PLANET MONEY | by Jacob Goldstein | April 15, 2013
After rising for years, the price of gold is now falling sharply. Lots of people are saying the gold bubble is over. It isn’t.
I have no idea whether the price of gold will rise or fall. But even if gold loses half its value tomorrow, the gold bubble won’t be over.
Defining a bubble can be surprisingly tricky, but here’s a working definition: when the price of an asset rises to a point that can’t rationally be justified by fundamentals. (In that sentence, “asset” basically means anything people buy and sell as an investment. “Fundamentals” basically means the stream of payments the investment generates.)
In real estate, for example, you can compare the price of a house to how much you could get if you rented the house out. This ratio has been pretty steady over the long run. But during the housing bubble, the ratio of home prices to rents shot way, way up. During the bust, it fall back toward its historic norm.
In the stock market, you can compare stock prices to corporate profits (also known as earnings). During the dot com bubble, the price-to-earnings ratio of the stock market rose sharply, then fell back to normal levels during the bust.
Gold is different. Unlike real estate or stocks or other traditional investments, gold doesn’t produce a stream of income — no dividends, no interest payments, no rent. There are some industrial uses for gold. But, unlike other other commodities such as copper, gold’s price isn’t driven by its industrial uses.
For a very long time, gold has been a safe haven in times of political and economic crisis. It is still widely seen as something to buy for the worst of times, and as a hedge against high inflation. To some extent, the recent fall in the price of gold may reflect a decline in fears of imminent crisis and inflation.
But to say that the price of gold rose or fell is to speak in relative terms. It tells us nothing about what the price of gold should be based on the fundamentals.
As the economist Tim Harford told us a few years back:
… it’s just not clear what the fundamental value of gold is. It’s worth something because people have always thought it’s worth something. And that’s really weird, because what it tells you is gold is in a 4,000-year-old bubble. And if it’s lasted 4,000 years, maybe it will last another 4,000 years. Who am I to say?