There has been an enormous flight to gold investing over the past few months.  It started towards the end of 2008, but has really picked up steam as the stimulus plan was unveiled and ultimately approved stirring more worries about deeper recession.

With the price recently surpassing the $1000 mark again, investors are back with gold thinking of it as the savior of their money.  $1000 gold can be likened to $100 a barrel oil, and when we crossed that threshold we had no idea where it was headed next.  In hindsight we know what happened, but that is not indicative of gold’s performance.

Both oil and gold are considered commodities.  The are sold in units and can be invested in without obtaining the actual product.  But this is where their differences end.

Think back to last year when the price of oil ran up to $100, then $125, and ultimately topping out just below $150 a barrel.  What did analysts and news sources tell us the reason was?  They kept telling us world demand for the limited resource had driven up the prices.  We learned later this was not the case, but that is another story.

So What is Driving Up the Price of Gold?

  • According to geology.com, 78% of all gold is used in the production of jewelry.  With the world in recession and jewelry stores having blowout sales like they’re selling furniture over a random federal holiday, it is unlikely that demand for jewelry has increased lately.  So the price of gold has not increased because of demand for “bling”.
  • Gold is also used in the manufacture and production of computers and other electronics.  Gold is a very versatile metal when it comes to electrical devices.  But retails and commercial sales of electronics has also suffered because of the economy.  Production capacity has been reduced, and a rise in price would send manufacturers to other metals that are cheaper than gold.
  • We probably all know someone with a gold tooth or some type of crown or bridge.  Beyond that gold is also used in small amounts as an additive to drugs, or even a decoration on food.  But these uses are so negligible they could hardly impact the demand for gold.

This leaves the use of gold as an investment.  The only logical reason for why the price of gold has spiked is simply because people are running out of places to put their money.  Real estate? Dead.  Bonds?  No one is credit worthy.  Stocks?  Heck no!  Oil?  Been there.  All that is left is gold.  With a mad investor gold rush we can only expect the price to rise.

Where Oil Shines and Gold Does Not
Up until now it would appear that oil and gold have a lot in common.  Both are highly valued in this society, have many uses to the economy, and the product is commodious in nature.  But the price of oil reflects the knowledge that we will someday run out of the stuff.  This means that over time it should be expected to increase in price as supply runs out.  This makes it a potentially good long-term investment.

Gold on the other hand is recyclable.  Once we run out of it in the ground, we can melt down computer components, teeth, and jewelry to put it to new uses.  You can’t sell oil after you’ve used it, mostly because it’s primary use requires it to be burned.  So when oil prices spiked to $150 a barrel last year, you didn’t see a bunch of people reselling their used gas.

What we’ve got here then is a situation of a market that will regulate itself with gold.  We’re seeing the beginnings of this already.  As the price goes up, people that own gold will be very interested in selling it, mostly in the form of melting down old jewelry.  But since the price is high, you’ll also see many gold miners and refiners digging more of it out of the ground.  Now you have two sources adding to the supply stock of gold.  But where is the demand?

Oil and Gold Alike Again
Remember above I said that the demand for gold’s industrial and aesthetic applications has wavered in the past year or so.  Yet the price has increased substantially.  The same thing happened to oil last year.  Despite curtailed demand, the price of oil jumped through the roof.  We later learned it was because investors were fleeing the stock market and wanted a place to park their money.  Sounds familiar doesn’t it?

This is exactly what is happening with gold right now.  With all faith in more traditional investments gone, everyone is flocking to gold, hoping for it’s price to jump to $2,000 so they can make a good return.

But now you’ve got these Cash4Gold.com websites and local jewelers offering to buy up your gold.  They’re willing to buy it because they know they can turn around and sell it at these expensive prices.  With two sources pumping up supply, and the only demand coming from investors, you’ve got the makings of a super bubble.  This bubble will pop, and it will pop hard. If you thought the price of oil fell quickly, just wait and see what will happen to gold if it hits $1,500 an ounce or more.

What will cause it?  One of two things.  The first possibility is that the economy will recover, and investors will move back to equities and bonds, sparking a huge sell-off of their gold holdings.  The other, and more likely possibility in my opinion, is that investors will realize there is a big bubble and start to sell off their holdings for a quick profit.

One final note that really disturbed me:  In the same commercial break on CNBC last week, I saw a Cash4Gold commercial telling me now is the best time to sell gold, and a commercial from US Money Reserve telling me now is the best time to buy .

Photo: Pythonboot

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categories: economics, investing