Is there a gold bubble now?

After reporting consistent gains for the past 10 years, gold continues to be the best performing asset this year as well. The year-to-date return is a whopping 35% as the price of gold touched an all-time high of Rs 27,840 per 10 gm on 19 August. While new investors and speculators are rushing to benefit from this 'golden harvest', seasoned players have already started raising an alarm. "Gold is getting into a bubble territory. Though the short-term uptrend may continue due to the ongoing sovereign crisis in the US and Europe, it can burst any time," warns Prithviraj Kothari, president, Bombay Bullion Association. So investors need to be cautious. While it is the 'safe haven' demand that is propping up gold, investors need to keep in mind that this is not a risk-free market. Gold had crashed to $260 an ounce (nearly 69%) after hitting a peak of $850 in 1980.

How long will the current rally continue? "Gold may remain strong for the next 6-9 months, but once things stabilise and other markets start doing well, money will move out of gold. After three years, gold prices may be lower than the current level," says Kishore Narne, head, commodity, Anand Rathi Financial Services.
What is triggering the gold rally?

Here's a look at some crises that are driving the gold market now.

US crisis: One of the causes has been the downgrading of the US sovereign debt to AA+ from AAA, a rating it had held for the past 70 years. The efforts by the US government to support the faltering economy is another reason. For instance, rising interest rates usually lead investors away from gold. However, the decision by the US Federal Reserve to leave interest rates close to zero for two more years will boost the gold market.

Euro crisis: Several European countries, such as Portugal, Ireland, Greece, Spain and Italy, may be forced to default in the short to medium term. Their efforts to reduce spending and increase taxes are being hampered by a faltering Eurozone economy, which grew by just 0.2% in the second quarter, its worst performance after emerging from the recession in 2009. There are also concerns about the ability and willingness of relatively stronger countries, such as Germany and France, to support the troubled ones.

Currency crisis: As two major economic blocks (US & Europe) suffer problems, central bankers of several countries have started losing faith in their reserve currencies and have decided to buy gold as an alternative. For instance, in July, Thailand, South Korea and Kazakhstan added gold valued at $2.56 billion to their reserves.

Falling consumption demand

While the investment demand is shooting up (holdings in exchange-traded products backed by gold rose to a new record of 2,217 tonnes on 8 August), the consumption (jewellery) demand is on the wane. According to the recently released World Gold Council report, the global gold demand in the second quarter of 2011 came down by 17% y-o-y to 919.8 tonnes. "Gold demand is very poor now because of the high price. The consumption is down by 50% in the country compared with that last year," says Kothari. The majority of purchases from investors are for gold bars. This falling consumption demand is a warning sign of an emerging bubble. "There is a difference between investment and spending. Unlike gold jewellery, there is no emotion attached to gold bars, so when the price starts falling, these will be resold in the market," says Narne.