Is it safe to buy gold even now?
Moneylife Digital Team 08 June 2011

The price of gold in India has been on a bull run for the last 13 years. Are gold prices nearing a bubble? 

Big investors and researchers predict that gold is headed towards a bubble. In January last year, George Soros, the famous Hungarian-American billionaire investor and stakeholder in the Bombay Stock Exchange, cautioned: "When interest rates are low we have conditions for asset bubbles to develop, and they are developing at the moment. The ultimate asset bubble is gold." He was speaking at the World Economic Forum in Davos.

Was Soros just talking through his hat, as he deliberately does many times? Apparently, from the middle of last month, the billionaire investor sold off 99% of his holdings in gold for $800 million, including whatever profit he made during the gold climb. Soros is one of the world's finest speculators and his action should worry some investors who might do well to ask: 'Is it true that gold prices have reached their peak?' The question is even more important, given that there is tremendous interest in gold in India.

From a master speculator, let's turn our attention to academics immersed in arcane quantitative concepts. In December 2010, a team from the Research Institute of Mining Geomechanics and Mine Surveying (VNIMI) and the Russian Academy of Sciences started looking at whether gold is in a bubble and they published their findings in a paper titled "Log-Periodic Oscillation Analysis and Possible Burst of the 'Gold Bubble' in April- June 2011". The researchers Sergey V Tsirel, Askar Akaev, Alexey Fomin and Andrey V Korotayev, came to a simple conclusion that gold is in a bubble and it is about to burst.

The team applied the methodology used by Didier Sornette, professor of the Swiss Finance Institute who is well known for his work on the prediction of crises and extreme events in complex systems. Using this method, known as "the Log-Periodic Oscillation analysis", the researchers calculated the probable time of the crash between April and June 2011. To further reinforce their prediction, the result was further verified by two other methods.

First, they compared the pattern of the gold price to the pattern portrayed by the oil bubble crash of July 2008, which gave them the timing around May-June 2011. Second, they estimated the critical time for the hyperbolic trend in the socio-economic processes (like population growth before the demographic transition, global GDP growth and energy production per capita, and so on). This also led them to May-June 2011 as the most probable time for the gold crash. The calculations also estimated a price range of $1,500-$1,700 when gold could top out.

The team of four of course provided a disclaimer saying, "The calculations performed by Sornette's method and other estimates are based on the idea that all players will try to maximize profit just in this market, and will not believe in forecasts like the one we propose (otherwise we shall deal with a "non-self-fulfilling prophecy"). If a very large player, such as the Central Bank of China, intervenes with other goals (longer-term, depending on political calculations, etc.), then the foundation upon which all such forecasts are based disappears." Like all predictions, their calculations too are based on assumptions that could turn out to be wrong.

Regarding the overall economic impact, should the gold price actually crash, the researchers write that the crash would lead to huge losses and even bankruptcy of major players in the markets, including dependent firms and banks. This negative reaction will be amplified by the media, drawing similarities with the events of the early 1980s and other such similar events. "The burst of 'the golden bubble' will be followed by a short-term downswing, and the further developments will depend on the directions of investment at the moment, as well as on the reaction of the US Federal Reserve and the Central Bank of China to the events." On the positive side, if at the time of the collapse some promising areas of investment appear in the developed or developing countries, investment capital can be moved to those markets, which would contribute to the production of new goods and services and accelerate the way out of the crisis.

Coming back to the main question, "Is it safe to buy gold now?" We at Moneylife have always considered gold as a purely speculative asset (Read: "Are gold prices infallible?"
Benjamin Graham, the famous investor, referred to speculation as the "greater fool" theory by saying, "I know I am a fool to pay such a high price for a stock, but I know that a greater fool will come along and pay me an even higher price." Though Graham was speaking about stocks, the same could be said about speculative instruments such as gold, beyond a point. Therefore, before buying gold think again.(You may also want to read, "Gold: All told")

1 decade ago
this is a very nice post.. thanks for sharing this i like this post.. very much.
sanjay doshi
1 decade ago
I feel the price of gold on an inflation adjusted basis was right at about Rs 20,000 . This rise to Rs 22450 seems to be pure speculation. I don't think it will rise above rs 23,000. Just as gold , silver , stocks,commodities rose together,since 2007, I feel they will fall together.
1 decade ago
Gold is a different class of asset. Not comparable to stock market investment. Stock market needs regular supply of fools to flourish. Not so with gold. It is safe investment and hedge against inflation. Gold is highly liquid. Any time is good time to buy gold in these uncertain economies.
1 decade ago
Very informative article. Please allow me to put forward some of my thoughts which might be contrary to your research. I am thinking like a layman.
Why is gold safe to buy and hold gold(this includes both physical and demat gold).
1. Increasingly uncertain world. US dollar in downtrend.Unreliabilty on Chinese Yuan due to lack of transparency. Indian rupee and India still a long way off from being the dominant currency and country respectively.
2. Though gold offers no regular income like other assets, its still what the world turns to for stability.
3. Deeply entrenched Indian mentality of finding safety in gold and also as a precious commodity which is usually gifted to our daughters on their marriage. This trend is still strong across all states and communities. Therefore the buying from india would hardly decrease. Even when gold touched life time highs, Jewellers across India made huge profits on days like akshaya trithya. Showrooms were kept specially open till 11 to 12 pm to enable people to buy gold.
4. Demat gold allows small investors like me to buy gold in small quantities for long term purpose for the same reasons mentioned above.
5. Even if gold prices crash, it will be speculators who suffer and not buyers as they always believe that gold is not for trading but an investment for generations passed down as heirloom.Infact they might buy more when prices go down and store for future.

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