I know better than to say “I told you so” (see “Gold: Has the Bubble Finally Burst?” from early last week).  The market gods tend to be jealous and vengeful and appear to take great pleasure in humbling the arrogant.  So I know better that to tempt them. 

Besides, even after last week’s bloodletting, gold is still one of the best-performing assets of 2011; the September selloff did little more than erase August’s parabolic surge.  And, in the interests of full disclosure, I’ve been on the record as a gold bear since it crossed the $1,200 mark (it was at about that point that the gold bull market entered the theater of the absurd with such novelties as ATM machines than dispense gold ingots).

Still, it would only be appropriate if last week’s action did mark the top.  The market gods may indeed have a twisted sense of humor, and Donald Trump’s high-profile blustery rant that immediately preceded the crash would have been a good opportunity for divine smite.   After Trump accepted $176,000 in gold bullion as a security deposit from a new tenant, he announced loudly that “It’s a sad day when a large property owner starts accepting gold instead of the dollar. … If I do this, other people are going to start doing it, and maybe we’ll see some changes.” (See “Trump’s New Gold Standard”)

Whether other people follow in The Donald’s footsteps and accept gold as collateral remains to be seen, but if they do they will no doubt require a few more ounces given the drop in price.

The question on everyone’s mind is “What now?”  Does the gold rout continue from here, or can gold bugs look forward to a nice bounce this week?

According to precious metals site kitco.com, the spot price of gold has continued its downward drift, falling to $1606 per ounce in Hong Kong early Monday trading ($GLD, $GC_F).  And while anything can happen once the larger American markets open, there is reason to believe that this correction has a way to go.

Gold’s parabolic rise in August prompted the CME Group to raise margins on its gold and silver futures contracts on Friday by 21.5% and 15.6%, respectively.  Given the recent price action and the uncertainty coming out of Europe, speculators are not likely to risk margin calls with aggressive bullish bets on the yellow metal at the moment.  Furthermore, with the end of the year fast approaching, portfolio managers who have profited handsomely from gold’s rise are more likely to take profits than to add to their positions.

But perhaps most damaging is the psychological angle.  Both market professionals and retail investors alike have been attracted to gold for its perceived status as a safe haven.  But after the wild ride that the price of gold has seen over the past month, its credibility as a haven is almost laughable.  What good is fire insurance that disappears the moment your house actually catches fire?

When global markets violently sold off last week, investors fled to the U.S. dollar and to U.S. Treasuries for safety.  Yes, that same fiat dollar that gold bugs love to hate and those same U.S. Treasuries that just got downgraded last month by Standard & Poor’s.  It appears that when the situation gets dire enough, ideology goes out the window.

These are all shorter-term concerns, of course.  But the long-term picture is even worse.  Let’s review some of the points that I’ve made over the past year:

  1. The inflation that so many feared in the wake of Bernanke’s 2008 doubling of the monetary base never materialized.  And guess what—it’s not going to.  Anyone who cared to consult a history book would have seen that the bursting of property and credit bubbles are generally followed by deflation, not inflation.  This was certainly the case in post 1990 Japan, the best historical example we have.   Gold’s alleged value as an inflation hedge will be of little use in a decade of stagnant prices.
  2. The dollar isn’t being replaced as the international reserve currency any time soon.  This is not some misty-eyed, patriotic support of my native land’s currency.   No, to the contrary.  America’s monetary policy is misguided, and the fiscal policy coming out of Congress and the White House is criminally incompetent and damaging.  But, to adapt Winston Churchill’s quote on democracy, “the dollar appears to be the worst currency…except for every other currency conceived.”  As grave as America’s problems are, they pale in comparison to those facing the Eurozone and Japan.  And no matter how much perennial presidential candidate Ron Paul might fancy it, there will be no return to a global gold standard.  Given currency supplies, a return to a gold standard would almost certainly mean massive deflation and high unemployment.  That is a political nonstarter, even in the age of the Tea Party.
  3. Let us not forget that gold is not really an “investment” in the classic sense.  Unlike a stock, bond, rental property, piece of productive farmland or even a piece of artwork that can be lent out for viewing, gold produces no income, nor does it create anything of value.  It’s a shiny trinket.  And its value as a shiny trinket has been under attack for quite some time now.  Gold’s use for jewelry purposes has been nearly cut in half over the past decade, while its hoarding for “investment purposes” has risen by a factor of 65 (see “Gold Climax”).  Meanwhile, many high-quality, dividend-paying stocks—companies that will survive financial Armageddon—are trading at valuations not seen in decades.  (see “Wintel: The Buy of the Decade”)

Again, I’m not calling the top of the gold bubble.  I’ve been down that rabbit hole.  I’ve angered the market gods before, and they have punished me.

Still, the short-term case for gold is questionable at best, and the long-term case even worse. We might have seen the high-water mark in the price of gold for the next 30 years.  Or, this could simply be a much-needed correction in a much longer secular bull market.  Only time will tell.

But investors should use last week’s gold-price plunge to get a little perspective—and maybe a little humility too.  Gold is not a safe haven.  It’s not even an investment.  It’s a high-risk speculation that’s had a great run.  And that run, if it hasn’t already, will come to an end.

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