02 _11_debunking the gold bubble myth

8/7/2019 02 _11_Debunking the Gold Bubble Myth

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Golds continuous ten-year rise hasntsheltered it from controversy. Despiteproducing consistent returns in virtuallyall currencies year after year, somemarket pundits still question its validity asan asset class. Its true that gold doesntpay any interest, and its also true thatmuch of the gold produced throughouthistory still exists in some form today.But these characteristics shouldnt inhibitit from performing as a monetary asset.

Cash, after all, doesnt pay real interesteither, and there is more at money inexistence today than ever before. Sowhy does gold still receive such harshcriticism?

We believe much of it stems from awidely held misconception that gold isforming a nancial bubble. Its a fairlystraightforward view that gold buyersare merely foolhardy speculators buyingon a whim with no rationale other than tosell to the greater fool at higher prices in

the future. Its a view that assumes thatgold has no intrinsic value and is simplya speculative asset that has capturedinvestors imaginations.

We dont take these views on gold lightly.Weve seen bubbles before and fullyknow how they end. We have no interestwhatsoever in participating in some sortof speculative frenzy thats a recipefor disaster in the investment business.Thankfully, however, our gold investmentspresent no such risk. As our analysis has

revealed, gold is actually a surprisinglyunder-owned asset class and onethat has generated far more attentionin the media than it probably deserves.While its exemplary performance since2000 is certainly worthy of discussion,gold simply hasnt commanded enoughinvestment to warrant the bubble fears itseems to have aroused among marketpundits and business commentators.The truth about gold is that most peoplesimply dont own ityet.

By: Eric Sprott & Andrew Morris

Contributing Editor: David Baker

www.Sprott.com

Debunking theGold Bubble Myth

February 2011


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To be clear, a speculative bubble forms when prices for an asset class rise above a level justied by itsfundamentals. For this to happen, increasing amounts of capital must ow into the asset class, bidding it upto irrational levels. Gold may be trading at all-time nominal highs, but a look at investment ows proves that

it isnt anywhere close to being overbought.In their Gold Yearbook 2010, CPM Group noted that in 1968, gold held by individuals for investmentpurposes represented approximately 5% of global nancial assets. By 1980 that amount had fallen toroughly 3%. By 1990 it had dropped signicantly to 0.6%, and by the year 2000 represented a mere 0.2%of global assets. By the end of 2009, nine years into the gold bull market that began in 2000, they estimatethat gold had increased to represent a mere 0.6% of global nancial assets hardly much of an increase.Gold ownership didnt change much last year either, as we estimate that this percentage increased to 0.7%of global nancial assets in 2010.1 So despite gold reaching record nominal highs, the world holds aboutthe same portion of its wealth in gold as it did over two decades ago. While this probably says more aboutthe proliferation of nancial assets over the past decade than it does about gold investment, it is surprisingto note how trivial gold ownership is when compared to the size of global nancial assets.

The increase in gold ownership from 0.2% in 2000 to 0.7% in 2010 is also misleading. If you consider the

approximate $227 billion that was invested in gold bullion in 2000, that level of investment would havegrown to $1.18 trillion, or 0.6% of nancial assets, by the end of 2010 - based purely on gold appreciationalone.2 In other words, the actual amount of new investment into gold since 2000 represents only 0.1%of current global nancial assets, or about $250 billion. Although this number may seem large, considerthat roughly $98 trillion of new capital owed into global nancial assets over the same period, so goldsapproximate 0.3% share of global investment ows is essentially trivial.3

The 0.7% ownership data point also has interesting implications for global gold ownership going forward.Consider that to return to a meaningful level of gold investment, say to the 5% level of 1968, it would requireover $9 trillion of gold investment today, or about 6.5 billion ounces of gold at the current gold price. Thiswould represent well over 1.3 times the amount of gold ever produced throughout history and four times theamount of known gold reserves.4,5 So not only is the public relatively underinvested in gold, but at currentprices it isnt even possible to increase our gold holdings back to a meaningful level.

Golds apparent underinvestment also applies to gold equity nancings since 2000. According to oursources, gold companies raised approximately $78 billion of equity capital in new nancings over the past11 years.6 To put this amount in perspective, this is equivalent to the total amount of equity raised bytechnology companies in the rst three months of 2000.7

To further illustrate the lack of activity in the gold equity capital markets, we compare last years goldcompany nancings with the technology company nancings in the year 2000 (Chart 1). Once again,looking at the relative amount of capital market activity in the gold equity markets, we nd no indication ofa bubble whatsoever.

Furthermore, we compiled information on mutual fund ows to get a sense for the average retail investorsappetite for gold equity investments (Chart 2). We found very familiar results in this area as well: comparedto the $2.5 trillion dollars that was invested in US mutual funds since 2000, precious metal equity funds haveseen a mere $12 billion in inows. If there is a bubble in gold investments, the average retail investor hasntparticipated in it.

www.Sprott.com

1 SAM estimate based on data obtained from McKinsey & Co., IMF, CPM Group, Thomson Reuters, BIS2 CPM Gold Yearbook 2010 CPM Group (March 2010)3 SAM estimate based on data obtained from McKinsey & Co., IMF, CPM Group, Thomson Reuters, BIS4 Larmer, Brook. The Real Price of Gold National Geographic Magazine. (January 2009) Retrieved on March 7, 2011 from: http://ngm.nationalgeographic.com/

print/2009/01/gold/larmer-text5 Mineral Commodity Summaries 2011 US Geological Survey (January 2011). Retrieved March 7, 2011 from: http://minerals.usgs.gov/minerals/pubs/

mcs/2011/mcs2011.pdf6 RBC Capital Markets, Dealogic7 Ibid.


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www.Sprott.com

Source: Bloomberg, Sprott Asset Management LP

CHART 3

Price-to-EBITDA(TTM

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Source: Morningstar, Sprott Asset Management LP

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To truly gauge the level of exuberance(or lack thereof) in todays gold market,its benecial to review equity valuations,

since they provide an excellent lens intoinvestor sentiment for an asset class.Certainly if a bubble was forming in gold,it would likely rear its head in the stockmarket, where speculative manias havebeen eecing greater fools for centuries.The best gold index to review for valuationis the Amex Gold Bugs Index (HUI),which has returned a stunning 674%since 2000. It is certainly an index thatcould be mistaken for a bubble basedon its incredible performance until oneconsiders its relative valuation. In Chart 3

we present a time series chart comparingthe price-to-EBITDA of the HUI vs. thatof the Nasdaq Composite since 1998.Price-to-EBITDA is a valuation metricthat compares a companys stock priceto its prots before accounting for taxes,interest payments, and non-cash chargeslike depreciation and amortization. It issimilar to the ubiquitous price-to-earnings(P/E) multiple but allows for a comparisonacross periods where net earnings arenegative and P/E ratios incalculable.

Looking at the price-to-EBITDA multiplefor the HUI Index we see absolutelyno evidence of a frothy market for goldstocks. At the current level of 13 timesEBITDA, the HUI is actually trading belowits 15-year average of 14 times. Moreover,valuations for gold stocks are currentlyone-third of the levels reached by theNasdaq in late 1999. There simply isntany evidence of excessive valuations ingold stocks, which is most certainly wherewe would expect the excesses to be mostapparent.

Based on our ndings, this notion of agold bubble is patently false. The currentinvestment interest in gold relative to othernancial assets remains surprisingly low- about where it was two decades ago.Moreover, the modest valuations of goldequities highlight the absence of unbridledinvestor enthusiasm for gold investments.

Source: RBC Capital Markets, Deal Logic, Sprott Asset Management LP

CHART 1

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The opinions, estimates and projections (information) contained within this report are solely those of Sprott AssetManagement LP (SAM LP) and are subject to change without notice. SAM LP makes every effort to ensure that theinformation has been derived from sources believed to be reliable and accurate. However, SAM LP assumes no responsibilityfor any losses or damages, whether direct or indirect, which arise out of the use of this information. SAM LP is not underany obligation to update or keep current the information contained herein. The information should not be regarded byrecipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particularcircumstances.

Views expressed regarding a particular company, security, industry or market sector should not be considered an indicationof trading intent of any investment funds managed by Sprott Asset Management LP. These views are not to be considered asinvestment advice nor should they be considered a recommendation to buy or sell.

The inormation contained herein does not constitute an oer or solicitation by anyone in the United States or inany other jurisdiction in which such an oer or solicitation is not authorized or to any person to whom it is unlawulto make such an oer or solicitation. Prospective investors who are not resident in Canada should contact theirfnancial advisor to determine whether securities o the Funds may be lawully sold in their jurisdiction.

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The fact is, despite all this talk about the gold bubble, the capital ows into gold vis--vis other nancial assetshave simply not been large enough to indicate any speculative mania. Investors can rest assured that theyare not participating in any speculative bubble by owning gold. They are merely protecting their wealth.

02 _11_debunking the gold bubble myth

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