The Gold Bubble and Bugs

Gold prices have been rising sharply, breaching the US$1,000 barrier and in recent weeks rising towards US$1,200 an ounce and above. Today's "gold bugs" argue that the price could top US$2,000. But the recent price surge looks suspiciously like a bubble, with the increase only partly justified by economic fundamentals.

Gold rose above US$1,000 again in February-March 2009, when it looked like most of the financial system in the US and Europe might be near insolvency, and that many governments could not guarantee deposits and backstop the financial system, because banks that were too big to fail were also too big to be saved.

That panic subsided and gold prices started to drift down again - after US banks were subjected to "stress tests". America's 'Troubled Asset Relief Programme further backstopped the financial system by removing bad assets from hanks' balance sheets, and the global economy gradually bottomed out.

There are several reasons why gold prices are rising, but they suggest a gradual rise with significant risks of a downward correction, rather than a rapid rise towards US$2,000, as today's gold hugs claim.

Indeed, investors increasingly want to hedge against such risks early on. Given the inelastic supply of gold, even a small shift in the portfolios of central hanks and private investors towards gold increases its price significantly.

The recent rise in gold prices is only partially justified by fundamentals. Nor is it clear why investors should stock up on gold if the global economy dips into recession again and concerns about a near depression and rampant deflation rise sharply. If you truly fear a global economic meltdown, you should stock up on guns, canned food and other commodities that you can actually use in your log cabin.

Nouriel Roubini is professor of economics at the Stem School of Business in New York University, and chairman of Roubini Global Economics.