Has the gold market reached a bubble? (page 1 of 2)

Gold prices tend to rise during times of economic uncertainty, and the debt crises in the US and Europe and fears of a double dip recession have provided plenty of fuel to boost the gold market. Holdings in exchange-traded products backed by gold rose to a record 2,217 tonnes on August 8 and stood at 2,142.4 tonnes last week, according to Bloomberg. But it's not just individual investors who are buying gold. In August, South Korea announced it had bought gold for the first time in more than 10 years, becoming one of many countries around the world that have been buying more gold as a hedge against their foreign currency holdings.

So far this year gold prices are up 27% and hit an all-time high of $1,921.15 an ounce on September 6 as the precious metal looks to post its 11th consecutive year of gains. "This price started its rally at $260 in July 2001, and is now the longest bull market in the history of gold," says Jeffrey Rhodes, Global Head of Precious Metals & CEO of Dubai-based INTL Commodities.

New highs raise concerns

However, with gold prices seemingly hitting new highs each week, questions are also being raised about whether the market has moved into bubble territory. Wells Fargo Private Bank recently issued a warning about the risks associated with the market. "We believe that we have reached the point where we can confidently state that interest in gold investing has reached the level of a speculative bubble," the report noted. "Prudent investors should be very wary of having substantial investment exposure to this precious metal in their portfolios."

Gold prices can fall quickly and without much warning, the report warned, noting that gold lost more than 30% of its value during a six month period in 2008. In the 1980s, in just over two years, the price plunged about 65%. Last month, gold corrected by over $200 or just over 10% from its then record high of $1,912 on speculation that financial markets were stabilising. European investment bank Credit Agricole CIB warned that the sudden price drop "should serve to illustrate to investors that any notion of it being regarded as a risk-free asset is misplaced."

Nevertheless, the bank said the longer-term financial and economic imbalances in the US and Europe and the negative real interest rate environment should continue to be supportive for the gold price. "In a recession scenario, gold is likely to be bolstered further by its important role as an excellent portfolio diversifier and viewed as a form of insurance and as a hedge against continuing uncertainty," it said.
Rhodes points out that prior to the 'brutal correction' last month, gold was technically overbought with the 30 day RSI (relative strength indicator) above 80, and historically whenever this reading exceeds 80 it has always been followed by a steep reversal in price. "However the market is now extremely neutral with the 30 day RSI at 56 and with good physical demand emerging from India and China on the move below $1800, gold seems to have created a solid foundation for further strength as we head into Q4," he said.

Bullish outlook

HSBC's Chief Commodities analyst James Steele says the gold market still looks bullish longer-term. "The market retreated very quickly when we reached 1,900, so investors have to expect increased volatility at these high prices," Steele pointed out, "but I don't think it's a bubble." The market has historical precedent to go to about $2,300, he argues, because that is the high in inflation-adjusted terms from its previous high in January 1980, when the price went to $850.