Gold washout to continue: weak hands forced to sell

The gold price dropped the most in 25 years last week, 8.4%, and remains down about 21% from the all-time high of $1,033 in March. Investors’ surveys showed bullishness on the metal in the high ninety percent range in March, with a bounce back to near 90% during the second peak of $989 in June. Simply put, almost everyone thought gold would go higher. The commentaries on Kitco.com hummed with the surety that gold would soon retake its 1980 inflation-adjusted high of $2500 as the dollar slid to Peso-like status.

The atmosphere was cult-like, and a bit intoxicating for libertarian-minded gold bugs (are there any other kind? ok, anarchy-minded), yours truly included. We are all waiting for the return of non-liability, non-printable, non-degradable, timeless money, for if civilization marches on (some would say, for civilization to march on), gold and silver should at some point reassume their rightful places in society. They just do the job so much better than all the kinds of paper, shells, clay tablets, fiddle sticks and digits that have been tried over the years. The great hope is that specie is taken up spontaneously when the world’s corrupt (is there any other kind) governments implode from the debt that their fiat money has enabled.

Well, I would say that that possibility grows stronger with each misstep by our bankers-in-chief, but it is by no means a sure thing in the near future, more like a long-shot, since the anti-gold and pro-central banking propaganda runs deep after a century of indoctrination and dumbing down of the populace. Our governments have become masterful manipulators, and crisis-management is their specialty (if you think Katrina was a failure, you must not have gotten any of that $80 billion), so don’t count on 1776 all over again. More like 2001 in Argentina: meet the new boss, same as the old boss.

But yes, while governments get viscous in a crisis (and be sure, retaining control over the nation’s money is top priority, justifying all kinds of emergency measures), they do get weaker internationally, and the financial system is international. I do expect to see greater use of digital gold banks among the world’s citizens who are free to use them, and the precious metals may see a resurgence in hand-to-hand use in markets where governments turn a blind eye, such as the bazaars of Asia.

I have believed since first waking up to gold that we would see a 1:1 Dow:Gold ratio again, but when the breakaway run to $1000 started in 2007, I became convinced that deflation would snuff it out and I bought long-dated puts to hedge my holdings. Deflation is now destroying wealth at a blistering pace, and gold is being wrested from weaker hands, such as people who need cash more than their old bracelets, or momentum-chasing hedge funds facing margin calls and withdrawals.

We are just now entering the strongest phase of the credit crunch, when bank failures will be a near-daily occurrence and the equity markets will be knocked back to 2002 or 2003 levels in short order. Job losses are mounting, and consumers are getting very tight, bringing bankruptcies to all kinds of bubble-era self-indulgence industries: home furnishings, electronics, coffee shops, restaurants, organic foods, big autos, toys with small engines, pleasure travel, clothing and accessories.

As of last week, almost every major asset class had tipped its hand, and all will lose to the house: cash and treasury paper. Real estate went first, then commercial paper, then stocks, then municipal bonds, and this summer energy and all of the metals turned. All I am waiting for is a washout in corporate bonds, but they can’t be far behind.

How low could gold go? A 50% retracement of the run from $253 in 1999 to $1033 would be $643. I give it better than even odds that we go a bit lower than that. But keep in mind that I think stocks will fall 80% from their highs and real estate 60%. Commodities are much more volitile, so a 40% fall in this context could still be considered a bull market setback (the same goes for oil). I’ll certainly be buying if it happens, and I won’t ever give up hope of being able to pay for groceries with silver pocket change or a home with an electronic gold transfer.

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