Now first of all, I refer to gold as “beloved” because since the year 2000, gold has consistently risen in all types of markets and is up over 800% from its bottom. It has thrived in recessions, stock market crashes, real estate market crashes, terrorist attacks and anything else you can name. It has also proven to be the most uncorrelated investment in the market place and has reduced risk for many portfolios of all kinds. And before I talk about why gold went down over 13% over a few days, let’s talk about what drove its price up over the years; there are basically 3 things that drive gold prices worldwide:
- Fear of inflation
- Distrust of government
- Geo-political instability
So the first thing to acknowledge is that it is a very difficult argument to make that any of those drivers have lessened over the last 12 years because all of them have become much more severe. Inflation, which is a direct result of money-printing, is still the number one fear of most investors around the world, and even though we have seen little inflation in the last 12 years, gold still rose over 800% because everyone knows that inflation will eventually be a big problem and no amount of government engineering will change that fate.
As for distrust of government, we have seen proof of this all over Europe, the Middle East and in the United States, and it is getting worse every day. In a recent PEW Research Center survey, over 73% of Americans surveyed said they distrust the federal government. So as terrible as this for the country, it’s great for gold and will continue to be great for gold over the long run.
The final driver of gold, Geo-Political instability, feels like it is at a very high level. It seems like every day, someone is threatening to eliminate another country off the face of the earth or most recently, attack the United States with a nuclear bomb. Gold trades on the fear of this type of event, whether it happens or not.
So why did gold drop 13% last week? I have no idea, since none of the fundamentals changed, in fact, they have improved! Now there are many theories about what caused the selloff, but none of them are too strong. One is that Cyprus might be asked to sell some of its 40 tons of gold to back up its bailout. Not very likely, for a couple of reasons: first, Cyprus has an economy that is smaller than Shreveport, LA. How’s that for small? Also, 40 tons of gold sounds like a lot, but to put it in perspective, America has 8,133 tons of gold. So, even if that happened, that would be the equivalent of .5% of our gold holdings, and that doesn’t count the rest of the world, so that doesn’t explain a 13% sell off. Now, the rest of that theory is that if Cyprus is forced to sell gold, then maybe France and Spain will be forced to sell as well. The reason this theory doesn’t hold water is because it is highly unlikely that anyone will be asked to back up monopoly bailout money with REAL assets. Think about this for a moment. The money that is being used to bailout all of these countries, just like the money used to bail out all of our “too big to fail” companies in 2009, is monopoly money fresh off the FIAT printing press. So it’s like you are playing Monopoly and you need a loan from the banker, and as he hands you the colorful paper money, he asks you for the actual title of your house as collateral. It is no different than a government bailing out a country or a company with FIAT currency and asking for real assets to be liquidated as collateral or payment. I don’t see it as a reasonable possibility, but anything is possible. Another weak theory is that since we have seen little inflation over the last decade, traders have suddenly lost their patience with their number one performing trade of 12 years, which is equally unlikely. So then why did gold go down? The answer is simple…More Sellers Than Buyers caused some pre-programmed technical support levels to be breached, triggering thousands of computer trading programs to sell, therefore forcing gold to take a long awaited breather. So is this a buying opportunity? Based on what I see, yes. So how should you play it? Should you just step in and buy gold naked or should you use a structure with some type of downside protection? That really depends on your risk tolerance. Although I am bullish on gold here, I have also been doing this for 30 years which makes me cautious and conservative in my approach.
So, just know that there are structures that allow you to participate in gold’s upside with some protection on the downside if it starts to fall again. If you want know how I am specifically playing gold please reach out me.
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Information presented in this blog post is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Discussions and answers to questions do not involve the rendering of personalized investment advice, but are limited to the dissemination of general information and may not be suitable for all readers. A professional adviser should be consulted before implementing any of the strategies presented.