The Next Bubble

I had some money in GLD that I just sold. I bought into it right before the market collapsed, thinking it would go through the roof. Well it didn't and I got killed, but I was lucky enough to stay in for the ride back up and got my money back. Will not be making that mistake again.

I seem to recall this has happened before. When was that? Oh yeah, 1979 I believe. As a purely speculative play buying and selling gold is pretty much the pinnacle of hubris, as the gold itself possesses no real intrinsic value beyond what some other (hopefully larger) fool will part with in order to possess it. Since it creates no real wealth, its real, expected return must be zero. Adjusted for overall CPI, has gold even come close to where it was in 1979? Me thinks not.

I had some money in GLD that I just sold. I bought into it right before the market collapsed, thinking it would go through the roof. Well it didn't and I got killed, but I was lucky enough to stay in for the ride back up and got my money back. Will not be making that mistake again.

I seem to recall this has happened before. When was that? Oh yeah, 1979 I believe. As a purely speculative play buying and selling gold is pretty much the pinnacle of hubris, as the gold itself possesses no real intrinsic value beyond what some other (hopefully larger) fool will part with in order to possess it. Since it creates no real wealth, its real, expected return must be zero. Adjusted for overall CPI, has gold even come close to where it was in 1979? Me thinks not.

There are 2 major differences between oil and gold. The first is that oil is a consumable commodity. While some gold is used in various applications, by and large the amount of gold available on the market is steady (it's not being destroyed). Oil, on the other hand, is consumed at a prodigious rate (~85 million barrels per day). The second difference is that oil is needed for much of our modern life, whereas gold is mostly a luxury item. We use oil to fuel our vehicles and heat our homes. It is processed into the plastic used to make everything from soda bottles to computers. It is used to produce the fertilizers we need to be able to grow enough crops to feed over 6 billion people. And it is used to create the chemicals for everything from medicine to pigments in paint or clothing dye. Even if we could magically replace it as a fuel source for our cars tomorrow, we would still be consuming millions of barrels a day for the other uses. I'd say that the price speculation on oil last summer was premature, but not completely unwarrented. Sooner or later it will pass the previous record, especially if demand starts to exceed world output after the recession ends (something that nearly happened last summer, hence the $140 'speculative” price).

Scientific American had some articles 3 or 4 years back that explained why oil production has peaked and is declining in almost all of the major oil fields around the world. Short of a miraculous (and some would say impossible, given how little area is left to be explored) find of another Saudi Arabia-sized oil field, production will start to decline within another few years even as consumption continues to rise.

@Robert- yeah, you will certainly get no arguement from that oil will
and maybe should be higher. My point here is that chasing these trends
is called speculating, NOT investing.

There are 2 major differences between oil and gold. The first is that oil is a consumable commodity. While some gold is used in various applications, by and large the amount of gold available on the market is steady (it's not being destroyed). Oil, on the other hand, is consumed at a prodigious rate (~85 million barrels per day). The second difference is that oil is needed for much of our modern life, whereas gold is mostly a luxury item. We use oil to fuel our vehicles and heat our homes. It is processed into the plastic used to make everything from soda bottles to computers. It is used to produce the fertilizers we need to be able to grow enough crops to feed over 6 billion people. And it is used to create the chemicals for everything from medicine to pigments in paint or clothing dye. Even if we could magically replace it as a fuel source for our cars tomorrow, we would still be consuming millions of barrels a day for the other uses. I'd say that the price speculation on oil last summer was premature, but not completely unwarrented. Sooner or later it will pass the previous record, especially if demand starts to exceed world output after the recession ends (something that nearly happened last summer, hence the $140 'speculative” price).

Scientific American had some articles 3 or 4 years back that explained why oil production has peaked and is declining in almost all of the major oil fields around the world. Short of a miraculous (and some would say impossible, given how little area is left to be explored) find of another Saudi Arabia-sized oil field, production will start to decline within another few years even as consumption continues to rise.

@Robert- yeah, you will certainly get no arguement from that oil will
and maybe should be higher. My point here is that chasing these trends
is called speculating, NOT investing.

A good point. Oil prices rose too fast, based upon a perceived imbalance in the supply and demand (consumption was at most only slightly higher than output for a while). Between several countries cutting their deep gasoline price discounts/subsidies (in Saudi Arabia gasoline was selling for 45 cents a gallon due to those subsidies) and then the global economic slowdown, demand suddenly dropped significantly and prices followed suit.

I'm of the opinion that while $140 was a premature price for oil (since demand had not yet outpaced production enough to justify that price) the present price of ~$35 is likely a bit too low. It is based upon the assumption that demand will remain low while production capacity will remain higher. Once the global economy starts to recover, demand will again pick up, though probably not reaching the same level as before for quite some time. On the production capacity side, the recession and low oil prices have frozen a number of projects that had been underway to increase output or open up new fields. As a result, as demand picks up production will have a greater likelihood of failing to meet the demand than if those projects had not been delayed or cancelled.

In terms of a large bubble, I'd pick oil as more likely than gold when the recession eases. While I agree that gold prices are moving into bubble territory, many people are still wary of gold after the gold price bubble of the 1980s. Also many potential speculators are simply too timid to rush into much of anything at the moment. Overall I believe that the number of people speculating in gold will remain a relatively small percentage of potential investors.

On the other hand, when world oil consumption starts to pick up the production capacity will again lag a bit and many more speculators will be faster to jump into a new oil bubble. I don't believe oil has garnered some of the negative impressions as a commodity that gold has in the mind of many speculators.

A good point. Oil prices rose too fast, based upon a perceived imbalance in the supply and demand (consumption was at most only slightly higher than output for a while). Between several countries cutting their deep gasoline price discounts/subsidies (in Saudi Arabia gasoline was selling for 45 cents a gallon due to those subsidies) and then the global economic slowdown, demand suddenly dropped significantly and prices followed suit.

I'm of the opinion that while $140 was a premature price for oil (since demand had not yet outpaced production enough to justify that price) the present price of ~$35 is likely a bit too low. It is based upon the assumption that demand will remain low while production capacity will remain higher. Once the global economy starts to recover, demand will again pick up, though probably not reaching the same level as before for quite some time. On the production capacity side, the recession and low oil prices have frozen a number of projects that had been underway to increase output or open up new fields. As a result, as demand picks up production will have a greater likelihood of failing to meet the demand than if those projects had not been delayed or cancelled.

In terms of a large bubble, I'd pick oil as more likely than gold when the recession eases. While I agree that gold prices are moving into bubble territory, many people are still wary of gold after the gold price bubble of the 1980s. Also many potential speculators are simply too timid to rush into much of anything at the moment. Overall I believe that the number of people speculating in gold will remain a relatively small percentage of potential investors.

On the other hand, when world oil consumption starts to pick up the production capacity will again lag a bit and many more speculators will be faster to jump into a new oil bubble. I don't believe oil has garnered some of the negative impressions as a commodity that gold has in the mind of many speculators.

I don't think there's a reason for most individual investors to be in commodities. They aren't an adequate inflation hedge. I agree that gold has very little intrinsic value (although it's a good conductor and widely used in electronics). Warren Buffett had this to say about gold:

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

It's hard to agree with his reasoning. I agree with the commentator who pointed out that very little gold is destroyed and it is still being produced. I wrote an article about this very thing on my site. Anyway, the bottom line is, you probably shouldn't be buying gold at these doomsday prices.

Thanks Todd. Yeah I think that if you understand the difference between
speculating and investing you know that you do not invest in gold, you
speculate.
That does not mean that you can't make money speculating, it just means that
you should not trick yourself into think that you are investing when you
attempt it.

I don't think there's a reason for most individual investors to be in commodities. They aren't an adequate inflation hedge. I agree that gold has very little intrinsic value (although it's a good conductor and widely used in electronics). Warren Buffett had this to say about gold:

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

It's hard to agree with his reasoning. I agree with the commentator who pointed out that very little gold is destroyed and it is still being produced. I wrote an article about this very thing on my site. Anyway, the bottom line is, you probably shouldn't be buying gold at these doomsday prices.

Thanks Todd. Yeah I think that if you understand the difference between
speculating and investing you know that you do not invest in gold, you
speculate.
That does not mean that you can't make money speculating, it just means that
you should not trick yourself into think that you are investing when you
attempt it.

A good point. Oil prices rose too fast, based upon a perceived imbalance in the supply and demand (consumption was at most only slightly higher than output for a while). Between several countries cutting their deep gasoline price discounts/subsidies (in Saudi Arabia gasoline was selling for 45 cents a gallon due to those subsidies) and then the global economic slowdown, demand suddenly dropped significantly and prices followed suit.

I'm of the opinion that while $140 was a premature price for oil (since demand had not yet outpaced production enough to justify that price) the present price of ~$35 is likely a bit too low. It is based upon the assumption that demand will remain low while production capacity will remain higher. Once the global economy starts to recover, demand will again pick up, though probably not reaching the same level as before for quite some time. On the production capacity side, the recession and low oil prices have frozen a number of projects that had been underway to increase output or open up new fields. As a result, as demand picks up production will have a greater likelihood of failing to meet the demand than if those projects had not been delayed or cancelled.

In terms of a large bubble, I'd pick oil as more likely than gold when the recession eases. While I agree that gold prices are moving into bubble territory, many people are still wary of gold after the gold price bubble of the 1980s. Also many potential speculators are simply too timid to rush into much of anything at the moment. Overall I believe that the number of people speculating in gold will remain a relatively small percentage of potential investors.

On the other hand, when world oil consumption starts to pick up the production capacity will again lag a bit and many more speculators will be faster to jump into a new oil bubble. I don't believe oil has garnered some of the negative impressions as a commodity that gold has in the mind of many speculators.

I don't think there's a reason for most individual investors to be in commodities. They aren't an adequate inflation hedge. I agree that gold has very little intrinsic value (although it's a good conductor and widely used in electronics). Warren Buffett had this to say about gold:

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

It's hard to agree with his reasoning. I agree with the commentator who pointed out that very little gold is destroyed and it is still being produced. I wrote an article about this very thing on my site. Anyway, the bottom line is, you probably shouldn't be buying gold at these doomsday prices.

Thanks Todd. Yeah I think that if you understand the difference between
speculating and investing you know that you do not invest in gold, you
speculate.
That does not mean that you can't make money speculating, it just means that
you should not trick yourself into think that you are investing when you
attempt it.