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Will the Gold Rush Become a Gold Bust?

Will the Gold Rush Become a Gold Bust?
Ron DeLegge, Editor
December 11, 2009

SAN DIEGO (ETFguide.com) – All bull markets follow the same general cycle; boom, bubble and then bust. It’s happened countless times in the past with stocks (NYSEArca: VTI), bonds (NYSEArca: AGG) and real estate (NYSEArca: RWR).

And even though we are still in the midst of a furious run in gold prices, the same cycle described above will play itself out just like it always has throughout history.

Nevertheless, gold has achieved record prices in 2009 and looks invincible. Is a gold bust next?

Gold’s New Cheerleaders
Commodity perma-bulls like Jim Rogers, James Turk and others are no longer alone in their rosy portrayal of gold’s immediate future. In fact, their bullish forecasts of gold prices above $2,000 an ounce have taken a backseat to gold’s newest set of cheerleaders. 

For example, Fox News host Glenn Beck has been advising his audience to buy gold ahead of a total collapse in the US dollar. Beck has also told his audience to construct fruit cellars and to rely on a “three-G system” of “God, Gold and Guns.” Beck has a relationship with gold vendor, Goldline International, that presumably involves receiving lots of paper money (the kind of “money” that will soon become worthless) to talk up gold.

For the first time ever, Harrods of London is selling gold bullion along with other luxury trinkets. In Germany, you can now buy gold via vending machines. TV commercials promoting gold have moved from their late night infomercial spots to primetime slots.

Ask yourself: Is this the sort of behavior that characterizes a lasting bull market?
 
“I’ve Heard that Song Before” – Harry James
The above evidence that a gold bubble and subsequent bust could be ahead still doesn’t phase goldbugs. John Hathaway, manager of the Tocqueville Gold Fund (Nasdaq: TGLDX), writes in his latest commentary: "Gold is a bubble only for those who maintain faith in the ability of politicians and financial authorities to swim against the tide of deflation. For the rest of us, it is protection against monetary damage still to come."

Question for Mr. Hathaway: Is investing in assets other than gold really a sign of blind trust in politicians or finance ministers? For instance, people that decide to buy a small income property or 1,000 shares of IBM - which political or financial system are they blindly endorsing?

It’s undeniable that world governments are intent on mis-managing their own finances, but the idea that gold is the only asset that will benefit from a currency crisis is a distorted view. Surely there are other asset classes (maybe liquor) that will rise in value, don’t you think?

“This time is different”
One of the main excuses given for a perennial bull market to continue uninterrupted is the conviction that “this time is different.” Wasn't this the case with Internet and technology stocks during the late 1990s? Many companies had cute business models but no profits. People piled in and the stocks rose until one day they suddenly didn’t. The crowd that boldly proclaimed “this time is different” was forced to learn otherwise.

The after effects of a boom turned bust are predictably devastating. 

During the Internet/tech frenzy, the Nasdaq Composite Index (NasdaqGM: ONEQ) reached an all-time closing day high of 5,048.62 in March 2000. From 2000-02 around $4 trillion in former stock market gains evaporated. But that’s not all. The idea that subsequent busts quickly reverse themselves couldn’t be further from the truth. Almost 10 years later, the Nasdaq sits roughly 57% lower and not even close to regaining its former illustrious glory. Will gold, an asset that has no earnings or dividends, have a similar fate?

Is India’s Central Bank: Sucker or a Genius?
Gold proponents point to gold demand as a sign that gold prices have yet to peak. Aside from more investment in gold by individuals and financial institutions, world governments seem to be following the same trend.

Last month, for example, India’s Central Bank bought 200 metric tons of gold from the International Monetary Fund. India’s gold spending spree cost the country $6.7 billion. While the exact price per ounce they paid isn’t known, India’s purchases were made between October 19-30, suggesting a purchase price between $1,000 to $1,040 per ounce.

The inability of governments and central banks to successfully manage their fiscal responsibilities makes them a favorite target of gold bulls. Haven’t we’ve lost count of how many times Jim Rogers has bashed the Federal Reserve or the U.S. government’s monetary policies on the public airwaves? Oddly, these same bureaucrat haters rarely criticize the same world governments they accuse of massive fraud, for buying gold at peak prices. Did any of them criticize India? Will India turn out to be a sucker or a genius for its gold investment?

Paper Gold vs. Physical Gold
The creation of the first gold ETF (NYSEArca: GLD) back in 2004 was a true turning point in gold’s modern history. Before that time obtaining market exposure to gold was limited to owning the asset in some physical form or owning gold stocks. GLD changed everything by making gold an easily accessible asset. Today, with the click of a button, a person can buy “paper gold” in the form of a gold ETF.

Even though gold soared, not much actual trading of physical gold has been taking place. In contrast, with $40 billion plus of assets and growing, the SPDR Gold Shares ETF dominates the market in paper gold trading. Could its success also become its downfall?

While GLD has converted millions of investors into goldbugs, its intraday liquidity can easily convert them into gold sellers. Once the number of new gold buyers dries up, who will be left to keep the gold market heading higher? Like any market, the contagious effect of selling pressure can quickly turn gold into an unwanted asset.

Gold’s Surprising Future
Unlike stocks, gold does not provide any income via yields or interest. It is, therefore, tougher to pinpoint how much one ounce of gold or one U.S. dollar should be worth. Gold is only worth as much as investors are willing to pay for it. Gold’s true value is largely derived by its perceived value.

While the destination for stocks is pretty much mapped out already, gold is likely to undergo two distinct stages over the coming years. One stage will be influenced by the extreme optimism present today, while the other stage should be closely linked to a continuation of financial turmoil.

The ETF Profit Strategy Newsletter contains a detailed forecast for gold’s two stage development, along with a short, mid and long-term forecast for U.S. stocks. If history is a correct guide, which it usually is, the upcoming twists in gold and equities will take many investors and goldbugs by surprise.   

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