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When Will the Golden Bubble Pop?

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So the NYT has a piece on how the price of gold has exceeded $1,500 an ounce. The article notes that while a nominal high, it was actually higher in real terms in the 1980s. I had been asked last Thanksgiving by a relative about the price of gold because a “friend” had invested heavily in gold and silver. I say now what I said then: It’s a bubble. And it’s going to pop.

But I was also a little curious. Gold, after all, while not completely useless, is basically only used for jewelry and other types of ornamentation. It’s not a really useful commodity like oil or silicon or corn. So why was the price so high? Why were Glenn Beck and others hawking it on TV?

The first thing I did was put together a graph of the annual price of gold going back to the 1950s, adjusting for inflation using the CPI.

Notice anything unusual? Well, the price of gold spiked from 1979-1982, hitting a high in 1980. Then it started spiking again in 2006 and 2007. To someone who spends a lot of time looking at unemployment numbers, this looked very familiar. After all, the highest unemployment rate since the Great Depression was in 1982. When you add the unemployment rate to the graph, you can see the correlation.

The correlation for these annual numbers is 0.6 which is fairly high when we’re talking macroeconomics. It also would seem to offer an opportunity for profitable arbitrage (although it’s hard to see from this graph if the price of gold is leading the unemployment rate or following it). But the one thing that seems to be clear from the graph is that when the unemployment rate falls, the price of gold is going to fall along with it.

If I’m correct in my surmise about the CES, then the unemployment rate may continue to fall substantially throughout the year. In real terms the price of gold fell from over $1,000 in 1982 to $650 in 1984, a 35% drop. If I was a rich risk-neutral investor, I would be shorting gold right now in a big way. Of course, timing the popping of a bubble is notoriously difficult and smarter people than I have lost their shirt trying to do it.

The sad thing is that the professional investors will no doubt get out of gold quickly when it starts to turn. It will be the smaller investors that will be left holding the bag of bullion. After all, the only people who are in gold right now must be the fools who invest in bubbles and the professionals who take advantage of them. And if you don’t know who the fool in the room is…


Written by Liam C Malloy

April 20, 2011 at 5:06 pm

Posted in Recession, Unemployment