A Gold Bubble?

As you know from my recent posts and updates, we are still holding a small position (10% of portfolio value) in gold. With the financial markets mired in uncertainty, is there more upside potential for the metal or will the Fed’s easing eventually create a gold bubble?

Lance Lewis of Minyanville had this to say:

With the equity market now likely set up for some sort of bear market rally in the wake of the Fed detonating its 75 bp “nuclear weapon” on Tuesday, the “fear of the margin clerk” – which has weighed on gold and gold shares over the past week or so – should now be removed, and that opens the door for both to release to the upside and make new all-time highs very shortly. My own near-term target for the yellow metal is $1000+, but that’s just me.

Remember, the Fed is easing with gold at an all-time high. When has this ever happened in history? It hasn’t, because never before has the threat to the financial system been so horrific due to all the leverage and financial engineering that has built up over the past 25 years. To allow this to “unwind” (as it should have been allowed to years ago) is now virtually impossible due to the dire consequences involved.

Faced with that prospect as stocks began to crash and the two largest credit insurers were teetering on bankruptcy, the Fed was forced to ease 75 bps in a single day on Tuesday (and promise more easing to come), even as the equal-weighted CRB (CCI) was just a few percent off its all-time high and gold was at an all-time high. The result is going to be that Wall Street will now take that 75 bps and create more money and credit (i.e. “print money”), but the “liquidity” won’t go where the Fed wants it to go (i.e. the US credit markets).

Where it will go, however, is into gold and certain other hard assets, because this time around “printing money” is not going to blow an asset bubble that will support the US economy, unlike in 1998 (when the Fed created the stock bubble) and 2001-2003 (when the Fed created the housing bubble). Now all we are going to get is a collapse of the world’s fiat dollar-based monetary system, more inflation on top of a weak economy (i.e. stagflation), and a “bubble” in gold.

Predictably, the Fed has chosen to “run the printing press” and inflate its way out of the housing bust, and inflation is exactly what it will get for its efforts. If this thought process sounds new, it shouldn’t be, because I’ve been talking about how the Fed would inevitably respond to the housing bust and what the likely result would be for over a year. And I feel things continue to unfold pretty much to script…

While we have seen a lot of volatility in most orientations over the past year, my records show that the gold ETF (IAU) was one of the more stable investments as measured by my MaxDD% indicator. This measures the drop from the highest to the lowest point (Maximum Draw Down) over a certain period.

Over the past 12 months, the MaxDD% for IAU was only -7.65%, which occurred on 3/5/2007. Compared to the S&P; 500’s (IVV) MaxDD% of -13.51%, gold has displayed amazing stability and lack of volatility. This is not to say that this trend will continue but, given the overall global turmoil, there may be more upside potential. However, I will always apply my sell stop discipline in case the trend reverses all of a sudden.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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