How much longer can gold rise?

By Bill Fleckenstein

There has been an endless amount of chatter about the price of gold being too high (it's not) and perhaps representing a bubble. It also seems that fair amounts of ink and windage have been wasted on worries about the gold trade being "too crowded."

In my daily column on my own Web site, on Sept. 17, I noted a remark by Dennis Gartman of The Gartman Letter that the gold market was "terribly, egregiously, preposterously, shockingly overpopulated."

That day, gold closed at $1,014 an ounce. Here we are, about two months later, and gold is more than 10% higher.

In a bull market, worrying about an idea being too crowded with like-minded investors is not very productive. More likely than not, it will help to eliminate you from a winning position.

At some point, when the gold market is finally reaching a top, it will, in fact, be too crowded. But we're almost nine years into this bull market in gold, and to me it seems that there are more people of the mind that "the trade" is too crowded than there are who say it isn't.

We'll know gold is overcrowded when . . .

For the long-gold trade to really become too crowded, certain events will need to occur:

• Goldman Sachs (GS, news, msgs) will have had "bus tours" to a bunch of mines, like the tours it and other companies have arranged for different industries, particularly technology.
• The public will have to be involved in a major way, and we'll see ads on Bubblevision encouraging people to buy gold instead of prodding them to sell their jewelry, as is the case these days.
• Banks will need to find a way to put money into gold -- because no modern mania has ever ended without the banks finding a way to lose money in it.
• We will most likely need to see a frenzy of mergers and acquisitions, and a leveraged buyout or two.
• Last, BusinessWeek will have to put gold on the cover, telling us how it's the wave of the future, or some variation of that theme.

I put this list together somewhat tongue-in-cheek, but over the past couple of decades, most of these events have occurred before a big mania has ended -- be it energy in the late 1970s and early '80s, stocks in the late 1990s or real estate in the middle of this decade.

So it seems to me that what's crowded is not the long-gold trade but more likely the camp of folks who think it's too crowded.

Dollar cries out: 'Et tu, Mauritius?'

At the intersection of yellow dog and greenback, it's worth noting that the tiny island of Mauritius became the third central bank to buy gold in the past month -- specifically, 2 metric tons worth $71.7 million from the International Monetary Fund (following in the footsteps of India and Sri Lanka).

I don't know what the fourth central bank will be, but I'm pretty sure there will be one.

Meanwhile, the Buttonwood column in last week's Economist, "Paper promises, golden hordes," cited the small quantity of gold that actually exists: "Two hundred metric tonnes of gold" -- that's what India bought -- "would occupy a cube of a little more than two metres on a side; it would fit into a small bedroom."

(For folks who might not know, all the gold that's ever been found would fit into two Olympic-size swimming pools!)

The column noted the psychological sea change that appears to be taking place at the central-bank level: "For bullion bulls, the implication is clear: central banks no longer trust the creditworthiness of other governments. And if they have lost confidence, private investors should do the same."

I think that pretty much sums up how the groupthink process gets started. Of course, that idea will have cut a wide swath through all levels of asset managers (witness my scenario above) before gold finally becomes too crowded and tops out.

Gold sky at morning, bonds take warning

The corollary of folks wanting to buy gold -- i.e., having no faith in dollars and other colored paper -- also has implications for the bond market. It's what I have alluded to with my shorthand nickname "the funding crisis."

That the Buttonwood column took this up for discussion is potentially an early sign that the concept of a funding crisis may now be going mainstream (at least sophisticatedly so):

"Developed-country governments have attempted to control bond yields through quantitative easing and to support stock markets through ultra-low interest rates. But they cannot support their currencies as well without risking problems in the bond and equity markets. Gold's surge may indicate that investors fear the next stage of the crisis will occur in the foreign-exchange markets."

Fleckenstein on video: Bull market or just bull?

That is a succinct warning of what I believe will likely be next year's serious problem for the xera, where weakness is no longer described as just excess volatility but a genuine cause for concern.

We'll know that it's time to start paying close attention to a potential funding crisis when the bond market trades lower in lock step with the dollar trading lower. That will be an indication that the foreign-exchange market is calling the tune -- the implications being higher interest rates and, I would think, lower price-to-earnings ratios and, ultimately, a weaker economy.

Dollar weakness is so widespread lately that even the Icelandic króna and the Latvian lats have been rallying against it, which suggests to me that the belief in our green paper as the world's reserve currency is being questioned seriously everywhere.

Housekeeping

On Thursday I was interviewed again by Eric King of King World News. As always, he did a tremendous job asking thoughtful questions (some I'd never been asked before). Click here to listen to the interview.

At the time of publication, Bill Fleckenstein owned gold.