By: Eric Sprott
Debunking the Gold Bubble Myth
Gold’s continuous ten-year rise, producing consistent returns in virtually all currencies year after year, still has some market pundits questioning its validity as an asset class. Despite all this talk about the gold bubble, the capital flows into gold vis-à-vis other financial assets have simply not been large enough to indicate any speculative mania.
So say Eric Sprott & Andrew Morris (www.sprott.com) with David Baker in an article which Lorimer Wilson, editor of www.munKNEE.com, has reformatted and edited below for the sake of clarity and brevity to ensure a fast and easy read. They go on to say:
Why Gold is NOT Forming a Financial Bubble
The widely held misconception that gold is in a bubble stems from a fairly straightforward view – that gold buyers are merely foolhardy speculators buying on a whim with no rationale other than to sell to the ‘greater fool’ at higher prices in the future. It’s a view that assumes that gold has no intrinsic value and is simply a speculative asset that has captured investors’ imaginations.
We’ve seen bubbles before and fully know how they end. We have no interest whatsoever in participating in some sort of speculative frenzy. Thankfully, our gold investments present no such risk. Gold is actually a surprisingly under-owned asset class – and one that has generated far more attention in the media than it probably deserves. While its performance since 2000 is exemplary, gold simply hasn’t commanded enough investment to warrant the bubble fears it has aroused among market pundits and business commentators. The truth about gold is that most people simply don’t own it – yet.
1. Gold Ownership Still at Trivial Levels
A speculative bubble forms when prices for an asset class rise above a level justified by its fundamentals. For this to happen, increasing amounts of capital must flow into the asset class, bidding it up to irrational levels. Gold may be trading at all-time nominal highs, but a look at investment flows proves that it isn’t anywhere close to being overbought.
In their Gold Yearbook 2010, CPM Group noted that in 1968, gold held by individuals for investment purposes represented approximately 5% of global financial assets. By 1980 that amount had fallen to roughly 3%. By 1990 it had dropped significantly to 0.6%, and by the year 2000 represented a mere 0.2% of global assets. By the end of 2009, nine years into the gold bull market that began in 2000, they estimate that gold had increased to represent a mere 0.6% of global financial assets – hardly much of an increase. Gold ownership didn’t change much in 2010 either, as we estimate that this percentage increased to 0.7% of global financial assets. Despite gold reaching record nominal highs, the world holds about the same portion of its wealth in gold as it did over two decades ago. While this probably says more about the proliferation of financial assets over the past decade than it does about gold investment, it is surprising to note how trivial gold ownership is when compared to the size of global financial assets.
In other words, the actual amount of new investment into gold since 2000 represents only 0.1% of current global financial assets, or about $250 billion. Although this number may seem large, consider that roughly $98 trillion of new capital flowed into global financial assets over the same period. Thus gold’s approximate 0.3% share of global investment flows is essentially trivial.
The 0.7% ownership also has interesting implications for gold ownership moving forward. To return to a meaningful level of gold investment, say to the 5% level of 1968, it would require over $9 trillion of gold investment today, or about 6.5 billion ounces of gold at the current gold price. This would represent well over 1.3 times the amount of gold ever produced throughout history and four times the amount of known gold reserves. So, not only is the public relatively underinvested in gold, but at current prices it isn’t even possible to increase our gold holdings back to a meaningful level.
2. Gold Equity Financings Remain Low
Gold’s apparent underinvestment also applies to gold equity financings since 2000. According to our sources, gold companies raised approximately $78 billion of equity capital in new financings over the past 11 years. To put this amount in perspective, this is equivalent to the total amount of equity raised by technology companies in just the first 3 months of 2000.
Compare last year’s gold company financings with the technology company financings in the year 2000 (Chart 1). Looking at the relative amount of capital market activity in the gold equity markets, we find no indication of a bubble whatsoever.
Mutual fund flows give us a sense of the average retail investor’s appetite for gold equity investments (Chart 2). We found very familiar results in this area as well: compared to the $2.5 trillion dollars that was invested in US mutual funds since 2000, precious metal equity funds have seen a mere $12 billion in inflows. If there is a bubble in gold investments, the average retail investor hasn’t participated in it.
3. Gold Stock Valuations Remain Low
Chart 3 presents compares the price-to-EBITDA of the HUI vs. that of the Nasdaq Composite since 1998. Price-to-EBITDA is a valuation metric that compares a company’s stock price to its profits before accounting for taxes, interest payments, and non-cash charges. Looking at the price-to-EBITDA multiple for the Amex Gold Bugs Index (HUI), we see absolutely no evidence of a frothy market for gold stocks. At the current level of 13 times EBITDA, the HUI is actually trading below its 15-year average of 14 times. Moreover, valuations for gold stocks are currently one-third of the levels reached by the Nasdaq in late 1999. There simply isn’t any evidence of excessive valuations in gold stocks, which is most certainly where we would expect the excesses to be most apparent.
Conclusion
Based on our findings, the notion of a gold bubble is patently false. The current investment interest in gold relative to other financial assets remains surprisingly low – about where it was two decades ago. Moreover, the modest valuations of gold equities highlight the absence of unbridled investor enthusiasm for gold investments. The fact is, despite all this talk about the gold bubble, the capital flows into gold vis-à-vis other financial assets have simply not been large enough to indicate any speculative mania
All Things Considered – John Commentary:
You can’t focus on the price alone. You must focus on the intrinsic value of the asset, in this case gold. You must focus on the fundamentals as outlined above. Take the time to re-read the article above. It makes about the clearest case possible for gold investment.
Action to take: Gold is poised to reach $1650 or more and silver $50 by the end of the year. Both are eventually going much, much higher. If you have been waiting, then you know the feeling of the market running away from you. Wait no longer.
Quote of the day: “Buy gold and sit on it. That is the key to success.” – Dr. Franz Pick
