Wednesday, August 17, 2011

Confirmation Bias and The Gold Bubble

I came across a classic illustration of 'Confirmation Bias' in an article about the gold price this evening.
Confirmation bias is not an arcane market indicator, but rather the simple observation that we all tend to place more trust in information which confirms our existing beliefs.

The example I have is a single article which confirms that gold is both the greatest investment opportunity and that gold is in a bubble. Its exactly the same article with the same information content which based on your initial bias is confirmation of one of two opposing conclusions.

You can read the article by following the link to Arabian Business at the end of the post, I have summarised the main information content below.

1) Dubai Gold Sales up 100%.
2) New types of customer are buying gold
3) We are going into the traditional gold buying season which should see additional demand
4) Dubai planning to launch a new gold coin to satisfy investor demand.

Now lets look at the bull and bear case for gold.

Bull - buy gold its the best investment opportunity.
Bear - avoid gold, its going up a bit more before it collapses, the upside is not enough to compensate for the risk.

1) Dubai Gold Sales up 100%.
Bull - Sales have doubled, gold is where its at, get some now !
Bear - Sales have doubled, sounds like gold is going exponential to me, generally its a sign of an imminent collapse.

2) New types of customers are buying gold
Bull - Yes of course they are, as everyone wakes up to the unique investment opportunity they are buying in and so am I.

Bear - New types of customers eh ? so people with no previous experience of the gold market are rushing in to buy gold, that has a history of ending well, I have some tulip bulbs they might also be interested in. (see references at the end if your wondering about the tulips)

3) We are going into the traditional gold buying season which should see additional demand

Bull - Yes, of  course it will, many nationalities buy gold at this time of year, festivals, marriage season, its all good for gold.

Bear - Ok, food has gone up in price, fuel has gone up in price. How much money is left to buy gold ? And isn't it possible that the high price of gold will drive people to buy less gold leading to a supply overhang ?

4) Dubai is planning a gold coin to meet investor demand.

Bull - Investor demand !!!

Bear - Exactly.

Its the same information, yet our in built confirmation bias prevents us from seeing any new information that would challenge our existing views, in fact our confirmation bias is so strong as to be able to bend information so that it provides additional support to our existing thesis.

I have made my case with regards to gold in a previous post here -

Should I Buy Gold

For the reference to Tulips see here -
Link to original article -

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