Is gold about to go vertical?

While many people claim gold is a bubble, very few actually own the asset unlike those of the dot-com and housing bubbles. If you compare gold to both of these bubbles then gold hasn't even peaked!

May 4, 2011, 12:01 a.m. EDT
By Brett Arends
MarketWatch

BOSTON (MarketWatch) — Gold is in a bubble. Anyone will tell you that. They’ve been saying it since gold was about, oh, $500 an ounce.

But it’s a funny kind of a bubble. It’s the only one I’ve encountered where so few people seem to own the asset in question.

During the dot-com bubble, you met lots of people with tech stocks. Taxi drivers told you what dot-coms they owned.

During the housing bubble you met normal, ordinary people who were trading up to expensive homes using adjustable-rate mortgages, buying new condos off plan to flip, and cashing out their fictional “equity” through a refinance mortgage.

But who actually owns gold? I keep hearing about the gold bubble, but every time I ask people if they own any themselves, they say, “no, no, of course not, it’s a bubble.”

Some bubble.

Now take a look at our chart.

It’s an updated version of one I ran nearly a year ago, when gold was $1,176 an ounce.

It compares the bull market in gold with the last two undisputed “bubbles,” namely tech stocks and housing. It shows the gold price since 2001, the Nasdaq Composite COMP -0.86% from 1989 to 2001, and Standard & Poor’s index of Homebuilding stocks from 1995 to 2007.

The picture is pretty remarkable.

If gold is a “bubble,” it doesn’t look like it’s peaked yet. Indeed it looks like it might be just about to enter its big, blow-off phase.

That’s when you make the real coin. In this case, gold coin.

Will this happen? It’s anyone’s guess. But there are reasons to think it might. Gold enjoys some of the key characteristics you need for a bubble, including a “this time it’s different” storyline.

Central banks around the world are printing more dollars, euros, pounds and yen. Gold may simply be a less awful currency than all the others. Banks can’t print any more of it, so its price should probably rise while other currencies fall.

And then there’s China. As it rises to global superpower status, the country will need to diversify its currency reserves. Right now the Chinese are way too dependent on dollars. They have a tiny amount of gold. If they shift even a bit more, the price will go stratospheric.

But there are problems with gold that make it very hard to buy with confidence. Gold is volatile. Nobody knows what it’s worth. I keep asking gold bugs for a sensible valuation, and they can’t tell me. And you can forget all the superstition. Despite what the true believers say, gold is no more “true” money or “real” money than anything else. As it generates no income, the gold market is effectively a Ponzi scheme. Your returns come entirely from the next buyer in line.

(Oh, and be aware that many of the people bragging today that they have “owned gold since 2001” have actually owned it for several decades longer than that. Through the eighties and nineties they lost their shirts as gold crashed.)

If you want to bet on a mania, you have any number of options.

One is to buy in stages — to ease yourself in, as it were. If you want to buy $10,000 worth of gold, and you are terrified you’ll take the move the day before it peaks, then just buy in $1,000 lots over time. (I’d suggest this seems a particularly good idea at the moment, because gold has risen a long way lately. The dollar may be overdue for a sharp bounce.) A second is to buy gold mining stocks. So far they’ve been left behind by the rise in the metal. John Hathaway, manager of the Tocqueville Gold TGLDX -2.39% mutual fund, says many big gold mining stocks, in particular, are cheap in relation to gold.

A third may be to take a wager on “out of the money” call options on the iShares Gold Trust GLD -1.85% , an exchange-traded fund that owns one tenth of an ounce of gold per share. This is a particularly high-risk, high-octane bet on gold going vertical, fast. Options allow you to make big profits in a mania, while only risking a small stake.

The iShares Gold Trust trades around $150 a share right now. The $200 calls, good until January 2013, cost just $6.52 per share. If gold passes $2,065 an ounce by then, equivalent to $206.52 on the GLD, you’ll make a profit. The downside is that if there’s no boom, you’ll lose your stake. But then your risk is limited to $6.52 per share.

Brett Arends is a senior columnist for MarketWatch and a personal-finance columnist for the Wall Street Journal.

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