The Crash in Gold is Good News

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Yesterday, the Dow rose.

Gold, the subject of today’s commentary, fell. From the Financial Times:

Gold has tumbled to its lowest level in nearly three years, putting it on track for its biggest quarterly fall since the collapse in 1971 of the Bretton Woods system of exchange rates, which pegged the value of the dollar to the metal.

This is good news. Gold is doing what it should do. And it is giving us another good opportunity to buy a life vest before the boat sinks.

No market goes up without a correction. Speculators typically get ahead of themselves. They need to be slapped around a bit…tested…and tempered. Like a steel blade, they need to be hammered before they are ready for the final battle.

In the last major bull market in gold — which lasted for most of the 1970s — the gold price rose from about $40 an ounce to over $800 an ounce.

This was one of the greatest bull markets of all time. But it wasn’t without its challenges. The price of gold moved up fast. It needed to be knocked down at least once before it finally reached its top. Gold fell by 47% before rising eight times to its peak in 1980.

Let’s see. Gold began its current secular bull market at a bit under $300 an ounce. It rose to $1,900 an ounce. That’s a gain of $1,600 an ounce. If gold were to lose half its gains, it would have to fall by -$800…or down to around $1,100. So, we’ve still got a way to go.

But how do we know that the underlying causes of gold’s march to glory are still in place? We can never be sure. For thousands of years, gold has not been the only kind of money…but it has been the best kind. While other forms of money have failed, gold is still in business.

It is the ultimate money.

Some wealth is held in the form of tangible things. Other wealth is represented by paper — bonds, notes, bills, stocks, IOUs, etc. When an economy is growing it becomes more sophisticated…with relatively more wealth in paper form.

These are claims on other kinds of wealth, elaborated in a period of prosperity and trust. The more faith people have in ‘the system’, the more faith they have that their pieces of paper can be exchanged, sometime in the future, for real goods and services.

When trust in the system slips, so too does faith in pieces of paper. Money holders begin to wonder about counterparty risk. Can the issuers of debt instruments really pay? Are corporations really as profitable as they say? Is the fellow who left us this IOU solvent?

When trust suddenly disappears, we get what is called a ‘panic’. This soon manifests itself as a ‘crash’ in asset (paper) prices. Often, tangible assets go down too — such as real estate, art and commodities.

That was the world, more or less, of the 2008–09 crash. When investors realized that subprime mortgage holders couldn’t service their loans, they began to wonder who else couldn’t pay. Surely, the banks that held billions of dollars of subprime paper would be in trouble too. And so would the homebuilders. And so would many others.

Usually, the value of a particular kind of paper goes up during a panic. Bills of immediate maturity — cash — tend to become more valuable. It’s the thing that most people don’t have, and the thing they most need, to pay their bills.

Even gold can go down against cash. It’s cash people need, not gold. But sometimes people’s trust in cash goes down too. That’s when you get a real panic.

That’s what happened in the 1970s. Cash was losing value, thanks largely to over-spending by the government and an excessively long period of negative real interest rates from the Fed.

Believing, like his successor Ben Bernanke, that there is a trade-off between inflation and employment levels, Arthur Burns lent too low for too long.

Again, during the Alan Greenspan era, the Fed lent too much at too low rates for too long.

Ben Bernanke misread the signs completely. He called it the era of ‘Great Moderation’. But the stability he saw was a mirage. EZ money was like a liquor store that made home deliveries.

It kept the problems from appearing in public. Debtors found it almost impossible to sober up. No matter how they mismanaged their affairs, someone would lend them more money.

The gold market realized that trouble was afoot. Investors kept bidding up the price of gold until, once again, they got ahead of themselves.

Now, gold is correcting…

But have the problems that gave rise to the bull market in gold been fixed? Has the level of debt been substantially reduced? Have dead-head institutions been cleaned out and cleaned up? Has the economy that got used to running on EZ credit shaken off the habit?

Is QE really coming to an end?

Probably not.

Regards,

Bill Bonner
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

From the Archives…

The Gold Bull is Dead. Long Live the Gold Bull!
21-06-13 – Greg Canavan

Marc Faber: People With Assets Are All Doomed
20-06-13 – Jason Farrell

The Holden Moment
19-06-13 ­– Greg Canavan  

The Pressure is Building in China’s Economy
18-06-13 – Greg Canavan

3,000 Year Old Logic: Don’t Sell Your Gold
17-06-13 – Byron King

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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BP
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Comment by BP on 29 June 2013:
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Hey, c’mon Bill. Just five months ago, the Big News was that Australia’s housing market wasn’t ‘looking so perky’.
But today, gold’s crashing value is The New Big News(?)

Now, we’d agree that contrarians _need_ to be contrary, but there seems to be some kind of contradiction here…

OK, I’ll put it up elsewhere, if you’d prefer…. with a link. (Wink ;) )

shortchanged
Guest

There has to be SOME reason central banks around the world are buying up gold.
Not to mention the Chinese and Indian people, not known for their lack of forsight with matters golden. The trick is not to panic, but as Basil Fawlty once said, ‘what else is there to do.’
Might have to wait a while though, no quick profits this time around, maybe buy more I would say. Now, where’s that piggy bank, has to be around somewhere.

truth and integrity
Guest
All true Bill. However if you are holding slaughtered gold stocks it’s like a knife in the back “Et tu Brute!” Particularly when we know there is $1 to 2 quadrillion debt obfuscated in the system and the governments and banksters are stealing our money and our hard earned wealth in a feeble attempt to recapitalize the banksters debt. This is how Hitler convinced the people to support him. Is this what we now have in the western banking system? These tyrants in power may have destroyed the system for centuries like the 21st century dark ages that we have… Read more »
BP
Guest

At last Godwin’s Law has been evoked. Had to happen, I guess!~

BP
Guest

The economic logic and mindware propelling gold to $10K/oz (let alone $30K) are stunning in naivety… but good luck with that, TAI…

truth and integrity
Guest

Only if you believe banksters and politicians BP.
1 Inflation has been running at approximately 9% since 1970.
2 Productivity has been negative since 1980.
3 GDP = Income + Expenditure + productivity When I=4%; E=10%; GDP=3% then you have P=-2%.
4 The velocity of money is the lowest on record since 1950.
5 The Baltic dry index is running at about 20% what it has been over the last 2 decades.
6

truth and integrity
Guest
6 $1 to $2 quadrillion of debt will never be able to paid back without hyper inflation or default. The government confiscating peoples wealth by 10% of annual income for 40 years with inflation at 20% might work but unfortunately not many will be employed under this scenario 7 Inflation from 1970 = 4000% 8 Population has doubled 9 Gold annual production is only 1.4% of total gold mined 10 Those holding gold will not relinquish it. 11 It is doubtful the US or UK have any gold 12 Gold is one of the highest valued metals that has and… Read more »
BP
Guest

T&I: “To match inflation gold needs to go up 600% and that puts it on $7500.”

Markets rarely work on the ‘should-be’ principle. The most common mistake made when emotions influence financial decisions is that very ‘if-this-then-that’ argument.

You don’t really believe that truth and integrity are an intrinsic part of modern finance do you?

truth and integrity
Guest

That’s the point BP, that there is no truth or integrity in finance.
The reason of financial catastrophe from 2007 that has been multiplied many times over by printing fiat money is going to be this much worse in the next 2 years.
I don’t know about shoulds and common mistakes, only facts, but watch gold, silver and platinum.

shortchanged
Guest

$10,000 an ounce, T&I, if only, I could buy that house I’ve always wanted. It is said if you beleive in something hard enough, it will come true, so, lets hope Santa’s listening. Truth and Integrity SHOULD be a part of life, any life, once upon a time Officers and Gentlemen would do the ‘right thing’ and pay the price for ‘mistakes or indiscretions’. We are in a another world now BP, mores the pity.

BP
Guest

SC: “It is said if you beleive in something hard enough, it will come true…”

Ah, but would you beLIEve a LIE?

shortchanged
Guest

I’m an honest, naive, country boy BP, and me mum said to listen to all, believe in no one, and keep your hand on your wallet. Wise mum she was, bless her.

BP
Guest

SC’s mum: “… keep your hand on your wallet….”

She may have been telling you to hold on to paper money, SC!~ ;)

shortchanged
Guest

Thats all we had back then, BP, 50 years ago owning gold was a dream.
The days of division, them and us, the haves and have not, when a £1 was 2 days pay. So, mum probably did mean cash, only the rich had sovereigns in their pockets. But yes, I get your point.

BP
Guest
I had read about our generation investing in coins through SMSFs and we’d wondered about adding this asset to our two main sources of income, rentals and cash, SC. Yesterday’s front-page headline in The West Australian dampened our enthusiasm: ‘Coin Dealer’s Collapse Snares Retiree Funds’. It’s claimed that nearly a quarter-billion in coins and banknotes is at risk and that “…some people are believed to have used their entire super funds, or the proceeds of selling their house to fund their purchase…” According to a Perth coin and stamps dealer “… the market was rising 15% on average… but no… Read more »
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