The hubbub started when hedge fund guru George Soros proclaimed gold to be in a bubble, and it is still roiling nearly six months later. Gold advocates jumped to its defense, while critics took the offensive. As it turns out though, Soros was not really issuing a warning so much as he was explaining why he was making a considerable investment in gold bullion. Only days after calling gold the “ultimate asset bubble,” the financial press reported Soros had doubled his holdings of physical metal. Both the advocates and the critics had misinterpreted what Soros was trying to say.

Over the years, I have seen gold called among other things the asset of last resort, the ulimate safe haven, the fiduciary asset par excellence, and the investment of kings and the king of assets. I have never before heard it called the “ultimate asset bubble.” Let’s explore what might be behind Soros’ unusual description and his newly-found interest in the yellow metal.

In that same speech (delivered at the January, 2010 Davos conference), Soros stated that buying at the beginning of a bubble was “rational.” Considering the fact that mania, i.e. bubbles, are most often defined by their level of irrationality, Soros’ choice of words seemed a bit out of kilter -- especially since, as it turns out, he was attempting to apply some postive spin. The most rational reading of Soros’ comments came from gold analyst Jeffrey Nichols: “Perhaps Soros thinks gold is going to bubble, but the bubble is going to last for a while and he wants to profit from it. we could have a bubble but gold can reach $2,000 or $3,000 before it’s over.”

Long term cycles accrue to gold’s benefit

Nick Laird at sharelynx.com developed a chart for USAGOLD supporting the theory that if gold is in a “bubble,’ it is, as Soros suggests, in the beginning stages. As you can see, gold would need to reach nearly $3500 per ounce -- about 14 times its $260/ounce starting point -- to match the stock market mania that ended in 2000. For those who understand the longer term nature of market trends, like Mr. Soros and his colleagues in the hedge fund business, gold probably looks very attractive as it enters into the second leg of the current bull market.

Soros built his reputation and his fortune on making the big bet (his infamous assault on the British pound in the early 1990s comes to mind). In the case of gold, his approach to the market reveals another, more conservative aspect to his thinking. Tellingly, instead of leveraging his investment in gold, he opted to purchase in physical form through an exchange traded fund. In both form and substance, Soros’ gold ownership appears more like a classic hedge than it does the big bet -- an approach that speaks volumes about what might be on this famous speculator’s mind. His acquisitions, according to press reports, thus far constitutes about 10% of his overall portfolio -- a position not too different from many first-time investors entering the gold market for hedging purposes.

Since the beginning of the fiat money era in 1971, gold and stocks have experienced bull markets alternately as the pendulum has swung from good times to bad.

• First, gold experienced a bull market from 1971 to 1980. If you take into account that gold had been under accumulation from 1965, another six years could be added to that ten-year bull market. Since the price of gold was fixed prior to 1965, the increased demand from both private investors and nation states was not reflected in the price. However, at times, premiums rose significantly on commonly traded gold coins.
• Stocks then took a turn in the driver’s seat from 1982 to 2000 (using the wider S&P index as a measuring stick) -- an eighteen year bull market.
• Now gold is taking its second turn under circumstances very similar to the crisis ridden 1960s-1970s. most analysts peg 2001 as the first year of the current bull market, making 2010 the tenth year of the uptrend.

Though short-term thinking seems to plague the markets in any era, the dominant cycle from bottom to top during the current fiat money era for both gold and stocks appears to extend over a roughly 15 to 18 year period. If the cyclical characteristics holds true, gold theoretically would not see a top in this cycle until sometime in 2019 -- 18 years from the trend’s starting point. Keep in mind though that markets, if anything, are unpredictable. Circumstances could come into play which could either shorten or lengthen this time period. If you read (or watch) the financial press, you already know that a good many analysts see the current economic environment as particularly dangerous for investors.

When you take into account that we are at roughly the midway point in the cycle with more surprises perhaps waiting in the wings, a 10% diversification into gold probably makes a lot of sense, and that could be why George Soros has gone with a physical gold hedge as part of his holdings.

For a free subscription to our newsletters, please go to the USAGOLD NewsGroup page.