Well before I answer those fascinating questions, let’s just stop and remember the three things that drive gold prices as an investment: Fear of inflation, distrust of government printed fiat currency and geopolitical instability.
Alright, so let’s talk about inflation. Basically, we have none at the moment with a 1.4% GDP growth, which is way below Chairman Bernanke’s target of 2.5%, which is the official number that we are told will shut down the money printing party of $85 billion a month that he and the boys at the Fed are currently doing. The other condition, if you recall, is getting unemployment down to 6.5% from its current 7.6%. OK, so even though we don’t have any inflation to speak of right now, unless people believe that inflation is a thing of the past and unbridled money printing has no inflationary consequences, I think the inflation fear factor is still in play.
OK, how about distrust of government? Well, in a recent survey here in America, the most stable government in the world, 72% of people surveyed by Pew research said that they do not trust their government! Imagine if that poll was taken in Turkey, Europe, Sweden or any of the other places where thousands of protestors are demonstrating. So, I think the distrust factor is still really high, and I think that covers geopolitical instability as well.
As far as fundamental reasons people would want to own gold, they have not changed. So what has changed? Well, there are many theories out there that I’ve studied, and none of them make much sense to me. Most of them seem to contradict the others, except for one…If the largest holders of gold on the planet are quietly selling some of their stash, then all fundamental bets are off for the moment. One theory that is reasonable is that the US government, which happens to own 8000 tons of gold, almost 3X more than any other country, is dumping a bit to drive the price down in order to drive more people into other investments that make the economy look better, like stocks and real estate. And if you think about it, gold does nothing for the economy and simultaneously makes other investments look bad in comparison when it gets real expensive. And remember, gold has been a better investment than stocks, bonds and real estate for the last 13, 10, 7 and 5 year periods, so to think that the FED might want to help gold off its high horse a bit is not crazy.
Now, while this may sound a bit like a conspiracy theory, keep in mind, the Federal Reserve is constantly manipulating things to get us to act in a certain way. For example, keeping interest rates at artificially low rates is designed to manipulate people into borrowing and spending more money and more recently, to make bonds less attractive than stocks.
Flooding the system with printed money is designed to weaken the dollar, making our exports cheaper and to artificially suppress interest rates on Treasury bonds. The Fed even is allowed to go in and buy stocks to stabilize the markets or drive them up a bit, if they deem that appropriate. So, to say that it’s a far-fetched idea that the Fed might be selling some of their 8000 tons of gold to crack the price and make things in other areas look better is naive.
Now, obviously I don’t know what’s really causing the unexplainable drop in gold, but I will say that for you longer term players, gold is cheap here although in the short term, it may get cheaper.
So what should you do? Well if you are a trader, there is probably some more downside here until it gets to its next support level, which is around 1150 from its current price of 1225 per ounce. If you are a longer term thinker there are several ways to play gold: hold onto it, buy more or hedge your position with options which can limit your downside as well as let you participate in some of the upside when this trend reverses.
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