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, as editor of Real Asset Returns, 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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