Conclusion

I can calculate the motions of the heavenly bodies, but not the madness of people.

—Isaac Newton

The herdlike behavior and highly speculative participation in gold is pointing to a huge bubble that poses severe risks and may soon collapse.

By analyzing the reasons behind gold's surge; presenting the relevant fundamental stories, projections, and catalysts; studying the price action, supply and demand factors, and technical levels; and pointing out the extreme and very unsettling psychological forces currently involved in the gold theme, we have explained why gold and related stocks and commodities are showing patterns of a bubble and should be avoided.

With global crises, currency devaluations, stagnant recoveries, and a looming threat of war, many funds and investors have flocked to gold as a diversification tool, protection from inflation, and even investment. And with prices up over 600 percent in less than 10 years, many still see more upside for this historic store of value. But with the most prominent banks, research firms, gold mining companies' CEOs, and investment legends predicting gold prices to reach anywhere from $1,000 to $15,000, who do we listen to? And can we really be sure these aren't extremely optimistic forecasts that will never be realized?

It is true that many of the most well-known individuals strongly believe in the continuation of the enormous gold bull market. It is also true that gold has been of tremendous interest to investors and speculators worldwide due to its importance as a fear hedge, as a store of value, as protection against currency devaluation, and as tangible wealth. But after an historically steep 11-year rise and domination of news and media headlines and investor attention for at least a few years, are most of the fundamental reasons to invest in gold already factored into the price?

Frankly, this gold bubble, which will eventually pop (if it hasn't already), has been dragging on for longer than I expected. It is completely possible that we will see an additional steep rise if global fears escalate. It is also possible that gold prices will soar for a short period, marking a blowoff top—which would also signal the beginning of gold's collapse. But the major issue regarding gold is the risk to average investors who have bought gold recently in hopes of riding along with the rest of the crowd. Not only will many latecomers suffer major losses, but if they have invested in gold in the form of coins or physical gold, they will be stuck with an asset plunging in value and hard to dispose of for a reasonable loss.

I am not arguing with the underlying reasons that make gold attractive. Gold's inherent value is understandable. As we saw in Chapters 1 and 2, the rapid price increase in gold over the past few years is due to mounting fears over currency, poor investment alternatives, and the lack of stability in just about anything else—among other things.

I completely understand the bullish case for gold: It's a “tangible” store of value, it can act as a hedge for currency risk, demand is expected to continue to grow, and so forth. What I don't agree with, however, is that the current price of gold is justified. Sure, demand has increased, uncertainty continues, and the threat of financial collapse still lingers over our heads. But at what point have we sacrificed our rational thinking by skyrocketing gold prices just to own a so-called tangible asset? Believing that gold will always retain its value is a complete misconception: Yes, gold will always be valuable; but its actual value relies on how much people are willing to pay for it. Gold would still be valuable at $800 an ounce. But if you buy it at $1,800 and the price drops to $800 because people start to realize they have become a little too exuberant, you still lose a lot of money. Gold may never be worthless but it may become worth less, and it could become worth much less. Gold is therefore not a screaming buy as many believe. Instead, I think that overspeculation, extreme expectations, faulty arguments, and massive publicity make investing in gold much riskier than many are willing to accept.

We currently stand at a major crossroads between the largest recession since the Great Depression and the uncertain future of the global economy. World markets are more connected to each other than ever before; what happens in one sector on one side of the world can affect companies on the opposite side of the world. Technology, innovation, and the search for profits have turned this entire world into an up-to-the-minute newsroom and stock exchange. Almost anything that takes place across the globe is virtually instantaneously uploaded onto the Internet. We just can't fight it—the world is highly intertwined, and failing to pay attention to any of the never-ending data coming from all corners of the globe could cost us.

We must first understand our current position in history in order to fully understand where we may be heading. Following a period of rapid growth in the 1980s and 1990s, we entered a 10-year period of ups and downs, from the dot-com bubble of the late 1990s through 2002 that brought the Dow Jones Industrial Average above the 10,000 mark for the first time in history and then collapsed on investors who were largely euphoric about the future of technology, investing in nearly any company that put a “.com” after its name; to the housing and credit bubbles that took the Dow to even higher highs from 2003 to 2007, where housing seemed to be the new road to lasting wealth and the introduction of extremely complex derivatives, such as mortgage-backed securities, ultimately caused one of the steepest plunges in stock market history and the failure of financial powerhouses such as Lehman Brothers and Bear Stearns.

But the story is not over. Since that devastating plunge from over 14,000 to below 7,000, the markets have rebounded and recouped almost all of their losses. The economy is nowhere near as healthy or as promising as it was before the stock market collapse, yet the markets are up over 100 percent from their early 2009 bottom. The questions now become: Is the worst behind us? Is the market really recovering? Is it time to invest again? What will be the next big investment opportunity? Are things really better? Are we setting up for a depression?

I am of the camp that thinks the market looks extremely dangerous at these levels. We have not yet fixed the main issues that brought about this recent recession, unemployment is still extremely high, the risk seems to have increased, emerging markets look frothy, and a multitude of other reasons exist for businesses and investors to remain wary.

It seems as if investors have moved from one hot investment to the next for the past 10 years or longer, constantly losing as the hot investment loses steam and collapses. We've gone from technology, to housing, to oil, and now on to what appears to be the new hot investments in technology and commodities. The world depends on emerging market growth, which has fueled investments in all of the emerging market essentials: food, commodities, and construction. But with many signs pointing to an overheated and weakening emerging markets theme, together with the possibility of a third massive bubble in just over 10 years, we may be finding ourselves at the juncture of a major market turning point.

Many clues pointing to a bubble have been hard to notice or accept because gold supporters have had so many counterarguments as to why gold is a good investment. The failing dollar, economic upheaval, volatile and falling stock markets, and unstable political leadership have convinced many investors and institutions to trust in gold as the only “safe” investment. However, the need to find a “stable” asset or investment has made gold a highly speculative and now unstable commodity. Gold has historically been a store of value and a very important tangible asset, but the rush to invest in gold has pushed prices way beyond reasonable levels and have turned it into an emotional trade based on fear and greed. The reasons to buy gold seem to make sense, and have justified the buying of gold for a few years. But the fundamental reasons don't work anymore because gold has turned into an object of mass speculation; the reasons to buy gold have already been priced in. The continued run-up now relies on more investors buying gold, rather than fundamental catalysts that justify higher prices.

Bubbles have a great way of appearing to be safe and profitable, but ultimately collapse on investors unexpectedly. They are supported by strong arguments and the illusion of safety. But safety, profitability, and appeals to emotion are classic factors in nearly all bubbles, and help reinforce investor enthusiasm and convince many to join the herd.

For all the reasons stated here and throughout this book, we think the risks involved in gold are too great to warrant investing in it. Not only have we seen soaring prices, media frenzy, overly enthusiastic investors, extreme speculation, and what appears to be an overly saturated investment theme, we are now seeing weakness, as emerging markets are falling, commodity prices are dropping significantly, and gold has even lost some of its strength as a “safe-haven” play during the Middle East crisis, Japan nuclear turmoil, and large volatile price swings. Furthermore, we think there are other investment opportunities that provide better value and further upside for much less risk.

I continue to hold the opinion that gold looks extremely dangerous at these levels, against what seems to be the entire investing world. With so many clues pointing to the near-definite gold bubble, accompanied by extremely optimistic investor sentiment generally seen in previous bubbles, we are short gold mining companies and awaiting further confirmation to pile on the short-gold trade.

When everyone thinks alike, everyone is likely to be wrong.¹

—Humphrey B. Neill

The Art of Contrary Thinking (1954)

Sometimes it pays to go against the crowd.