Gold Prices Skyrocketing: Will the Bubble Burst?

Amid the worries of U.S. equities and government debt volatility, the price of gold in dollars per ounce has increased steadily. This can be a result of the instability that has impacted the global economic system. Historically, gold has been used as protection against inflation and an indicator of the precariousness in the dollar. With professional research, analysts are expecting gold prices to encounter a parabolic rise. There is an opportunity to position an investment portfolio to exploit the fragility of the U.S. market.

History of Rising Gold Prices

On August 15, 1971, forty years ago, President Nixon took the U.S. off the Gold Standard. By doing this, he was debasing the dollar and allowing the dollar to float and be free of direct government intervention. At the time, gold was priced at $35 an ounce in August 1971 and exponentially rose to $850 an ounce in January 1980.

The graph below shows the appreciation of gold over time after Nixon took the U.S. off the Gold Standard.

Investment in Gold

For the average investor, gold seems to be an interesting venture. When the economy is underperforming, gold is expected to be a perfect hedge for any portfolio. The problem is that gold is most likely overvalued at this time. An adjustment can occur that would wipe out all gold price appreciation. This “hedge” could be dangerous.

Why would a person want to take on the risk to invest in gold? Analysts have explained this recent phenomenon.

“Lack of confidence in the global economy is pushing people towards gold,” Tom Pawlicki, a Chicago-based analyst at MF Global Holdings Ltd., said in a telephone interview. “Gold will continue to advance unless leaders are able to resolve the European or U.S. debt crisis.”

The apparent riskiness of gold is not apparent enough when gold prices are rising and U.S. equities are falling.

Future Expectations for Gold

Gold analysts have predicted that the price of gold could reach a staggering amount of $2,500 an ounce if the global economy continues to worsen. I would not trust an analyst to determine whether I should invest in a prospective venture. There is a possibility of  price fluctuations and I look forward to see how gold prices advance or retreat in the future.

Applied Comparative Advantage

In courses of Introduction to Economics across the country, a term known as comparative advantage is usually covered. David Ricardo first applied it as he used it to define trade between two countries. If two countries can produce the same good, but one can produce it at a lower relative cost, the fortunate country would benefit by focusing on that good and trading the surplus.

Comparative advantage can be useful for teamwork when analyzing group dynamics. When forming a team of any kind, it can be beneficial to have a wide range of specialists that are great at what they do. With each person having a different circle of competence, the overall group can achieve more in a shorter period of time. If a team consists of members who have the same area of expertise, the group member’s skills may overlap. Inefficiency would occur that would plague the team when working together on difficult problems. By having a broad spectrum of experts from different fields, comparative advantage will offer the greatest probability that problems will be solved swiftly.

After considering the positive benefits of creating a distinct group, here are a few questions that can be contemplated:

• What actions can I take to become the best in one area of proficiency?
• How can I work with a homogenous team that employee the same strengths and weaknesses?
• Is it best to concentrate on improving old skills or learning new and unique ones?

Worries of Inflation?

As the recession ended, the interest rates have remained close to zero. This is an encouraging percentage because business and household investment is promoted. When businesses and people have the incentive to invest, they help the economy. Products that need demand to survive are being purchased and the economy is receiving the benefits of producers and consumers interacting.

The conundrum of investment and consumption appears when inflation increases. The real cost of products are increased and are less likely to be invested in. A wage-price spiral occurs when the consumers who were able to purchase goods at the low price demand a higher wage to keep up with inflation. Businesses have to raise prices to offset the added expenses of paying workers more. This causes margins to decrease and innovation to come to a halt.

Policymakers may decide to increase inflation to get out of the current situations, but it has been proven in other countries that it does not work. Inflation–when encouraged–can run-up rather quickly.

When policymakers are confronted with the issue of an increase in inflation, they greet it with an air of normalcy. They claim that inflation should be measured by core inflation and that inflation is not measured correctly. The true measure of inflation is not accurate because it includes the volatile prices of food and energy. Once commodity prices increase the public believes that inflation will be soon to follow. The problem is that the people that are hurt the most by inflation are the people who consume groceries and other products that are not measured by core inflation. Inflation must account for the food and energy prices to receive a fair assessment on the future of inflation.

Households are pessimistic as ever and do not seem to be persuaded that their income will increase over time. If inflation does increase as expected, the people in the middle-class will be hit the hardest. Here is a graph that indicates that households are worried that their incomes will not increase and stagnate at zero percent. The future could be in jeopardy for households if their predictions match the actuality.

(ClevelandFed)

In order for the economy to be boosted, innovation must be created and risk taking must be valued. If prices increase, the value created will need to provide a level of quality that has never been achieved before. In order for this country to prosper, goods cannot be made with less effort and determination.