Why Investing in Gold During A Gold Rush is a Bad Idea [Gold Bubble]

The purpose of the article “Why You Should Avoid Investing in Gold During a Gold Rush” is to warn readers about the potential risks and downsides of investing in gold during a gold rush. I’ll emphasize that, although gold may seem like a safe investment, investing during a gold rush can be risky. This is due to high demand, inflated prices, and increased speculation. You’ll find here useful insights that can help one avoid falling into the trap of the gold rush hype. For quick answers, read the FAQs.

Introduction

What is a gold rush? From the point of view of gold investing, a gold rush is a period of time when there is a sudden surge in the demand for gold (cause). During a gold rush, investors are tempted to invest more in gold due to the perceived scarcity and potential capital gains over time.

However, investing in gold during a gold rush can be risky. The increased demand for gold can cause prices to become inflated and can lead to a bubble. Eventually, when the bubble bursts, it may lead to losses for investors. Therefore, it’s important for investors to carefully evaluate the risks and benefits of investing in gold during a gold rush before making any investment decisions.

During the COVID times, the price of 24-carat gold surged to Rs.57,500 levels. Now, in Feb’2023, it even touched Rs.60,000 levels for a day. Is this a gold bubble? It sure looks like that. Hence, I thought to share my views on the gold bubble with my readers.

In the last four months, Nov’2022 to Feb’2023, there has been a gold price appreciation of about 14%. Price appreciation in such a narrow time frame is certainly indicating a bubble.

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What can cause the sudden surge in the demand for gold?

1. Economic uncertainty: When there is economic uncertainty, investors often flock to gold. Historically it has been the investor’s safe haven asset. Investing money carefully in gold can be a reliable wealth protector in times of turmoil.
2. Inflation: Gold is often seen as a hedge against inflation. Why? Because the value of gold tends to rise during times of high inflation.
3. Geopolitical tensions: Geopolitical tensions, such as wars or conflicts, can cause investors to seek refuge in gold as a safe and stable asset. This is especially true for those regions that are more war affected. Like presently, Russian and Ukranian investors would prefer investment in gold to other asset types.
4. Currency Depreciation: When the value of a country’s currency falls, the price of gold tends to rise. This happens because gold is priced in US dollars, and when a currency devalues, gold becomes more expensive in that country.
5. Supply Constraints: A sudden decrease in the supply of gold due to mine closure or other factors can drive up the demand for gold, which can lead to price increases.

It’s important to note that a sudden surge in the demand for gold can also be driven by speculation or hype, which can cause prices to become artificially inflated and can lead to investment bubbles.

How to identify a gold bubble? To understand this, we’ll have to first establish a stable gold price growth rate. We’ll use the last 58 years of gold price data to do this analysis.

Gold Price Data (General Observation)

The above chart is based on the historical price of gold over the last 58 years. Here are some observations:

1. Price Trend: The price of gold has generally been on the rise over the past five decades. There have been a few periods of decline, such as in the years 1976, 1982, 1993, 1997, 1998, 2001, 2013, 2014, and 2015. But overall the trend has been upward.
2. Price Fluctuations: The data also shows that the price of gold can be highly volatile, with large fluctuations occurring over short periods of time. For example, there was a sharp increase in the price of gold in 2011, followed by a significant decline in 2013. Between 2016 and 2022, the gold price increased relatively fast.

End to End Growth (1965 to 2022)

Above is the last 58 years’ data analysis of the gold price in India. On the face of it, this price data will look like “ever-increasing.”

In 1965, the gold price was Rs.72 and in 2022 it was Rs.52,950 per 10 grams. This is a spectacular price growth rate of 12.05% per annum.

At this rate, Rs.5,000 worth of gold in 1965 will value about Rs.36.5 Lakhs in 2022. it’s spectacular, right? This is what pulls people towards gold.

Growth Rates (10-Year Holding)

In India, people buy gold to hold it forever. It is often bought to transfer it as an inheritance to the next generation. So, unless the need is special, gold is never sold. So it will be safe to assume that, on average, the purchased gold stays with the investor for at least a 10-year period.

Let’s calculate the return given by gold for every 10-year holding period, starting from the year 1965 to 2022.

SL	Holding Periods	Start Price	End Price	CAGR	SL	Holding Periods	Start Price	End Price	CAGR
1	1965 – 1974	72	506	21.53%	26	1990 – 1999	3200	4234	2.84%
2	1966 – 1975	84	540	20.45%	27	1991 – 2000	3466	4400	2.41%
3	1967 – 1976	103	432	15.42%	28	1992 – 2001	4334	4300	-0.08%
4	1968 – 1977	162	486	11.61%	29	1993 – 2002	4140	4990	1.88%
5	1969 – 1978	176	685	14.56%	30	1994 – 2003	4598	5600	1.99%
6	1970 – 1979	184	937	17.68%	31	1995 – 2004	4680	5850	2.26%
7	1971 – 1980	193	1330	21.29%	32	1996 – 2005	5160	7000	3.10%
8	1972 – 1981	202	1800	24.45%	33	1997 – 2006	4725	8400	5.92%
9	1973 – 1982	279	1645	19.41%	34	1998 – 2007	4045	10800	10.32%
10	1974 – 1983	506	1800	13.53%	35	1999 – 2008	4234	12500	11.43%
11	1975 – 1984	540	1970	13.82%	36	2000 – 2009	4400	14500	12.67%
12	1976 – 1985	432	2130	17.30%	37	2001 – 2010	4300	18500	15.71%
13	1977 – 1986	486	2140	15.98%	38	2002 – 2011	4990	26400	18.13%
14	1978 – 1987	685	2570	14.14%	39	2003 – 2012	5600	31050	18.68%
15	1979 – 1988	937	3130	12.82%	40	2004 – 2013	5850	29600	17.60%
16	1980 – 1989	1330	3140	8.97%	41	2005 – 2014	7000	28006	14.87%
17	1981 – 1990	1800	3200	5.92%	42	2006 – 2015	8400	26343	12.11%
18	1982 – 1991	1645	3466	7.74%	43	2007 – 2016	10800	28623	10.24%
19	1983 – 1992	1800	4334	9.18%	44	2008 – 2017	12500	29667	9.03%
20	1984 – 1993	1970	4140	7.71%	45	2009 – 2018	14500	31438	8.05%
21	1985 – 1994	2130	4598	8.00%	46	2010 – 2019	18500	35220	6.65%
22	1986 – 1995	2140	4680	8.14%	47	2011 – 2020	26400	48651	6.30%
23	1987 – 1996	2570	5160	7.22%	48	2012 – 2021	31050	50045	4.89%
24	1988 – 1997	3130	4725	4.20%	49	2013 – 2022	29600	52950	5.99%
25	1989 – 1998	3140	4045	2.56%		–	–	–	–

To simplify the above dataset, allow me to present the same numbers in a chart form. The chart presents to you 49 numbers instances of a holding period was 10 years. It starts with 1965-1974, 1966-1975, till 2013-2022. In the holding period of 1965-1974, the gold price grew at 21.52% per annum. Similarly, between 2013-2022, the growth rate was 5.99% per annum.

Here are my few observations:

• Average Growth: In the last 58 years, for 10-year holding periods, the average return generated by gold was 10.75% per annum. In some years, the returns were -0.08% per annum (1992-2001) and in some years it was as high as 24.45% per annum (1972-1981).
• Return Probability: In the last 58 years, there were 49 numbers instances of a holding period of 10 years. In these 49 instances, 26 times the returns were lower than the average (10.75% per annum), and 23 times it was higher than 10.75% per annum. It means, there is more than a 50% chance that the gold investment will fetch a return lower than 10.75% per annum.

In all those years when gold price grew at less than 10.75% per annum (53% times), the average growth rate was about 5.82%. Likewise, in years when gold prices grew at faster rates (47% times), the average growth was 16.31%.

Why Investing in Gold During A Gold Rush is a Bad Idea

As an investor, we must be mindful of the data presented above (53% vs 47%).

It explains why investing in gold during a gold rush is a bad idea. Investing during a gold rush will put the investor in the 53% probability matrix. On average, such investors earn only 5.82% returns. This kind of return we can get from a bank’s fixed deposit, right? Why put our money at risk by investing in a physical asset like gold?

The flip side is, if one can avoid investing in a gold rush, it puts the investor in the 47% probability matrix. Here, the chances of gold price growth rate are about 16.31% on average.

So, an investor must learn how to identify a gold rush (Bubble) so that investing during such times can be avoided.

How we can identify a bubble building in gold prices?

Gold price is affected by a wide range of factors, including economic conditions, geopolitical events, currency strength, inflation, etc. Hence, identifying a bubble in gold prices is not easy. But careful observation can give hints about the bubble.

• #1. Rapid price increases: When gold prices rise sharply over a short period of time, it can be a warning sign of a bubble forming. We’ve already seen that on average, the gold price grew at a rate of about 12% per annum over a 58 years time horizon. If the holding period is reduced to 10 years, the average growth rate is about 10.75% per annum. So, whenever the gold price (in short term) is growing at a rate higher than these two numbers (about 20% per annum), it is a sign that it is heading toward a bubble. Check the below chart, every price growth of beyond 20% is followed by mediocre growth rates.

• #2. Inflation: Check the below chart where gold’s growth rate is compared with the inflation rate prevailing in the same period. The chart is establishing a pattern very clearly. Every time the inflation rate is hitting its peak, gold price growth is also at its peak. So, to identify a gold bubble, we must look at the inflation rate. If the inflation rate is on the rise, it is a sign that gold price is also heading towards a bubble (peak).

#3. Weak Currency: News about the country’s currency becoming weaker compared to USD will lead people towards gold investing. Since the start of the Russia-Ukraine war, the strength of USD has increased. It has created a weakening effect on the other currencies of the world. A gold price surge when paper currency is weaker may not create a big bubble in gold pricing. In fact, it creates very strong support for its long-term pricing. But yes, excess speculation in such times may lead to a bubble.

When the media starts reporting extensively on the price of gold, it is an indicator that a bubble is forming. During this time one can also look at the news reports about inflation. If the news channels are talking about high inflation rates, it is again an indicator that a gold bubble is forming on the sides.

Conclusion

Investing in gold during a gold rush may seem like a good idea due to the hype and excitement surrounding the price rise. However, it is important to keep in mind that bubbles often burst, and the gold price can correct as fast as it rose. In gold’s case may be the correction is not as steep as equity, but investing during peaks can certainly dampen future yields.

Gold prices can be influenced by many factors, including inflation, economic conditions, global events, currency valuation, etc. Hence, it is difficult to predict when a bubble will burst. Investors who are heavily invested in gold during a gold rush may suffer significant losses if prices fall.

Moreover, for me, gold is not a perfect investment. I often consider it more as a savings option than an investment. While it can be a good hedge against inflation and market volatility, it is not a great wealth builder (like equity). It also does not generate any income, hence it is almost impossible to estimate its intrinsic value. Read here about how we can value a fixed deposit.

In conclusion, investing in gold during a gold rush can be a bad idea. While it may seem like a good opportunity to make quick profits, it is important to consider the risks and potential downsides of investing heavily in a single asset that may be subject to volatile price swings. A better strategy for investing in gold may be to hold a small portion of one’s portfolio in the metal as a long-term hedge against inflation and market volatility while diversifying one’s portfolio with other assets to manage risk.

FAQs

Have a happy investing.