Opinion

Felix Salmon

Gold: The fear bubble bursts

By Felix Salmon
April 15, 2013

The total amount of gold in the world, according to Thomson Reuters, is 171,300 metric tonnes, or 5.5 billion troy ounces. What that means is that every time the price of gold falls by $100 an ounce, as it did on Friday and it has done again today, the value of the world’s gold falls by more than $500 billion.

That doesn’t mean investors have lost $1 trillion in the space of two trading days. Some gold is used in industry or jewelry, and there’s a huge amount in central banks, which don’t mark to market and therefore aren’t really investors as we normally understand the term. Still, with a “market capitalization” at the end of 2012 of about $9 trillion, the gold market is not much smaller than the NYSE, is twice the size of the Nasdaq, and is almost three times the size of the Tokyo and London stock exchanges.

As a result, the falling price of gold is more important than simply being an opportunity for schadenfreude around the likes of Glenn Beck or John Paulson or Zero Hedge. At the end of 2012, for instance, Paulson owned 21.8 million shares of GLD. Those have sunk some 19%, or $30 per share, since then — a total loss of more than $650 million, for Paulson and his investors. But that’s just a drop in the bucket compared to the $1.6 trillion wiped off the value of gold more generally during the same period.

To put that number in context, the NYSE has risen 6.6% since the end of 2012, a rise in value of some $930 billion. Which means that the value of gold has been falling faster than the value of stocks has been rising. But gold is held in much more concentrated hands: most people have very little exposure to it, while a relatively small number of investors have huge allocations. As a result, the wealth effect from the fall in gold prices is likely to be felt quite acutely.

Gold is the classic zero-coupon perpetual bond: an asset whose industrial value is a tiny fraction of its cash value, and which represents, as Joe Weisenthal says, a costly failure of markets to efficiently allocate capital to where it is best invested. Goldbugs are by their nature defeatist and pessimistic; get enough of them together at the same time and they become self-fulfilling. (That’s why they tend to be so evangelical about their beliefs.)

So what does the fall of the gold price mean for the rest of us? The first thing to worry about is the wealth effect: if people have suddenly lost a trillion dollars, does that mean they’re going to spend less, and hurt the broader economy as a result?

I doubt that, somehow. About 2,500 tonnes of gold is tied up in gold ETFs. That’s about 80 million ounces, which translates to investor losses of about $16 billion in the past couple of days. On top of that, there have probably been about $3 billion of losses in the futures market. Those numbers — a proxy for the gold positions which are marked to market regularly — are relatively modest: they’re much smaller than the $100 billion or so that has been wiped off the valuation of Apple this year alone.

What’s more, very few investors have leveraged positions in gold, and when asset bubbles burst, it’s normally the leverage, more than the bursting bubble itself, which does the most damage.

Still, there will be pain — pain which is necessary to break the gold fever. It’s important that goldbugs are seen to not only have silly beliefs, but also to have lost a substantial amount of money. Gold is a fear trade rather than a greed trade — it’s defensive, and defensive investors are always particularly loss-averse. If you lose money betting on high-flying tech stocks, that’s much more likely to be money you can afford to lose than if you lose money after putting your life savings into precious metals. (Silver, as befits its status as the “B” share of gold, is also being hit badly today.)

The biggest problem in the markets right now is that they’re still far too risk-averse. Fear-based assets like gold, Treasury bonds, and cash are in high demand, while there isn’t enough money flowing through greed-based assets like stocks and bank loans and into the economy as a whole. Even if the stock market is expensive, the number of primary and secondary offerings remains low; similarly, banks are not expanding their loan books nearly fast enough.

What the system needs, then, is a stark reminder that fear-based assets can be just as risky as greed-based assets. Rising interest rates can eat away the value of your bond portfolio, inflation can erode your cash, and as for gold (or bitcoins, for that matter), well, it can plunge in value literally overnight.

My hope is that the price of gold will continue to fall, that goldbugs will look increasingly silly, and that as a result Americans with savings will conclude that the best thing to do with those savings is to put them to work in a productive manner, rather than self-defeatingly trying to protect what they have.

At the end of the 1990s, and again in the mid-2000s, we had greed bubbles. Both those bubbles burst, and the weird result was a fear bubble, which manifested itself in negative risk-free real interest rates and a soaring price of gold. Let’s hope that what we’re seeing right now is the fear bubble bursting. It’s what the world needs.

Comments
24 comments so far | RSS Comments RSS

“”an asset whose industrial value is a tiny fraction of its cash value”"

Can this be right? If it were, then there would be no industrial use of gold at all surely? I would have thought that the law of one price holds and the industrial value of gold is roughly the same as its cash value, with the very small number of industrial uses of gold (unless you count jewellery as an industry, which in my opinion you should) being a consequence of this high cost equilibrium.

I don’t think the concept of an “industrial value” versus a “cash value” is on very strong philosophical grounds – everything has a variety of different industrial uses depending on the price, and all we are really doing here is restating the fact that the price of gold is very high. I agree that there’s something arbitrary about it being gold that has this high price rather than, say, cowrie shells, but thinking about it in terms of an “industrial value” is bound to lead to confusion isn’t it? Or am I wrong here.

Posted by dsquared | Report as abusive
 

Mr. Salmon
What is your recommendation for putting “money to work in a productive manner”?
The stock market has just gotten back to the level it was 13 years ago, and that’s in nominal dollars. In terms of real purchasing power, the stock market is about 30% below where it was 13 years ago.
Do you suggest government bonds paying 1 or 2%? When Prof. Bernanke is printing $85 billion/ month of new Federal Reserve Notes?
Where do you put YOUR money?

Posted by unclepie | Report as abusive
 

Mr. Salmon
What is your recommendation for putting “money to work in a productive manner”?
The stock market has just gotten back to the level it was 13 years ago, and that’s in nominal dollars. In terms of real purchasing power, the stock market is about 30% below where it was 13 years ago.
Do you suggest government bonds paying 1 or 2%? When Prof. Bernanke is printing $85 billion/ month of new Federal Reserve Notes?
Where do you put YOUR money?

Posted by unclepie | Report as abusive
 

And consider the market-clearing price that XAU (and other assets) would trade at today if central banks the world over had *not* engaged in Quantitative Easings.

Posted by dedalus | Report as abusive
 

“What the system needs, then, is a stark reminder that fear-based assets can be just as risky as greed-based assets. Rising interest rates can eat away the value of your bond portfolio, inflation can erode your cash, and as for gold (or bitcoins, for that matter), well, it can plunge in value literally overnight.”

Inflation? Seriously? Every central bank in the world has been trying to engineer inflation into being for the past 4 years. Of course there is no transmission mechanism for the printed money to make into the real economy (personal incomes). The wealth effect aka “asset bubblenomics” policies of Greenspan and now Bernanke are desperate measures that cannot be sustained indefinitely. Until we see a major government come along and commit to FISCAL policy on an order comparable to the monetary shenanigans we’ve seen over the past 4 years, growth and inflation will be low to negative, and I will hang on to my cash, bonds, and yes, some gold, being the only currency in the world of finite supply.

Posted by the_pop | Report as abusive
 

Wow. The GLD ETF is down 8.78% in a single day of trading, the IAU ETF is down 8.85%, the PHYS ETF is down 8.59%…wow. Just wow. The Zerohedge, Peter Schiff and Glenn Beck-following crowd must be really licking their wounds right about now.

I agree with Felix, this is something that the (investment) world needs. It’ll be a useful purge.

Posted by Strych09 | Report as abusive
 

What asset class is not in a bubble, Felix?

Until at least one major government has the gonads to institute FISCAL policy comparable in scope to the monetary free-for-all of the last 4 years (which is futile given the lack of transmission mechanism to the real economy a.k.a. personal incomes), inflation will remain subdued at best, and cash and bonds and yes a bit of gold (the only currency of finite supply) are the only places to hide.

Posted by the_pop | Report as abusive
 

Hmmm… if I have submitted multiple comments, it’s because they take a long time to appear here after submitted, and there was no message telling me they had been submitted. As yet none of mine are showing.

Posted by the_pop | Report as abusive
 

People buy gold simply because they DO NOT TRUST THE GREEDY CORRUPT AMERICAN CAPITALIST SYSTEM that manipulates commodity markets and turns the average citizens all around the world (other than maybe those who live by subsistence farming) into economic slaves. Americans are so full of their own narcissistic arrogance of their philosophy of “free market economy” that they fail the only way for non-rich fat cat Yankee Whites to preserve their hard-earned wealth is by owning gold….and that’s if the American army does not come along to kill them and steal it….in the name of freedom.

Posted by anthonymaw | Report as abusive
 

I had a good friend I advised to get out of gold maybe 4 years ago or so when it was at $1,400. in the interim he was right, but it is now back there and he has even more and thus large losses and is not happy.

More foolish than a thousand fools.

Posted by QCIC | Report as abusive
 

I will believe it is the end of the fear trade when the Fed stops printing money

Posted by Tillingite | Report as abusive
 

“The biggest problem in the markets right now is that they’re still far too risk-averse.”

Problem for whom? Is there some shortage of equity capital that I’m not aware of? Valid business ideas going unfunded?

If not, then why Felix’s assertion? Or does he just think equities are mispriced, and dresses that up in musing on market macro?

Posted by SteveHamlin | Report as abusive
 

My greed based investing definitely includes gold jewelry so I hope the price falls enough to spur the resurgence of Italian goldsmiths (who have been busily investigating the possibilities of alloys and bonding in the meantime).

Posted by rb6 | Report as abusive
 

Agreed with SteveHamlin, investing in the S&P500 is not terribly productive — these companies are not raising new capital, so the purchases simply push the shares higher.

What is needed to get the economy flowing again is consumption, not investment. Specifically, the people who are accumulating investment capital need to start spending more of it so the money ends up in the hands of working-class America (who will then turn around and spend it again). Redistribution of wealth through consumption is vastly preferable to redistribution of wealth through taxation.

Will a collapse of the gold and bond markets spur consumption?

Posted by TFF | Report as abusive
 

What a strange, spiteful article. Gold purchasers deserve to lose money, because they have taken some insurance about macro-economic and -political events ? Have you looked at the news in the last 5 years ?

Fascinating that you pick on Apple as a comparison. There’s a stock that rose by *107 times* over nine-and-a-half years (compared to gold’s 6 times), and has now dropped over 40% in 7 months, yet none of the media seem to be crowing about that bubble bursting, or calling people idiots for investing in it.

Opinion aside, it’s also disingenous to equate the gold market to “the total amount of gold in the world”. That figure is a widely-accepted estimate of all the gold *ever* mined, including King Tut’s treasures, the Queen of England’s crown, and thousands of other jewels and museum pieces which are obviously not for sale; not to mention the amount wasted in modern electronic goods, and all the people who were ever buried with their gold teeth in… none of these are part of the “gold market”.

Far better to say that every year, we mine 80 million ounces, or $120 bn worth, or $20 worth per person on Earth, or $120 per person in China. Compare that to the current market cap of Apple alone – about $400 bn – and you realise it’s actually a tiny market.

Which makes me wonder exactly why the media are absolutely swamping their pages with ‘gold bubble popping !’ stories (at the time of writing, I count NINE links about gold on Bloomberg’s front page alone)…

Posted by AlreadyGotOne | Report as abusive
 

What a strange, spiteful article. Gold purchasers deserve to lose money, because they have taken some insurance about macro-economic and -political events ? Have you looked at the news in the last 5 years ?

Fascinating that you pick on Apple as a comparison. There’s a stock that rose by *107 times* over nine-and-a-half years (compared to gold’s 6 times), and has now dropped over 40% in 7 months, yet none of the media seem to be crowing about that bubble bursting, or calling people idiots for investing in it.

Opinion aside, it’s also disingenous to equate the gold market to “the total amount of gold in the world”. That figure is a widely-accepted estimate of all the gold *ever* mined, including King Tut’s treasures, the Queen of England’s crown, and thousands of other jewels and museum pieces which are obviously not for sale; not to mention the amount wasted in modern electronic goods, and all the people who were ever buried with their gold teeth in… none of these are part of the “gold market”.

Far better to say that every year, we mine 80 million ounces, or $120 bn worth, or $20 worth per person on Earth, or $120 per person in China. Compare that to the current market cap of Apple alone – about $400 bn – and you realise it’s actually a very small market.

Which makes me wonder why the media are absolutely swamping their pages with ‘gold bubble popping !’ stories (at the time of writing, I count NINE links about gold on Bloomberg’s front page alone)…

Posted by AlreadyGotOne | Report as abusive
 

This article sums up why economics is not a science and those blogging about economics can spout whatever non-sense and ad-hominem attacks they like…

Instead of talking about pure numbers, look at the socio-economics in reality. The European Union is being crippled by a handful of countries. Then, suddenly, another country in the Eurozone declares its financial woes and a radical plan to nationalize the people’s money becomes realized. Banks close; they have a soft opening where limited cash can be withdrawn. But the people remain utterly screwed.

Now Cyprus cannot follow the US’s path and print money at will to pay off its debts, so they look to assets; one asset they have been holding is gold (I guess, at the current moment, their UN vote is a less desirable asset because the people need to look to government issued inflation numbers, not something the government lacks the ability to manipulate at will). Gold is now going to be dumped into the market. Most have no idea how much will really be thrown onto the supply side, but when markets are driven by emotion and apparently bloggers with financial interests elsewhere and backed by large and (quasi-)trusted news sources, then the average investor is going to freak when they hear an entire country is liquidating their supply of gold lest the Eurozone face collapse.

Gold went down in price, but have the underlying issues driving the price of gold been fixed?-Not that I’m aware of. And your hope for people to suddenly start unleashing investment capital and consumers to go out and spend all their non-existent cash because gold has taken a hit is just insane. Gold will snap back; this little flash of smoke that has been thrown in the eyes of the people will soon dissipate. And in a year or maybe less, when the inflation driven speculative market gains come crashing down (the NYSE rises ~7000 pts in 3-4 years…whilst QE 1,2,3, and trillion dollar operating deficits compound year after year and with no ability to even budge interest rates is in existence (without plunging us all into a depression) to account for this upsurge in liquidity doesn’t even raise a tiny red flag?

And cash has become a real asset now? And purchasing gold is greed driven…it sounds a lot more like you are seething with greed when you “hope…that the price of gold will continue to fall, that goldbugs will continue to look increasingly silly,” and advocate that the few Americans who have savings should put their money to work…by placing their money on the table with rigged dice? Why not recommend corporations with incredible reserves of cash currently do something with that? Oh, wait, that would reveal that we are not in a liquidity crisis at all (thus the lack of spending), rather a solvency crisis and every year the reckoning from this misunderstanding will just become more and more painful when it comes. So yes, attack the “goldbugs,” take profit when your stock rises a couple points…that’s all well and good, but you too will soon face a hit that won’t recover and when you’ve lost all your offensive-investments (?) that are “guaranteed a sure bet,” there’ll be some there to help you in your time of need; whether they choose to or not…?

Posted by JJ216216 | Report as abusive
 

It is a point well taken that gold is a zero coupon perpetual bond and backed by something worth a fraction of its intrinsic value. On the other hand, what is the US Dollar? A zero coupon perpetual bond backed by what exactly, promises?

Gold is also currently the only major “currency” out there where there is no Central Bank not actively trying to depreciate it.

Admittedly farmland or something of the sort might be a better investmetn in the long run but that’s harder for an average individual investor. Gold has, or should have, some place in everyone’s else investment portfolio.

Posted by BEMB | Report as abusive
 

Criminy, UTC UTC UTC AGAIN and again and again.

Anyways, no UTC…..consumption (not just hedge funds and foreigners investing in REO in major municipals) will not return. Not until people start getting better pay and feel confident that policy makers are not listening to and quoting liars like R&R.

Posted by krimsonpage | Report as abusive
 

let’s see….Markets driven by statistics and numbers that come from who knows where and why. countries printing fiat currency by the ton…and gold drops in price! If this isn’t manipulation by something/someone to suppress the value of precious metals for..then I wonder what this can be..!

Posted by rikfre | Report as abusive
 

Well whats wrong with the picture portrayed by Felix.

Well, its just naive for a start.

Felix does not seem to understand essential cause and effect in the market place.

Here’s an example of silliness.

“…………………My hope is that the price of gold will continue to fall, that goldbugs will look increasingly silly, and that as a result Americans with savings will conclude that the best thing to do with those savings is to put them to work in a productive manner, rather than self-defeatingly trying to protect what they have…………………”

Invest in the US stock market and everything will be fine, right Felix, we will all live happily ever after?

It is so sad to hear people make these lame statments.

My hope is that the people of the United States of America will finally learn to live within their means rather than racking up an 20-80 trillion dollars debt, and then exporting it to the rest of the world as toxic ‘money’ an hope that no one notices.

Posted by Cranston67 | Report as abusive
 

Fear trade I don’t think so. Holding gold is about freedom. It’s about getting your money out of the debt Ponzi scheme. It’s a vote for freedom – far better than any vote you can cast at the ballot box. It’s opposing the entrenched elite of bankers and politicians. It’s about the future and the children. Pathetic article.

Posted by zabbage | Report as abusive
 

I wrote this the other day at zerohedge. It was not appreciated by some of the posters. Maybe you guys will like it!

PWNED
by Squeeky Fromm, Girl Reporter

Quick, Maw! Hock the trailer!
And hock the pickup, too.
Gold is 18 hundred,
So, let’s buy an ounce or two.

And when it hits 10 thousand,
Oh, how we’ll swell with pride!
Sell it off, pay back the loan,
And buy a double-wide!

Paw, it’s Fred, the pawn shop guy.
He’s says a payment’s due.
Should we sell an ounce of gold,
Or maybe even two???

Nope, it’s 16 hundred now,
We need to buy the dip.
Hock the shotguns, and the dog,
We’ll wait and sell the rip.

Paw, it’s Fred, the pawn shop guy.
Another payment’s due.
Should we sell an ounce of gold,
Or maybe even two???

Nope, it’s 15 hundred now,
A sure sign to invest!
Let’s go get a paycheck loan,
I think that’s what is best.

Paw, it’s Fred, the pawn shop guy,
And the loan girl, Betty Lou.
Should we sell an ounce of gold
Or maybe even two???

Nope, it’s 14 hundred now,
So let’s stick out our necks.
We’ll gamble on the rally,
With some insufficent checks.

Paw, it’s Fred, the pawn shop guy,
And Betty Lou’s on hold.
They’re mad about the hot checks.
Pretty pleeease, let’s sell the gold???

Nope, it’s 13 hundred now,
It’s got to take off soon.
Nowhere left to go but up.
A rally to the moon!

Paw, it’s Fred, the pawn shop guy.
Our trailer has been sold.
Betty Lou has garnished us,
You’ve got to dump the gold!

Maw, the stuff is selling
For 8 hundred bucks an ounce.
Cross your fingers, hope and pray
We get a dead-cat bounce.

Paw, it’s getting serious.
The Sheriff’s at the door.
He says we have to clear out.
Oh please sell it, I implore!

Maw, I can not sell the gold.
The price could not be worse.
I thought I had the Midas touch.
I did. . . but in reverse.

. . . .

Paw, this cardboard box, it leaks.
The sidewalk’s awful cold.
I’m about to starve to death,
Too bad we can’t eat gold.

Maw, I know just how you feel.
My pillow is a log.
I miss my shotgun, and my job.
I really miss my dog.

I miss my trailer, and my truck.
I can not be consoled.
All I have to keep me warm,
Is a stupid chunk of gold.

Time for me to dump the gold.
I’ve gotten a few tips,
About an opportunity
Investing in TU-LIPS.

Squeeky Fromm, Girl Reporter

Posted by SqueekyFromm | Report as abusive
 

Please may I invite you to step into this lovely golden bear trap? Well OK but first can I ask a few questions – if the gold price is falling it must mean that labour force participation has improved? Err no! Has GDP improved despite QE and budget deficits >10% of GDP? Err no! Has QE stopped and have bankers started behaving responsibly? Hell no – they will probably fail again at the mere sniff of a crisis! Has a huge supply of Gold that nobody wants suddenly been discovered? Err no in fact ore grades are declining and Germany is waiting 7 years for its gold from Uncle Sam! So with no fundamentals behind any economic recovery, a gold price at it lowest for a couple of years, and record physical demand you want us to dump it and embrace some horrendous QE bloated stock/bond fest? Yes but we have a printing press and lots of other suckers so everything will be fine, just step forward!

Posted by maxim_moto | Report as abusive
 

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