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Home Uncategorised

Why Gold could be a Bubble

by Ram Balakrishnan
November 23, 2009
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Recent returns from conventional asset classes such as stocks and bonds have been, to put it mildly, disappointing. But, there is one asset class that has posted red-hot returns: gold. Since 2000, the price of gold has more than doubled in Canadian dollar terms but the price trend has been accelerating in recent years. In the past five years, gold has appreciated (in CAD) at an average annual rate of close to 20%.

[5 year Gold Price in CAD 2004-2009]

Like moths to a flame, investors are attracted to recent returns. The prospectus for the SPDR Gold Trust (GLD) provides a fascinating insight into the gold market. Jewellery, the primary source of demand for gold has been dropping at the same time that investment demand has been exploding. In the past five years, demand for retail investment products such as coins and bars and gold ETFs has tripled and investment demand alone now accounts for a quarter of total gold demand, up from 10% in the early 2000s.

[Investment Demand for Gold]

It must be recalled that, unlike conventional asset classes, gold pays neither interest nor dividends. Therefore, gold investors, as tulip bulb and dot com investors before them, must rely on the “greater fool” theory of investing for their profits. It is possible, of course, that competing asset classes would continue to languish, gold prices continue to increase, driving more investment demand for the yellow metal. Then again, the feedback loop could easily go negative due to any number of reasons ranging from increased mine supply to scrap supply and once again burn investors who chased returns.

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