The End of the Golden Age: is Gold the Next Bubble?

Ancient Greek mythology divided the Age of Man into five different eras, the first being the ‘Golden Age.’ Noted for its peace and tranquility, the Golden Age represented a time where one could do no wrong, and neighbors lived harmoniously with each other.[1] Since roughly 2001, speculators in the gold market have experienced the capitalist version of a Golden Age.[2] Even through turbulent economic times, gold prices have gone through the roof, hitting all-time nominal highs of over $1,350 per ounce. If Greek mythology continues to lend itself as a metaphor, it’s all downhill from here. By the time the fifth and final stage of man was reached, “mankind was hopelessly violent and cruel.” So, will gold prices continue to climb, extending the Golden Age even in the midst of a possible ‘double-dip’ recession, or will it be the next big bubble?

Only time can tell, and students of financial markets are doing no more than speculating on a commodity whose prices themselves seem purely speculative. Looking back to the most recent catastrophic bubble, the mortgage-backed security (MBS) bubble that burst in 2007, there are some notable similarities to gold. First, both mortgage-backed securities and gold outperformed the S&P 500 consistently on a year-by-year basis. 

Second, both are asset-backed, the difference being that one generally buys gold or gold Exchange-traded Funds (ETFs) outright, whereas MBS pools were hundreds or thousands of packaged mortgage commitments to repay long-term debt. MBS pools and gold investments both relied on the value of the underlying asset to increase over time. Finally, both MBSs and gold were seen as inflationary hedges. Although commodities such as gold are classic inflationary hedges, MBSs represented real assets that one could use to diversify their portfolios in times of economic uncertainty.

There are also some notable differences between pre-crash MBSs and gold. Gold is inherently a speculative instrument and only a speculative instrument (people can live in houses). Also, gold is not nearly as widespread an instrument as residential real estate.  In fact, gold represents less than two percent of global capital.[3] Finally, there is a widening spread between the price of gold and the cost to mine gold, signifying a disconnect between value and price (in 2007, the cost to mine one ounce of gold hit $317/ounce)[4]. All financiers would agree that the market dictates gold prices – and when the stock market rebounds, alternative investments will yield greater returns with less risk, and the demand for gold will decrease significantly (along with the price). Thus the gold bubble will burst; but only if and when investors deem it to be no longer an effective hedge against the other equity stakes that they hold. We could well find ourselves surprised in a post-recession world where battered and bruised investors irrationally cling to their positions in gold. One thing’s for sure – the Golden Age will not last forever.