Riding the Golden Bubble

By Lara Crigger

Podcast listeners might remember a few months ago when I bet our research editor a steak dinner that gold would top $1,250/oz before it would sink back below $1,000/oz. For awhile there, things weren't looking too good for me or my appetite, as gold plunged off its December highs like a diver in free fall; the metal scraped as low as $1,052/oz early last month. But as gold closed above $1,117/oz on Friday, I'm happy to say that I might just get my dead cow after all:

Gold Price, February 2010

Source: Kitco.com

Of course, renewed strength in gold means a revival of The Big Question from last fall: Is gold in a bubble? This time, however, it seems the answer on everyone's lips is: "Who cares?"

"I absolutely believe [gold's] heading into a bubble, but that's why you buy it," Charles Morris, manager of HSBC Global Asset Management's $2.5 billion Absolute Return Fund, told Bloomberg earlier today. After predicting that gold could hit as high as $5,000/oz in the next five years, he added, with shades of Gordon Gekko, "A bubble is good."

Investors Big And Small Piling Into Gold

Perhaps that's why we've seen such incredible upswing in investment demand for the yellow metal year over year, particularly in ETFs. According to the World Gold Council, ETF demand in 2009 hit 594.7 tonnes—85 percent higher than 2008 levels. Granted, most of that was driven by outsized buying in the first quarter of '09, as investors, smarting from the 2008 financial crisis, fled perilous markets into supposed safe haven assets like gold. Still, ETF buying has remained brisk, with demand in Q4 2009 hitting 31.6 tonnes.

Most of that demand has gravitated toward the SPDR Gold Trust (NYSE Arca: GLD), the world's biggest bullion-backed ETF and the second-largest ETF overall. Investors big and small piled into GLD last year, which saw $13.8 billion in new net investment dollars in 2009. The fund now sits at over $35.4 billion in assets under management.

Even noted gold skeptics now want a piece of the action. Famed hedge fund manager George Soros—who not too long ago dubbed gold the "ultimate bubble"—has increased his GLD holdings; in the fourth quarter of last year alone, Soros Fund Management bumped its holdings in GLD by 152 percent. According to Bloomberg data, as of Dec. 31, 2009, the firm is now the fourth-largest holder of GLD, at 6,178,342 shares.

Still, that's nothing compared with John Paulson's ETF bet: Paulson & Co. holds 31.5 million shares of GLD (nearly 96 tons' worth)—which, at today's prices, is worth just under $3.45 billion.

What's interesting is that the other two U.S. bullion-backed gold ETFs—the iShares COMEX Gold Trust (NYSE Arca: IAU) and the ETF Securities Physical Swiss Gold Shares (NYSE Arca: SGOL)—haven't seen nearly the same boost in demand as GLD.

IAU and SGOL are substantially smaller than GLD, with only 25.2 million and 3.2 million outstanding shares apiece, respectively (in comparison, GLD has about 363 million outstanding shares). IAU holds about $2.76 billion in assets under management, while SGOL holds $334 million, according to the National Stock Exchange.

One might think that with increased general interest in gold ETFs, both funds might see a pickup in investor demand. But in fact, we're seeing the opposite: Since the beginning of 2010, SGOL has started cannibalizing IAU's shares, like Ross Perot siphoning votes from George H.W. Bush:

Shares Outstanding For U.S. Bullion-Backed Gold ETFs

Source: Bloomberg data. Figures quoted in thousands (000).

And the rock that is GLD remains.

So ... Where Does Gold Go Next?

If gold truly is in a bubble, then the sky's the limit for where gold goes next. A recent Bloomberg survey reported 15 of 22 analysts forecasting that the yellow metal would make further gains this year, with Goldman Sachs predicting $1,380/oz in the next 12 months. HSBC concurred, predicting a peak of $1,300/oz in 2010.

Continued buying by central banks may lend support to prices as well. Last year, the world's central banks became net gold buyers for the first time in two decades—and according to CPM Group, at least, the trend could continue. Currently, central banks hold approximately 18 percent of the total gold ever produced. Add that to continued uneasiness over the world economy—and, of course, fears over inflation—and we could see gold go much higher in the days ahead.

Still, despite its great run recently, gold has a long way to rise before I get my free steak dinner. And I haven't forgotten what Brian Nick said when we had him on our site a few weeks ago (in an interview many of our readers found very controversial): "Look at virtually any other market where you'd see signs that people were worried about inflation, and they don't exist anywhere—except the gold market."

Disclosure: None