As Good as 

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole and bury it gain and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head” Warren Buffet

In the current financial crises lead by a property bubble and cheap credit, the nominal price of gold has risen 159% between July 2007 and March 2012. Could gold be our next bubble? Warren Buffet seems to be talking along those lines. Many investors have significant positions in gold, including John Paulson and George Soros. But Warren Buffet does not.

I have always had an interest in bubbles, having myself traded through two bubbles, the dot com bubble in the early 2000’s and more recently through the financial crises.

Over the past 8 months, gold prices fluctuated and countless investors disregarded the long-term fundamentals sustaining this precious metal; the western world remains caught up in debt and governments are taking the easy way out by of dealing with this crisis by printing money and keeping interest rates low.

I began investing in gold when I first considered the obvious reality of the global debt crisis. I became bullish on gold very quickly, yet I could never understand why gold performs the way it does in crisis’. At the time, I made the usual assumptions that gold is a hedge against uninspiring performance in global financial markets and current financial crisis. Having being intrigued by this I dug deeper some research and from a general consensus among academic research; gold as a commodity has been described as many things, a “safe haven”, a “hedge against inflation”, a hedge against the dollar” or even a “zero beta asset”, McCown and Zimmerman (2006).

During my research I found that, despite the usual assumption, the price of gold can rise in bullish stock markets and fall during times of financial crisis and what really drives the price of gold is the value of fiat money.

I looked at three key secular time periods over the last decade:

Period 1 - January 2003 – December 2007 – Bull Market in equities

• ·         Gold increased 153%
• ·         S&P 500 increased 69%
• ·         US dollar index lost 25% of its value

Period 2 – January 2008 – March 2009 – Bear Market in equities

• ·         Gold increased 9%
• ·         S&P 500 decreased 52%
• ·         US dollar index increased 18%

Period 3 – March 2009 – April 2011 –Bull Market in equities

• ·         Gold increased 66%
• ·         S&P 500 increased 86%
• ·         US dollar index decreased 18%

It is clear from looking at trends 1 & 3 that gold tends to perform well when the US dollar doesn’t. Based on this it could be argued that, this precious metal is a hard currency and as such mirrors other currencies.

Investors should remember one thing: the bigger the financial disaster, the larger the monetary reaction by central banks. All dips in gold prices because of momentary jumps in the US dollar index are a possible buying opportunity. Real interest rates in the US will continue to be negative for the foreseeable future as the US economy remains laden with debt. Until gold’s fundamentals change, it would be my opinion that the long term bull market for gold will continue.

Thanks for reading
Rois

References
McCown, J.R. & Zimmerman J.R. 2006, "is Gold a Zero-Beta Asset? Analysis of the Investment Potential of Precious Metals",.
http://www.ecrresearch.com/famous-gold-quotes