Are we heading towards a gold bubble?

A couple of reports in the American press revealed that more individuals are selling their broken and unwanted gold jewellery as the yellow metal’s price soared, while the recession blues refuse to go away. Back home, we have had a number of queries from investors considering whether or not to invest in gold via exchange-traded funds (ETFs).

Such queries are not surprising at a time when gold is selling near $900/ounce (six years ago it sold for around $325/ounce). Not to mention the leap to over $1,000 an ounce in February. But it is not as if investors are minutely tracking the gold price. It is the presence of Gold ETFs and gold stock funds that makes them all the more aware of the performance of gold.

As on April 2, 2009, Gold ETFs delivered a one-year return of 27.01 per cent as against the diversified equity fund category return of -36.76 per cent. Currently, gold ETFs lie at the top of the heap on just about every performance table other than 1-month: 3-month, 6-month and 1-year. So even if one does not track the precious metal, just looking at the performance of these funds gives you a clear indication of the price. The failure of gold ETFs in the 1-month returns was due to the recent correction of 7.16 per cent (Mar 20, 2009 – Apr 6, 2009).

But still the allure of gold has never been more tempting as in today’s volatile markets. The more important issue isn’t whether an investor should consider investing in gold, but rather the logic behind doing so.

Gold has been historically viewed as a safe haven. But that bit of wisdom does not seem to hold ground anymore. Thanks to Gold ETFs, the metal is now more of a paper asset whose value is increasingly driven by the demand and supply of paper gold on financial markets.

Consider this: In March 2009, NASDAQ Dubai launched the region’s first Sharia-compliant tradable security backed by gold. Named Dubai Gold, it is the first ETF to list on NASDAQ Dubai.

Meanwhile, reports state that in the first six weeks of the year, the buying by gold chasers drove more than 200 tons of gold bullion into SPDR Gold Shares, the world’s largest gold-backed ETF representing more than 1,000 tons of gold.

Gold ETFs have driven up investment demand because of the ease with which individuals may invest in the commodity. As a result, gold is now clearly subject to the same volatility as other financial assets, as investors’ interest flows in and out.
 

COMPARATIVE PERFORMANE
Category	1Mth	3Mth	6Mth	1Yr
Gold ETFs	-6.38	7.9	11.11	27.01
Medium & Long-term Gilt Funds	-2.02	-10.79	9.36	12.11
Medium-term Debt Funds	-0.6	-3.6	6.5	9.05
Cash Funds	0.5	1.5	3.5	7.74
Balanced Funds	10.5	-0.6	-13.9	-24.21
Diversified Equity Funds	14.6	-1.4	-22.3	-36.76
As on April 2, 2009                                                                 (All figures are in %)

Moreover, gold certainly did not appear to be a great hedge against falling stock prices. Remember, when the global financial panic was at its peak in October 2008, gold prices were at their recent lows. International gold prices peaked in March 2008 and, from then till the end of October, gold fell by about 25 per cent.

Gold is no longer physical wealth but a paper asset whose value can fluctuate widely. No doubt, gold does have its value as a hedge against the dollar and a great option in a worldwide monetary collapse, but it does appear to a lot of market watchers that the price is currently overvalued. We could well be in a gold bubble, which is just as ephemeral as the stock or oil or real estate bubbles were. Waking up to gold one of these days could be like waking up to stocks or real estate in 2007.
 

Gold ETFs
Scheme	1Mth	3Mth	6Mth	1Yr
Gold Benchmark ETF	-6.38	8.05	11.38	27.48
Quantum Gold	-6.39	7.89	11.18	27.42
Kotak Gold ETF	-6.4	8.0	11.3	27.39
UTI Gold ETF	-6.4	7.9	11.2	27.31
Reliance Gold ETF	-6.4	7.6	10.4	25.45
As on April 2, 2009                                               (All figures are in %)c

But for every cautious or cynical observer, there are plenty of optimists making predictions of the highs that gold could reach. U.S-based Swiss America Trading Corporation (SATC) came out with an editorial piece in March which listed 70 economists who, on an average, predict that gold is poised for a dramatic surge and could touch $2,000 an ounce.

The justifications varied, the most common being gold as a hedge against anticipated inflation and gold being globally liquid which is of paramount importance with the debasing of currencies in developed economies.

But as a coin dealer in the US was quoted as saying: “If someone says he knows whether it’s a good or bad time to buy gold – run away. Because if he knew that answer, he wouldn’t be working for a living.”