Money Matters
5:00 am
Tue June 19, 2012

Is the gold bubble going to burst?

Gold has been trading for more than $1,600 an ounce lately. That's down from its high of nearly $1,900 an ounce last year.

Will gold stay at these relatively high levels? Or is the bubble going to burst?

Financial commentator Greg Heberlein and KPLU's Dave Meyer look at the warning signs about gold on this week's Money Matters.

Here are Greg's notes:

Warren Buffett’s brief comments on gold at the Berkshire Hathaway annual meeting last month generated passing interest in the media. But I was surprised a lengthier discussion in his March annual report didn’t get any publicity.  His comments are relevant, especially with the sharp turns the precious metal has carved out in recent months.

As I became familiar with financial subjects, I had two mentors. One was the news columns of The Wall Street Journal, and the other was the Berkshire Hathaway annual reports penned by Buffett. This year, he spent time discussing the value of investing in gold. Or the foolishness. The topic was largely ignored.

How does tulip mania figure into this?

Certain commodities, Buffett says, benefit only by the greater fool theory. That is, when they are purchased, the only hope for making money on them is the hope that someone down the line will pay more. 

A classic example was tulip mania in 17th century Holland. The price of tulip bulbs went so high that one bulb fetched more than 10 times the annual pay of a skilled worker. The bubble burst, and many were left penniless.

Is the publicity encouraging gold purchases actually hype?

Gold is a much preferred commodity these days. The air waves and the print media assault the public with expectations of great riches. Buffett says it is popular, even though nothing will be produced with it. Gold does have some industrial and decorative value. But the real demand for those purposes is easily covered by current production, with a lot left over.

If you own one ounce of gold, Buffett says, you could hold it an eternity, and you’d still own one ounce of gold. Gold purveyors play on fear. Buyers enter the market fearing the apocalypse. Gold has soared in the past decade. That buying feeds on itself, luring others into the inflating bubble.

But aren’t there legitimate reasons in the early stages of a bubble?

Bubbles often have sound beginnings. Bubbles in internet stocks and housing began rationally, but ended destructively. Buffett offers a proverb:  “What the wise man does in the beginning, the fool does in the end.”

So if not gold, then what?

Sparked by prices that have gone out of control, the value of all the world’s gold is about $9.6 trillion. With the same amount, you could buy all the cropland in the United States plus the equivalent of 16 Exxon Mobil corporations, and still have a trillion dollars left over.

In a century, valuable farmland crops such as wheat, corn and cotton will continue to generate income. Those 16 Exxon Mobils will have trillions of dollars of assets and have returned to shareholders trillions in dividends. The amount of gold will be essentially unchanged, will not have returned a dime and still won’t produce anything.

The conclusion?

Buffett has it right.  Own productive assets – businesses, farms, real estate. You’ll get a better return, and a far safer investment.