Falling gold price could mean the gold bubble is about to burst

A young boy blowing a big soap bubble

A gold bubble burst would hurt investors who dumped their portfolios into gold as a safe haven during the global financial crisis. nathalielaure/Flickr photo.

Talk of a gold bubble burst is spreading. Investors have perceived gold as a safe haven during the global financial crisis. But after rising in value steadily since October 2008, the gold bubble may be reaching the bursting point as the global financial crisis fades. If the markets continue to rally, the demand for so-called safe investments like gold will fall. For those investors who bought gold when it reached a record high of $1,266.50 on June 21, a further drop from the Aug. 3 level of about $1,185 could be disastrous.

Signs of a bursting gold bubble

Some say the gold bubble is about to burst because gold prices are too volatile. Brian Rezny at Seeking Alpha writes that India and China, the world’s first and second largest gold markets respectively, are buying a lot less gold. He said that gold is a commodity with a value based entirely on the assumption that it will increase in price. Gold became a safe haven during the global financial crisis based on perception. The only reason gold is valuable is because investors have believed it is valuable. A gold bubble burst would change that perception overnight.

Markets overreact to European credit crisis

One reason the gold bubble may be about to burst is because the markets may have exaggerated the effects of the credit crisis in Europe to the global economy, according to Ron Acoba at Daily Markets. With recent news about the surprise earnings of European and U.S. banks, Acoba said the effect of the credit crisis on their business turns out to be minimal. Rezny said that the gold bubble is about to “end in tears,” and that the recent decline in gold prices will get worse. He reminds us that back in 1980, gold was used as an inflation hedge, and it peaked at $850 an ounce. Adjusted for inflation, that $850 was equal to $2,300. And then it tanked, falling to $253 by 1999.

A safe haven gets risky

The gold bubble is precariously large as millions of people are buying gold. Celebrities are endorsing gold. Hucksters like Glenn Beck are convincing average people to dump a large percentage of their investment portfolios into gold — even their life savings — to be safe when the global economy collapses into the stone age. Beating Broke wonders what will happen if (when?) the economy recovers. Those who bought gold at $1,100 and $1,200 an ounce may see the gold price adjust back down to something like $800 or $900. If these investors lose 30 percent of their savings or portfolio, the gold bubble will burst. The price of gold will drop even further as people rush to sell off their holdings. True believers in gold will lose even more.

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