A Report From The Front Lines Of The Gold Bubble
A very illuminating report out of BNY's Nicholas Colas and Beth Reed describing the front lines of the so-called gold bubble. A must read for everyone who would rather listen to third-hand anecdotes and speculation instead of actually doing their homework. As Beth summarizes: "Bubbles are clearly punctuated – and driven to their final demise – by bad behavior on the part of market participants. My short, but colorful, excursion to the heart of the physical precious metals market revealed no such excess. Is that enough proof to eliminate the possibility of a gold bubble? Of course not. But I think it is enough to characterize recent calls for the demise of the gold/silver rally as very much premature."
@#$% My Boss Makes Me Do – A Trip to the Center of the Gold “Bubble”, from BNY ConvergEx
Summary: We recently did some firsthand investigation into the likelihood of a gold/silver bubble by heading straight to a source of the would-be bubble – the precious metals mecca that is New York City’s 47th Street Diamond District. Surprisingly, absent from our findings was any sort of bubble-like human behavior. Yes, the booming asset prices are there, but just as critical to any bubble is the bad behavior that launches it into the stratosphere. Think subprime jumbo mortgages sold to part time hairdressers or 10x oversubscribed IPOs for profitless dot com companies. We tried every way possible to get salespeople to lure us into unwise, non-economic precious metals investments, but with no luck. Yes, we know this is “anecdote” rather than “data.” But the utter absence of heavy-duty hustling and cajoling in what precious metal bears call a bubble leads to a common-sense conclusion: this is no bubble. Not yet, anyway.
(Note from Nick: Nearby our office in New York is 47th Street – the toughest, most aggressive retail/wholesale marketplace for jewelry, gemstones, and precious metals in the world. A logical place to find proof of a retail-driven gold bubble, but too daunting for me. I hate pushy salespeople. So I sent Beth. This is her report from the front lines of the precious metals market.)
A typical day at the office entails about 10 hours at my desk staring at computer screens backed by a blank white wall. I have my own window view of sorts – about a 1” x 2” opening that gives a 48th floor perspective of lower Manhattan, and if I lean over a bit I can even see New Jersey. Nonetheless, it does occasionally feel like I sit in one of those sensory deprivation tanks, just one that is equipped with a keyboard and screens.
Wednesday, however, was quite a different story. I spent my afternoon trapped in a non-air-conditioned Midtown pawn shop with a Swiss tourist who wasn’t permitted to leave after politely declining the owner’s offering price for a used Rolex. Yes, not only do they buzz you in the door (for security purposes), they must buzz you out as well. Apparently the shop girls are instructed not to let customers leave if they haven’t purchased anything. That way the owner has more time to cajole, haggle and even harass.
Eventually the girl allowed the tourist to leave, at which point she was berated by the owner while I stood awkwardly in silence.
Ahh, the things I do in the name of research… And why isn’t Nick here? This was his idea originally…
However, there was a purpose behind this field trip to the only pawn shop in Midtown. With all the commotion surrounding gold and silver these days and speculation we may be in the midst of a precious metals bubble, it made sense to do a little firsthand investigation.
Every bubble has a “home” – Wall Street for the dot com bubble, literally “homes” in Arizona and Florida for the housing bubble, and so on. Naturally, one home for any potential gold/silver bubble must be jewelry and coin dealers, long known as a bastion of high-pressure sales and don’t-let-a-prospect-leave-empty-handed intensity. Hence the point in visiting New York City’s (in)famous 47th Street Diamond District: to scope out the source of the bubble in retail demand for precious metals.
Yes, we know that central banks and ETF buyers are also sources of gold demand. But when one of the global hubs for the jewelry trade is about 500 yards from your desk, there’s just no excuse for not taking the pulse of one key part of the market – small buyers purchasing physical gold and silver – with some site visits.
What I was looking for, in two words, was bad behavior. Yes, everyone thinks they can spot a bubble just by looking at a price chart. But there is a lot more to a bubble than price action. There are all the greedy, unscrupulous, sordid actions that humans engage in when greed takes over. Stupid negative amortization mortgages sold to senior citizens. Initial public offerings of online retailers whose only real asset was a well-known sock-puppet spokesperson. A jumbo loan issued to a part-time hairdresser with no working knowledge of English or basic math.
So it came as quite a surprise that my trip to 47th Street was, in this sense, uneventful.
Before I tell you the details of my visits, however, a little background on this slice of jewelry heaven/hell: An estimate popular with the press places the value of a single day’s trade on the block at a cool $400 million, and other reports say as much as 90% of diamonds in the U.S. first stop on this 150 meter stretch of real estate. And as home to more than 2,600 independent businesses (most of them simply one-man-operations who have set up booths within the various jewelry exchanges), it is in theory a jewelry hustler’s dream.
As someone who can’t even stand being approached by a Bloomingdale’s salesgirl, believe me when I say there was a complete absence of sketchy con-man types, high-pressure salesmen, and any other shady characters trying to rip me off. I’ve spent 3 years of my career working in close enough proximity to this block that I’ve aimlessly ventured down it on my way to 5th Avenue more than a few times. As often as I’ve been unwillingly harassed by unabashedly intense salesmen, I was shocked at the low pressure atmosphere that awaited me when I willingly approached them.
The idea once inside was to get a feel for what average, non-financial people in the precious metals trade think about the direction these assets are headed. I simply told them I had $500 that I wanted to invest in a precious metals portfolio of sorts and that I would like their opinion on what I should purchase, whether it be gold or silver, coins or jewelry. And then I let them talk.
The six vendors I spoke with fell into one of two camps – those who love gold and those who champion silver. Though they didn’t agree on which specific precious metal should highlight my $500 portfolio (one even suggested platinum), they all quite emphatically discouraged me from purchasing jewelry as an investment. I unintentionally approached two vendors who only dealt in jewelry (no coins, etc.), and even they reluctantly told me they couldn’t recommend jewelry as an investment. The reasoning behind this revolves around the labor and design costs associated with “wearable” precious metals.
Though everyone was in agreement that coins are the way to go, surprisingly gold coins were not the overwhelming favorites. Half of the dealers suggested that with my $500 I purchase one ¼ ounce gold coin (cost = approximately $350) and use the remaining $150 to buy seven 1-ounce silver coins at about $21 each. One vendor with supposedly 20+ year of experience reasoned that gold will always gain in value. While it may not go up as rapidly as we’ve become accustomed to lately, his belief was that it will never experience another significant, lasting drop in value.
On the other side of the spectrum, three of the six retailers recommended without hesitation that I invest all of my $500 in silver coins. That would equate to about 23 silver coins at roughly $21 each. Reasoning varied from the simple (although not necessarily inaccurate) to the complex. For example, one retailer hypothesized that since silver is the poor man’s gold, and there are more poor people than rich people, obviously silver is a better investment. He asked what I did for a living, so I replied for the sake of simplicity that I worked for a bank. His response? “And they don’t tell you that there? You have to come to me?”
A more complex argument for silver over gold involved the ratio of the price of gold to the price of silver. Currently it stands at 60:1 while in previous peak times it has been closer to 20:1. Currently, silver is proportionately undervalued in comparison to gold, by this logic, and hence it theoretically has more room to grow. The price of gold is also rapidly approaching the price of platinum, and some of my contacts questioned how high it can actually go from here. I’ve attached a chart showing the gold/silver price relationship over time so you can reach your own conclusions on this point.
The main takeaway here is that there was no bubble-like bad behavior. I expected something out of the high-pressure school of sales. Men dangling gold chains with “Beth” in fake diamonds and telling me it was a better investment than a prosaic gold coin. Or perhaps a creative soul pushing some crappy ¼ carat uncut diamond as a “superior” choice to precious metals. But none of this happened, despite my repeated attempts and encouragements to all who would listen. As a final note, keep in mind that recent or current issue gold coins have some of the thinnest margins in the business. Maybe you buy some as a dealer and the price of the metal rises, but generally the bid/ask spread is no better than 10-15%.
To me, this experience was somewhat like walking into a mortgage broker in Florida in 2006, asking for a $750,000 loan with no income verification, and being laughed out of the office. Which is what should have happened, but obviously rarely did. I am not trying to portray every jewelry and precious metals dealer as the paragon of virtue; that’s obviously not true. If you keep up on this space, you know the criticisms of organizations like Goldline International.
But perhaps what my visits highlighted most clearly is that the precious metals business, at least at high volume locations like 47th Street, does not feel the urgency to “make hay while the sun shines.” Maybe my non-hustling salespeople have confidence that underlying demand is robust (so why push?) Perhaps the family/small business nature of their enterprise gives them a longer term perspective on the precious metals cycle.
Bubbles are clearly punctuated – and driven to their final demise – by bad behavior on the part of market participants. My short, but colorful, excursion to the heart of the physical precious metals market revealed no such excess. Is that enough proof to eliminate the possibility of a gold bubble? Of course not. But I think it is enough to characterize recent calls for the demise of the gold/silver rally as very much premature.