Gold Bubbles
The rapid rise in real estate prices seemed to indicate that we may be approaching a time of inflation. Early
investors in gold did very well compared to stock market investors or real estate investors. The question
now is what will happen going forward.
For some reason, we humans seem to like fads. Whether it is Beanie Babies, Cabbage Patch Dolls, Florida
land, dot com stocks, real estate in general or gold; we seem to go from one fad to another. This creates
bubbles and bubbles burst. If you listen to ‘what people are talking about’ you will find that more and more
people are asking if they shouldn’t be buying gold to hedge the “coming inflation”.
Here is my question. How much inflation do you think we will be getting? Gold has already tripled in
anticipation of inflation. If inflation actually comes, it will cause the price of everything to go up including
copper, silver, oil, fertilizer and real estate.
My motto is to buy low and sell high. If you wanted to buy gold, you should have done it at $250 per ounce,
not at $950 per ounce. Of those things which would inflate in price if we have inflation, you should choose
something whose price is still low. One such item is real estate. It is hard to buy the things that have been
going lower, like real estate, because “they might continue to go lower” and it is easy to buy the things
which are going higher like gold because “they might continue to go higher”. The emotion attached to
“continue to go lower” is fear. The emotion attached to “continue to go higher” is greed.
One of the ways to make money investing is to avoid buying into fads after the item has already gone up in
price. I would avoid gold or if you want to buy gold, buy put options to insure that you don’t get caught
when it sells off.
Looking at a chart of gold prices it indicates to me that we are in danger of a sell-off in gold as soon as
“everybody” buys in. Professional traders tend to do the opposite of what “everybody” is doing.
I cannot tell you when it will peak. It could be $1500 or more. After it peaks, it will come down very fast as
the bubble bursts. Don’t get caught buying gold at $1000 and still owning gold at $500 per ounce.
To see how fast gold prices can move, look at chart from 1980, when we had real inflation.
Part Two
During this past decade both the Democrats and the Republicans pushed for home ownership. They did it
by lowering standards for getting a mortgage and the Federal Reserve Board (FRB) cooperated by leaving
interest rates too low for too long. If everything goes up in price, you call it ‘inflation’ but if only one thing
goes up, you call it a ‘bubble’. Most people loved the housing boom and loved the fact that their house price
was going up. Since politicians love voters to be happy, they didn’t stop the bubble before it turned into a
problem. They tend to think short term and only worry about “the next election”.
Some few investors noticed this bubble forming and that more and more home owners had purchased their
houses at ‘bubble prices’. Typically the way to ‘solve’ this problem is to allow inflation. As a result, these
investors bought gold in anticipation of the government ‘inflation solution’ to the housing crisis. As gold
prices increased it began to look attractive as an investment to more and more people. Then the investment
newsletters started getting wider circulation and more and more people got on the gold bandwagon.
Instead of solving the housing bubble with inflation, the FRB decided to raise interest rates. This prevented
inflation and caused the housing bubble to burst. The bursting of this bubble has been much worse than
was anticipated by the government.
Normally a bubble like we have had in housing might be solved by inflation which is why people started
buying gold. It appears that this crisis will be solved by ‘bailouts’ instead. Bailout the bankers, bailout the
homeowners, bailout the automobile manufacturers, and bailout the insurance companies.
Meanwhile, the anticipation of inflation caused by the “old way we usually solve these problems” has
caused another bubble to form. This second bubble is in the price of gold. Bubbles attract more investment
and if you want to climb on board the roller coaster as it approaches the peak, you can but it is dangerous
http://www.the-privateer.com/chart/gold-pf.html
and you had better be ready to get off before the price dives. The first chart above shows the price of gold
back in 1980 when we had actual inflation. Notice that the market responded to Paul Volker raising
interest rates and the inflation was stopped and gold prices subsequently fell back down in 1981 (the
second chart). People who purchased gold at over $800 per ounce in January 1980 found themselves
holding it at $400 per ounce in December of 1981. That same Paul Volker is now a close advisor to the
President and I have no doubt that if any inflation starts to happen, interest rates will be increased to stop it.
After the bubble burst in housing, prices of houses and other things started to come down and we have been
walking closer to deflation, not inflation. To solve the deflation crisis, the government has been pumping a
lot of money into the system. As a result, fear of inflation has grown in spite of the fact that it is hard to see it
happening yet. When Bernanke gave his press conference a few weeks ago, he answered the question as to
precisely how he intended to prevent inflation. What happened is that Congress has recently passed a law
allowing the Federal Reserve Board (FRB) to pay interest on money that banks have. This will allow the FRB
to pull money out of the banking system rapidly by raising the interest rate that they are willing to pay for
this money. Since inflation is defined as “too much money in the banking system”, this sounds like a good
answer as to why inflation won’t happen “this time”.
Bernanke’s argument is quite logical and sound. But what will happen when he implements it? Answer:
Interest rates will go up.
As a result, we want to bet on interest rates going up on treasury bonds rather than the price of gold going
up further.
The way we are doing this in our investment club is to purchase the TBT exchange traded fund.
The trick is to “pick the bottom” in TBT. We believe that we have identified it as having occurred last
December. If you go to Yahoo Finance and compare GLD (Gold) to TBT, you will find that Gold is up about
10% this year and TBT is up about 40%. We believe that this trend will continue and that you should have
some TBT in your portfolio.
In addition, you may wish to have a small portion of a fund which invests in the inverse of gold. In other
words, it is designed to make money when gold goes down in price. This fund is DZZ and is described as
follows:
Gold could spike up to $1500 and then dive to $500 in a short period of time. If it does, Bernanke will raise
interest rates and TBT should go up faster than DZZ goes down. This is our hedge. Short Treasuries and
Short Gold.
Personally, I am recommending a 5% position in TBT and a 1% position in DZZ for myself. I own two
houses and a condo so my real estate is part of my hedge for inflation. Depending on your own finances,
you may want to use different percentages. If inflation does “take off” your holdings in real estate should do
well. If it doesn’t, then you may wish that you had more DZZ to compensate for the lack of inflation.
Be careful not to buy fads just before the fad runs its course. In hindsight you didn’t really want to own real
estate back in 2006 when it was hitting its peak. You also didn’t want to own technology in 2000 after the
bubble burst. I don’t think you want to own gold when its bubble bursts either. If you can buy it at $900
and sell it at higher prices before it crashes, then good for you. Just be careful not “to be caught holding the
bag” when GLD crashes to $500 per ounce or lower.
Right now, “everyone knows that inflation is coming and that you should buy gold”. Remember the water
cooler talk back in January 1980? Everyone was talking about how much money they made in gold. In
general, be careful when “everyone knows something”. Usually you want to do the opposite of what
“everyone knows”.
donbot
Gold, Part Three
Show graph of price:
http://kitco.com/charts/livegold.html
According to Guy Adami on CNBC, Gold could break sharply to the downside. He traded gold for Goldman
Sachs back in the 1990s. Check his bio: http://www.cnbc.com/id/15838261/
The housing crisis in the US has caused a number of problems, including the weakening of the dollar. The
real "buy America" boom started when the dollar started to strengthen against the Euro. The next
interesting thing is that the top rated mortgages in parts of the US are now heading for being underwater
like the sub-prime. This will cause additional write-downs. Goldman Sachs is net short sub-prime and is
talking its book. If people listen to them (and they have a lot of credibility at this point) then more downward
pressure will be placed on the housing and mortgage markets.
Next
The rapid rise in real estate prices seemed to indicate that we may be approaching a time of inflation. Early
investors in gold did very well compared to stock market investors or real estate investors. The question
now is what will happen going forward.
For some reason, we humans seem to like fads. Whether it is Beanie Babies, Cabbage Patch Dolls, Florida
land, dot com stocks, real estate in general or gold; we seem to go from one fad to another. This creates
bubbles and bubbles burst. If you listen to ‘what people are talking about’ you will find that more and more
people are asking if they shouldn’t be buying gold to hedge the “coming inflation”.
Here is my question. How much inflation do you think we will be getting? Gold has already tripled in
anticipation of inflation. If inflation actually comes, it will cause the price of everything to go up including
copper, silver, oil, fertilizer and real estate.
My motto is to buy low and sell high. If you wanted to buy gold, you should have done it at $250 per ounce,
not at $950 per ounce. Of those things which would inflate in price if we have inflation, you should choose
something whose price is still low. One such item is real estate. It is hard to buy the things that have been
going lower, like real estate, because “they might continue to go lower” and it is easy to buy the things
which are going higher like gold because “they might continue to go higher”. The emotion attached to
“continue to go lower” is fear. The emotion attached to “continue to go higher” is greed.
One of the ways to make money investing is to avoid buying into fads after the item has already gone up in
price. I would avoid gold or if you want to buy gold, buy put options to insure that you don’t get caught
when it sells off.
Looking at a chart of gold prices it indicates to me that we are in danger of a sell-off in gold as soon as
“everybody” buys in. Professional traders tend to do the opposite of what “everybody” is doing.
I cannot tell you when it will peak. It could be $1500 or more. After it peaks, it will come down very fast as
the bubble bursts. Don’t get caught buying gold at $1000 and still owning gold at $500 per ounce.
To see how fast gold prices can move, look at chart from 1980, when we had real inflation.
Part Two
During this past decade both the Democrats and the Republicans pushed for home ownership. They did it
by lowering standards for getting a mortgage and the Federal Reserve Board (FRB) cooperated by leaving
interest rates too low for too long. If everything goes up in price, you call it ‘inflation’ but if only one thing
goes up, you call it a ‘bubble’. Most people loved the housing boom and loved the fact that their house price
was going up. Since politicians love voters to be happy, they didn’t stop the bubble before it turned into a
problem. They tend to think short term and only worry about “the next election”.
Some few investors noticed this bubble forming and that more and more home owners had purchased their
houses at ‘bubble prices’. Typically the way to ‘solve’ this problem is to allow inflation. As a result, these
investors bought gold in anticipation of the government ‘inflation solution’ to the housing crisis. As gold
prices increased it began to look attractive as an investment to more and more people. Then the investment
newsletters started getting wider circulation and more and more people got on the gold bandwagon.
Instead of solving the housing bubble with inflation, the FRB decided to raise interest rates. This prevented
inflation and caused the housing bubble to burst. The bursting of this bubble has been much worse than
was anticipated by the government.
Normally a bubble like we have had in housing might be solved by inflation which is why people started
buying gold. It appears that this crisis will be solved by ‘bailouts’ instead. Bailout the bankers, bailout the
homeowners, bailout the automobile manufacturers, and bailout the insurance companies.
Meanwhile, the anticipation of inflation caused by the “old way we usually solve these problems” has
caused another bubble to form. This second bubble is in the price of gold. Bubbles attract more investment
and if you want to climb on board the roller coaster as it approaches the peak, you can but it is dangerous
http://www.the-privateer.com/chart/gold-pf.html
and you had better be ready to get off before the price dives. The first chart above shows the price of gold
back in 1980 when we had actual inflation. Notice that the market responded to Paul Volker raising
interest rates and the inflation was stopped and gold prices subsequently fell back down in 1981 (the
second chart). People who purchased gold at over $800 per ounce in January 1980 found themselves
holding it at $400 per ounce in December of 1981. That same Paul Volker is now a close advisor to the
President and I have no doubt that if any inflation starts to happen, interest rates will be increased to stop it.
After the bubble burst in housing, prices of houses and other things started to come down and we have been
walking closer to deflation, not inflation. To solve the deflation crisis, the government has been pumping a
lot of money into the system. As a result, fear of inflation has grown in spite of the fact that it is hard to see it
happening yet. When Bernanke gave his press conference a few weeks ago, he answered the question as to
precisely how he intended to prevent inflation. What happened is that Congress has recently passed a law
allowing the Federal Reserve Board (FRB) to pay interest on money that banks have. This will allow the FRB
to pull money out of the banking system rapidly by raising the interest rate that they are willing to pay for
this money. Since inflation is defined as “too much money in the banking system”, this sounds like a good
answer as to why inflation won’t happen “this time”.
Bernanke’s argument is quite logical and sound. But what will happen when he implements it? Answer:
Interest rates will go up.
As a result, we want to bet on interest rates going up on treasury bonds rather than the price of gold going
up further.
The way we are doing this in our investment club is to purchase the TBT exchange traded fund.
- The TBT investment seeks daily investment results, before fees and expenses, which correspond to
twice the inverse of the daily performance of the Lehman Brothers 20+ Year U.S. Treasury index. The
fund normally invests at least 80% of assets to investments that, in combination, have economic
characteristics that are inverse to those of the index. It also typically invests in taking positions in
financial instruments, including derivatives that should have similar daily return characteristics as
twice the inverse of the index. The fund is non-diversified.
The trick is to “pick the bottom” in TBT. We believe that we have identified it as having occurred last
December. If you go to Yahoo Finance and compare GLD (Gold) to TBT, you will find that Gold is up about
10% this year and TBT is up about 40%. We believe that this trend will continue and that you should have
some TBT in your portfolio.
In addition, you may wish to have a small portion of a fund which invests in the inverse of gold. In other
words, it is designed to make money when gold goes down in price. This fund is DZZ and is described as
follows:
- The investment seeks to replicate, net of expenses, twice the inverse of the daily performance of the Deutsche Bank
Liquid Commodity index - Optimum Yield Gold Excess Return. The index is intended to reflect changes in the market
value of certain gold futures contracts and is comprised of a single unfunded gold futures contract.
Gold could spike up to $1500 and then dive to $500 in a short period of time. If it does, Bernanke will raise
interest rates and TBT should go up faster than DZZ goes down. This is our hedge. Short Treasuries and
Short Gold.
Personally, I am recommending a 5% position in TBT and a 1% position in DZZ for myself. I own two
houses and a condo so my real estate is part of my hedge for inflation. Depending on your own finances,
you may want to use different percentages. If inflation does “take off” your holdings in real estate should do
well. If it doesn’t, then you may wish that you had more DZZ to compensate for the lack of inflation.
Be careful not to buy fads just before the fad runs its course. In hindsight you didn’t really want to own real
estate back in 2006 when it was hitting its peak. You also didn’t want to own technology in 2000 after the
bubble burst. I don’t think you want to own gold when its bubble bursts either. If you can buy it at $900
and sell it at higher prices before it crashes, then good for you. Just be careful not “to be caught holding the
bag” when GLD crashes to $500 per ounce or lower.
Right now, “everyone knows that inflation is coming and that you should buy gold”. Remember the water
cooler talk back in January 1980? Everyone was talking about how much money they made in gold. In
general, be careful when “everyone knows something”. Usually you want to do the opposite of what
“everyone knows”.
donbot
Gold, Part Three
Show graph of price:
http://kitco.com/charts/livegold.html
According to Guy Adami on CNBC, Gold could break sharply to the downside. He traded gold for Goldman
Sachs back in the 1990s. Check his bio: http://www.cnbc.com/id/15838261/
The housing crisis in the US has caused a number of problems, including the weakening of the dollar. The
real "buy America" boom started when the dollar started to strengthen against the Euro. The next
interesting thing is that the top rated mortgages in parts of the US are now heading for being underwater
like the sub-prime. This will cause additional write-downs. Goldman Sachs is net short sub-prime and is
talking its book. If people listen to them (and they have a lot of credibility at this point) then more downward
pressure will be placed on the housing and mortgage markets.
Next
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