 per oz.  Of course, it also means that the Dow could decline to around 4300….as that would accomplish the same degree of correction.  (By the way, which outcome would you rather see?)  And, if history is any guide, this process could easily “overshoot” and, as many expect, return to the “bubble” territory with a 1:1 ratio….meaning that both could happen.

You might ask, reasonably enough, why even care about the Dow-Gold ratio?  Well, there are any number of references that you might consider, but the nominal valuation of assets in dollar terms clearly isn’t up to the task.  Dollars, and a whole host of other relative metrics are just too easily manipulated.  That’s the whole point, isn’t it?  Inflation does not equal growth, it equals distortion of the truth. 

So, if it is your thesis that market valuations are being purposely inflated, you need something that isn’t subject to similar manipulation.  Pick your poison, but that has been gold’s historical role.

So, here’s the “real” problem:  Do you really have a firm grasp on just how “overvalued” the stock market was in 2008?  How about your house?  And, by the way, how would you really know?  Also, have you ever given any thought as to why you can’t buy a 1962 silver dollar for its $1 face value anymore?  What should its value or price be today and, again, how would you know? 

The answer to each of these questions has nothing to do with speculative “bubbles”, per se, although speculation is a natural side effect of the inflation process.  The answer is both simple and obvious:  Fiat Money Printing.  You know it, I know it, everybody knows it….except when they are busy pretending it doesn’t matter.  The degree of distortion in valuation is, at it’s root, a function of excess money and debt creation.

What always changes everybody’s mind, in the end, is when the Fiat Currency House of Cards begins to fall apart, as it always has and always will.   But, during the build-up, we become convinced that real growth has returned.  We recite a “litany of hope” to convince ourselves that, at last, good times have returned.  We do this until “reality” returns; when we, collectively, realize that debt levels have gotten too high (again), that the economy is not as large as we once imagined it to be (again), that we’ve been buying a lot of stuff that nobody really needs (again),  that too many of our jobs are obsolete (again), that (surprise, surprise) politicians have been lying to us all along and making promises they simply can’t begin to keep, that we imagined as progress has been something else altogether. 

Is this familiar territory?  We don’t even have to consider the impacts of unknown risks (like the recent Japanese earthquake), the known risks are boldly obvious.  “Unsustainable” is the word that best describes the paradigm of the bubble economy and, though we recite this fear under our breath, we drink in the lies and respond with “this time it’s different”.  That is the essence of the “litany of hope”.

We promote the boldest liars to lead us into a world where we can always have our cake and eat it too.  We give them the best part of our labor and our savings, always responding with the hopeful “this time it’s different”.  We believe that we are the masters of our fate and there are no risks that progressive human management can’t overcome.  We believe that our leaders are honest and bold.  And, eventually, we discover that, no, these were lies all along.

The “litany of risk”, with which we are, once again, becoming more familiar, has as it’s call, “the worst is past” and, as it’s refrain, “now what”, “not again”, and “quit lying to me!!!!”.  We need not read the headlines every day to see this going on before us….we know it in our hearts.  Well, some of us do.  

So, yes, for what it’s worth, gold will, in time, enter into bubble territory…after all the bills are finally tabulated, after all the lies have been exposed, and when all the excess money that is left in the system finally pools into the one last “safe place”.  That day is coming, but it isn’t here yet.  The litany of hope is still being recited by almost everyone I know and, bless his heart, Ben Bernanke is still testing the faithful.

Harry Tuttle

 P.S.  For more on this subject, please read Eric Sprott’s most recent answer to the “Gold Bubble” question



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