A lot of gold investors like to criticize people who play the stock market as people who are playing in a bubble economy. There is a sense of self-satisfaction in the minds of true gold believers that in the end, they will win out. Well, a lot of speculators in the stock market and people who make their money trading in equities, level the same criticism against gold speculators. They say that there is such thing as gold bubble, and just like with any bubble, gold bubble can crash. So, is true that gold is a bubble commodity? Or put it in another way, is it true that gold is not in a bubble? To address that issue, you have to focus on what defines a bubble. The classic definition of a bubble is a market condition where market valuations far outstrip the underlying value of whatever it is that is being traded. Also, you have to view this in the context of the performance and health of the larger economy. A classic bubble example is in the early 1600's in Holland when tulip bulbs (I'm talking about tulip plants here) reached crazy valuation because people were just buying and selling tulips to a market that would buy tulips in the hopes that somebody would buy the same tulips from them at a higher price. Whenever this mentality sinks in, where the focus is not so much the intrinsic value of the item being traded, but the expectation that somebody will increase the price in the short-term future, you have a potential bubble economy. I say potential because you still have to cause in other elements. What made the tulip a real bubble was the underlying economic foundation of the tulip mania in Holland is unsustainable. You have to remember, people can plant tulip bulbs. Tulips are not intrinsically rare. Given the right temperature, the soil conditions and the right nutrients, you can plant it on a range of places. When you do this, you explode supply and the speculative price will shoot down like a rock because the demand can be easily satisfied by the huge supply. With that in mind, is gold in a bubble? Keep the following considerations in mind.
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The first thing that you have to remember when trying to analyze if gold really is in a bubble market situation is gold rarity – is it rare or not. Unlike tulip bubbles which can be planted, germinated and just multiplied, you can do the same with gold. There's just so much gold you can extract every single year. Also, there are processes that basically destroy gold and there is a heavy industrial demand for gold. Moreover, there are lots of people who buy gold jewelry and would not give up that jewelry up until they die so this locks up lots of the gold that has been taken out off the ground. Based on this reality, gold is maybe rare enough to avoid a bubble market situation. The keyword here is maybe because there are other factors you need to keep in mind. Keep reading.
When looking at investment options and determining whether they are overvalued or they are stocked in some sort of bubble market situation, you have to look at the investment option to other investment options. This is one thing that most of critics of gold don't get. They see gold as the stand alone unique type of investment options that is just floating out there, and the main reason it has value is that people people believe in it. The main reason people believe in it is because they cannot believe in other things. In other words, other investment options the gold is compared to, some reason or other fail in the eyes of true gold believers. The same logic can be applied to believers in Google stock, for example. These people probably look at precious metals, they've looked at oil, they've looked at coffee, they've looked at real estate bonds and they place their fate in Google. Fair enough, it's all about comparing what other investment options out there. That's how you factor in intrinsic economy. How does one investment option compare with others? Gold compares favorably because of its ability to retain its value as well as its role as a hedge against economic uncertainty. These are not neutral value judgments. These carry with them pricing factors. Basically, when you are buying a life insurance, you are going to pay money for that life insurance. Life insurance doesn’t come for free. This is the same with gold. People will pay an insurance premium to get into gold. It doesn't exist in a vacuum; its value is related to other investment options. This is why it cannot be said with a straight face that gold is caught in a bubble situation.
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Primarily in ordinary times, gold is not fueled by speculation. People get into gold as a hedge or is a form of insurance against the market collapsing. When it becomes abundantly clear that the market is headed south, that's when the speculation begins. That's when people keep piling up the gold because it's like rats fleeing a sinking ship, but at the same time the appreciation in gold at that time cannot realistically be called a bubble because that's where the market is headed. There’s no other place to go. So when the market loads up in gold, that is the real values because markets have crashed through the floor. Instead of looking at this as a sad situation, it's actually a happy situation when you if got into gold at the right time because you can unload some of that gold and scoop up a lot of blue chips and really solid stocks so you can only wait a short period for the market to recover a bit for you to cash out enough to recover whatever you've spent for those stocks. You can actually come out of such a situation much wealthier that before. For all these reasons, it's very hard to see gold entering a bubble market territory except for really rare historical situations. But for the most part, it's hard for gold to become a bubble commodity.