The Three Triggers of the Global Gold Bubble

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By Peter Krauth
Contributing Editor
Money Morning

As you review your investment portfolio to size up your current exposure to gold, keep one key point in mind: When it comes to profits, there's no rush like a speculative gold rush.

And that's just what we have at hand.

Inflationary fears are on the march the world over. And most of those worries are due to the trillions of dollars in stimulus spending the world's central bankers have engineered. Those worries about the pressure from rising prices are destined to cause the next big asset bubble.

And the color of this particular bubble will be gold.

The irony here is that even though central bankers are the cause of this looming bubble in gold prices, a higher gold price isn't their objective.

They apparently believe that freshly minted "fiat dollars" – trillions of them – are just what's needed.

Let me explain.

The plan, you see, is quite ingenious – on its face, at least. With a simple wave of their monetary wands, and a midnight run of their printing presses, central bankers such as U.S. Federal Reserve Chairman Ben S. Bernanke will be able to "create" the money that's needed to repay their governments' obligations, shore up their financial systems and jump-start their economies, all at the same time.

But nothing is ever that simple.  And there's a problem that's been overlooked, or perhaps just ignored.

It's called an "imbalance."

As central bankers flood the world's financial system with ever-increasing amounts of cash and increasingly easier credit, there won't be an offsetting increase in the amounts of goods and services available for purchase.

The result: you have more capital chasing the same amount of production.  As your mind treks back to Economics 101, you'll realize that the laws of supply and demand haven't been rewritten. The additional dollars will cause the prices of the goods (especially such commodity assets as precious metals, crude oil, industrial metals, agricultural commodities, and later on even property assets such as global companies) to rise in a scenario that's akin to a global auction.

That means there's only one possible outcome.

Higher prices. Just around the bend.

As that almost-certain inflation tsunami approaches, gold will be your safest flotation device.

The Three Trigger Points of the Coming Global Gold Rush

Every bull market in gold runs through three stages:

  • Stage One: Currency Devaluation.
  • Stage Two: Investment Demand.
  • Stage Three: A culminating Mania-Buying Spree.

In Stage One, gold gains the most ground against the leading global currency. This one's easy.  Gold, and virtually every other commodity I follow, is quoted in U.S. dollars. Despite the many epitaphs that have been written, the greenback remains the world's dominant legal tender.  Its status is very likely to change someday, but that's fodder for another essay. 

Since April 2001, and until a couple of years ago, the increase in the price of gold was much more muted in other currencies. With gold seemingly locked in a sideways trading market, demand for the "yellow metal" remained low.

In Stage Two, gold begins to decouple from the dominant currency (the U.S. dollar), rises versus most other monies, and investment demand kicks in.  That inflexion point was reached by mid-2005, and gold's upward slope began to take shape.

It's at this point that foreign investors begin to take notice. Investors from Asia, Europe and other key markets outside the United States have a much stronger attraction to gold than we do, and often better recognize its ability to preserve wealth.

Just as important: At this point in the cycle we see sophisticated individual investors – and professional institutional investors – increase their portfolio allocations.

Twice before gold has taken a shot at the psychologically significant $1,000-an-ounce price level, even eclipsing it for a time and setting a new record high in March 2008.

Already, demand for physical bullion has been on a marked rise since entering Stage Two. And with last fall's stock-market panic, demand zoomed almost vertically.

During the fourth quarter of 2008, for instance, North American and European purchases of gold coins and gold bars rose 811% over the same period the year before, and premiums on physical gold escalated stratospherically.

Overall, this intensified interest in the yellow metal pushed the global retail investment in gold up n early 400% in last year's fourth quarter, compared with the final three months of 2007, according to the World Gold Council.

Exchange-traded funds (ETFs) have been a tremendous catalyst for swelling gold demand. SPDR Gold Trust (NYSE: GLD), the largest physically backed ETF on the planet, is now the sixth-biggest holder of gold bullion in the world, holding more than 1,000 metric tones of the precious metal.

Indeed, the fund's influence on the market is such that it actually seems as if every year or so it moves up past year another nation in the global rankings of gold-bullion holders.

Because it's becoming so much easier to invest in gold, individuals are becoming much larger owners and holders of the yellow metal, a reality that's gradually decreasing global government influence over the valuable commodity.

We've clearly passed Stage One. And we've certainly completed much of Stage Two.  That means the fun is about to begin.

Enter Stage Three …

Stage Three is when all the stops get pulled out.  That's when the public finally becomes aware of gold's progressive rise.  It's when we see a market bubble akin to what we saw with "dot-com" stocks back in the late 1990s, or U.S. stocks (and a Dow Jones Industrial Average in excess of 14,000) in late 2007.

A mania sets in and higher prices, by themselves, beget higher prices, with gold now rising in the kind of near-vertical climb that is the hallmark of a speculative mania – a bubble.

According to famed market observer Richard Russell, publisher of the Dow Theory Letters, we have entered the beginnings of Stage Three.  Russell has the perspective to understand what he's saying: He's been following and writing about the markets for more than 50 years – without interruption – having started all the way back in 1958. And Russell says that "my belief is that we're now nearing the beginning of the third speculative phase of the great gold bull market …"

And Russell's not alone.

In an interview with Bloomberg TV, Marc Faber – another noted writer and commentator – was asked about the inflationary pressures facing the United States, and responded by saying that he is "100% sure that the U.S. will go into hyperinflation. The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate."

So if Russell is predicting a bubble (Stage Three), and Faber is predicting a huge surge in demand (inflation – Stage Two), that leaves us to find a recognized outside expert to address Stage One (currency devaluation).

For that we turn to noted author and global adventurer Jim Rogers, who has been interviewed many times by Money Morning.

And Rogers isn't keen on the future of the U.S. dollar.

"We're going to have a currency crisis, probably this fall or the fall of 2010," Rogers said recently. "It's been building up for a long time. We've had a huge rally in the dollar, an artificial rally in the dollar, so it's time for a currency crisis."

How Dark Will it Get for the Dollar?

Currency crises occur all the time. Even the really bad ones – known as "hyperinflation" – have occurred on a fairly regular basis throughout history: Zimbabwe has experienced this extremely painful affliction for much of this decade; in Germany's Weimar Republic, the paper mark/gold mark ratio went from a one-to-one ratio in 1921, all the way to a one-to-1.0 trillion ratio in 1923 (see accompanying chart).

Now just imagine what would happen to gold in any remotely comparable situation involving the U.S. Dollar.  Remember, the dollar is the world's reserve currency today.  Simply put, this is an experiment pure and simple, since there is no precedent for the current world money order.

All it would take is a loss of faith in the greenback. It's important to understand that dollars are nothing more than paper and ink, backed by the full faith and credit of the U.S. government.  In a year in which the budget deficit could easily top $2 trillion, this does not reassure me.  

The dollar holds its value only as long as the greenback's holders maintain their faith in the currency. The moment people decide they don't want your dollars, they become worthless, or at least worth much less.  In that case, it will take a lot more dollars today to buy the same thing you bought with many fewer dollars only yesterday.

Historical anecdotes recount stories of workers having to be paid several times a day (because the Weimar mark was falling in value so quickly), or of wheelbarrows full of marks being trundled up to the local store just to purchase a loaf of bread. At one point, the mark had fallen so far that it had more value as a wallcovering than as a currency.

The worst part of such a scenario is when there's an actual "panic run" on the dollar, where holders dump it en masse, meaning there are a lot of folks trying to exit all at once through a very narrow doorway. For the greenback, it would be nothing short of the currency's death knell.

Painting a Picture of a Powerful Profit Play

But in the dollar's demise would be a major profit opportunity. As noted, gold is priced in U.S. Dollars all around the world.  That's why I have no doubt that gold will absolutely soar, as people the world over will seek refuge in its anti-inflation properties.

Add into the mix the fact that – compared to stocks, bonds and currencies – gold is actually quite a small market, and you start to understand the magnitude of the opportunity we're depicting.

Add in the cash held back by investors who were burned by last year's panic sell-off, coupled with the liquidity being created by the often-profligate government stimulus programs. That's a potentially hefty catalyst in such a small market.

How hefty? Just think back 10 years to the dot-com bubble of 1998, 1999 and the first part of 2000, when any company with a "dot-com" suffix was automatically lumped into the "Gold Rush" in cyberspace.

Or, if you want something more recent, think about the near-vertical-ascent in housing prices we watched just a few years ago – a real estate bubble that induced countless numbers of homeowners to take cash advances on the homes that they lived in to buy second homes, vacation houses, or rental properties "as an investment."

In both cases, think about the profits reaped by those who got in early, and who understood the game that was afoot.

Fueled by the long-term, inflation-supercharged changes in the world financial system, the flood of newly printed money, and the looming demise of the dollar, the imminent gold mania will put the dot-com craze, and even the real estate frenzy, to absolute shame.

Here's one last point to consider: We're only about seven to nine years into a "secular bull market" in commodities that was poised to play out anyway, and that has an additional eight, nine or 10 years to run. And key among those commodities is gold.

But if you really want to juice your returns, be sure to get some exposure to companies that explore for and produce gold, as their margins will rise exponentially along with a rising gold price.

After all, as history shows us, there are a lot of ways to profit from a gold rush.

[Editor's Note: If it's inflation you're worried about - and commodities you want to invest in - there's no better place to look than the Global Resource Alert trading service, which ferrets out companies poised to profit from the so-called "Secular Bull Market" in commodities. If you're new to the commodities-investing arena, and are uncertain about the landscape - or even if you're an "old hand" at natural-resource stocks, but want some insights into the new profit plays and new players - consider hiring a guide: Money Morning Contributing Editor Peter Krauth, a recognized expert in metals, mining and energy stocks, who is also the editor of the Global Resource Alert. A former portfolio advisor, Krauth continues to work out of resource-rich Canada, which keeps him close to most of the companies he researches. Against the growing global financial malaise, Krauth says that commodities are among the most-profitable and least-risky investments available, and notes that this may well be the most powerful bull market for commodities we'll see in our lifetimes. He makes a strong case. To read more about his strategies, and the sector plays he likes the most, please click here. ]

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About the Author

Peter Krauth is the Resource Specialist for Money Map Press and has contributed some of the most popular and highly regarded investing articles on Money Morning. Peter is headquartered in resource-rich Canada, but he travels around the world to dig up the very best profit opportunity, whether it's in gold, silver, oil, coal, or even potash.

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  1. Sue Larsen | July 28, 2009

    I really loved your article on the 3 stages of gold and believe it goes into much more detail than many other articles discussing similar information- t hank you!

    What I don't understand however, is that if the gold price soars but the value of the greenback declines, for those of us who have bought in non- US currencies such as AUD, any increase in our gold price is more than eroded by the damage done when we convert it back into AUD. So what do we do?? Is there any point to buying gold…?

  2. tom lamont | July 28, 2009

    I share your views, but what about silver? With the mis-pricing of silver relative to gold, do you anticipate that silver will share in the run-up in gold prices?

  3. Jack Worthington | July 28, 2009

    The price of gold is a watchman on the counterfeiters, the government-central banker consorts, so when the criminals increase fiat currency and fiat computer bit credits, the price should rise. But if the price of gold rises, performing its function, then the central banker-governments are forced to suppress the price of gold else their criminality be exposed. So, as the banksters and politicians sell physical gold to suppress the price of gold, they lose power to conrol as their reserves of gold are depleated or if they sell gold forward, paper gold, not the real stuff, then they merely delay the day of reckoning and the "rubber band" is stretched tighter until the day it breaks and the subsequent pain is worse than if the crime had been addressed at its beginning, i.e. 1913 or 1914, as Elihu Root so presciently warned.

  4. Daniel Philippot | July 28, 2009

    Re: Sue Larsen's comment

    There are funds that will provide you with a hedge against this scenario. I personally have invested in a Canadian (I am Canadian) TSX traded entity called Claymore Gold Buillon Fund. You might want to check it out. Cheers.

  5. Frederick | July 29, 2009

    This is further to the comment by Sue Larsen.What would happen to gold in Aussie dollar terms. Will the gain in the gold price be eroded by thefall in the US dollar exchange rate(rise in Aussie dollar)

  6. Mizou Carillo | July 30, 2009

    Re: Gold in AUD

    If the US$ runs into a "currency crisis", and US$ being the world's reserve currency, wouldn't all currencies around the world be out of wack simultaneously?
    Also, given that for example, Qld Treasury Bonds are traded in USD on the http://www.sec.com and if US$ collapses, what happens to our liability / debt.. How is it now measured…

    I can only see chaos if (when) the US$ fails and I can see gold being traded for nothing else but essential, tangible items.

    Could I have your thoughts on this scenario please.

    Best Regards

    Mizou

  7. NT | July 30, 2009

    Re Sue Larsen's post.

    Fair comment Sue, However, when "stage 1" approaches, the USD will go through a few stages, i will use the quick approach as an example.

    Hyperinflation: when it comes to this, USA will require to introduce a new currency (like the continental in 1775) and your gold will be adjusted accordingly. Alternatively, if a new trading currency is introduced, (like the Chines Yuen) as china and russia are already pushing for, then gold will be priced at the new standard. for eg, 1/oz = 10,000 yen.

    On a side note, Australia "HAS" to devalue their dollar specifically to keep up with the printing of the USD. why? because if they don't, then their exports become too expensive for other countries to consume and would head toward a deflationary cycle.

    Above all, ensure that you actually hold physical gold in your possession, not the ETF's as mentioned above because you cant believe they hold any gold on your behalf. goldmoney is a website that is reputable, but still, if its not kilo's of the stuff your holding, keep it stored away safely in your posession.

    Silver on the other hand is an undervalued commodity and great entry price for those who cant afford gold. Silver unlike gold is a consumable resource and too expensive to retrieve once consumed (like pc motherboards, lights, solder etc)

    hope that helps
    NT

  8. Anthony Maw | July 30, 2009

    If you really believe that gold will to really "take off" in U.S. dollar value, you'd better get a gun, lots of ammo, stockpile non-perishable food and sandbag your home, presumably where you'd keep your gold. Think about it: A huge run on gold could mean a run on the banks as citizens withdraw their cash savings to buy gold. Also a stock market crash as investors dump their shares to buy physical gold. Even gold companies would be NOT be immune: The share values could double, triple, quadruple, etc. but if your dollars are depreciating by orders of maginitude you're still F@#CKed. If our lovely American friends have to pay $10 (or more) for a loaf of bread you can bet your bottom dollar there's gonna be trouble in the most heavily civilian armed country on the planet…..my 2 ounces worth.

  9. Quarmby | August 2, 2009

    The whole problem actually began when we all stood back and allowed the half whitted politicians and the theiving bankers go off the gold standard. The GS was the only thing keeping them semi honest and protecting the general public from 23 year old currency traders and defecit junkie politicians. These so called leaders ("the people get the government they deserve…Ben Franklin) as neither bright enough, nor honest enough, to be allowed any flexablity with regards to currency valuations. The Swiss have the right idea when it comes to defecits….public vote…if the politicians can't run their respective domains on budget, then fire them and find someone who IS capable….and BAN all lobbyists period….it wll keep the children (read politicians) from temptation.

  10. saul bernstein | August 2, 2009

    and where do you suggest I put the gold? remember 1930's..our government went into the safedeposit boxes and took the gold..now when purchasing gold we have to surrender our SSI number and who do you think gets that?? and lastly since the last decade all phone calls and internet calls are picked up by the government..and without a warrant..and so now they(the feds) can come into ones house without a warrant and do what they want..there is no place to hide the gold..if one looks back in time it was illegal to own any and if caught one could face a $10,000 fine or 10 years in jail(or both)..what do you think now?

  11. art youmans | August 3, 2009

    Excellent article.

    I've hesitated buying the Exchanged-Traded-Fund "SPDR Gold Trust (GLD)" because I've been told that the IRS taxes Americans annually on the gain (like a mutual fund does) even if you never sell GLD. Is this true?

    Any suggestions about keeping up with hyperinflation in the future by buying Gold Bullion coins, like the American Eagle Gold coin or miscellaneous rare coins? I haven't bought any yet but I'm thinking about it. Any suggestions are appreciated.

  12. Rich Salvagni | December 30, 2009

    Gold is a poor investment, averaging a return at or below inflation over the past 60 years. The worst time to buy gold is also the worst time to buy real estate, tech stocks and oil futures….when there is a "frenzy" that accelerates the value of an asset beyond the par value of it's use. There is no "gold standard" any longer. Gold's value is almost wholly intrinsic to demand. The value of it's actual use as jewelry or an industrial metal has not changed substantially. This fact assumes that heightened demand or "frenzy" has pressed the value well beyond gold's equilibrium price. In times of crisis gold is NOT the method of currency. Whatever utilized commodity that is in short supply becomes valuable; think Katrina, a flashlight, gasoline or drinking water exponentially inflated in value. The world economy has essentially stabilized gold is being propped up by consumer demand…demand for a product with a utilizable value that hasn't changed much. When your barber suggests it's time to invest in anything, it's time to sell it or short it.

  13. sell jewelry in clearwater | August 15, 2010

    Lets just assume vanity isn't just a vulgar part of human existence and ask ourselves, " Who really notices if you are wearing a diamond, or any other kind of jewelry for that matter?" When I see a woman that I might be interested in asking out, sure I look for a ring, but I could care less about what it's made of. The fact that people spend thousands of dollars for vanity's sake makes me sick enough but there are others being enslaved and killed over it too.
    Flag

  14. Dave Ziffer | January 14, 2011

    Funny, your chart of the price of gold during the Weimar Republic has approximately the same shape as the graph of the percentage change of the growth in the US money supply as shown on http://www.chartingstocks.net (see the "historical" tab). Most of this money (as I understand it) went to prop up the balance sheets of the banksters' big banks and hasn't even entered circulation yet. When it does, it seems to me that we will see a simply unprecedented and breathtaking price inflation. My estimate of price inflation in 2010 (not using the bogus government figures) is about 10%. Given that the Fed's currency injection has been on the order of 100%, we can expect that once all this money circulates, we will have experienced 100% inflation, and that will be the limit only if the Feds don't print any more. But they will print more – trillions more – as the option ARMs reset in 2011 driving us back into recession, and as state and municipal bonds start collapsing like dominoes, probably also this year.

    What will the price of gas be in 2015? I'd say we'd be lucky to see it as little as $6 per gallon. What will the price of gold be? My guess is at least twice what it is today (which would be about $2800 per ounce). Not that it will buy you any more at the supermarket; merely it will have held its purchasing power. And with the dollars we'll be printing by 2015, $2800 will be cheap.

  15. Dave Ziffer | January 14, 2011

    One more point: I've read lots of pro/con opinions regarding whether we're in a gold bubble. I used to think that we are, but now I think that we're not, despite the spectacular price rise of the last eight years. Why would I come to such a conclusion?

    It all has to do with what you believe about the character of American politicians at every level – local, state, and federal, and about where we are headed fiscally. First understand that from 1776 to 1913 the US built some of the most solid financial credibility on the face of the earth due to the gold standard upon which its currency was based. Despite the various debasements between 1913 and 1980, we were still able to function reasonably because we had a positive trade balance and a near-zero national debt. But since 1980 we have been going hog-wild. Thirty years of expensive wars and an increasingly negative trade balance have left us paupers, although many still can't see it (the trappings of wealth can confuse observers for quite awhile).

    So two things have happened. We have run out of real positive economic steam (i.e. positive trade balance) and there is no reason to expect recovery from this – ever. The other thing is that we've developed an electorate that has no concept of this problem, and which is hooked on more and more spending. If we were electing fiscally responsible people who were going to reverse our decline by cutting spending, then there would be a possibility of recovery. But that is the issue: it is politically impossible in the US to reduce spending. In fact, we can't even reduce the rate at which we increase spending. Actually, we can't even reduce the acceleration of the rate at which we increase spending.

    These two factors together are leading us to demise. The only escape would be if we were to somehow elect a fiscally responsible government at every level. If this isn't going to happen, then we have only one future: escalating currency debasement forever.

    As an illustration: I live in Illinois, which just raised its income tax from 3% to 5% in order to avert total fiscal meltdown in 2011. The observer must ask: will this solve our problems or will it make them worse? The naive person would presume that we will be better off because we will prevent further degradation of our bond rating and we'll have money to pay our bills this year. But the more astute observer will look at our history and realize what is really going to happen. I predict that Illinois will now use this increase to justify a 100% increase in state spending over the next ten years or so, leaving us even more broke in 2020 than we are today. It's basically inevitable. There is no controlling the appetite of the public sector. I assure you: absolutely all the money in this tax increase has been divvied up behind closed doors already.

    So back to the price of gold: in order to imagine that its price will eventually drop, we'd have to presume that the US will put its financial house in order, i.e. that it will stop printing money. That would require no more bank bailouts, no more stimulus, and an actual reduction of spending at every government level in order to avert bailouts of the states and municipalities. Is that going to happen?

    Nah.

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