Here’s what I think. During the third quarter of 2012, gold moved up $200 an ounce when the Fed began hinting that it would soon launch its third round of Quantitative Easing (QE 3). However, when the price of gold didn’t move any higher after QE 3 began in September – and particularly when gold actually began to drift lower even after the monthly size of QE 3 was doubled to $85 billion a month at the end of the year – investors in gold started to become very nervous. QE 3 did produce a big stock market rally and even a pickup in home prices, but the price of gold languished. In fact, in retrospect, it now seems pretty certain that the stock market rally actually sucked money out of gold as many investors took money out of gold ETFs and put it into equities instead.
The failure of gold to surge higher once QE 3 was in full swing dashed expectations and put in place the conditions for the vicious selloff that occurred over the past week. After all, gold had risen more than six times in less than 10 years, from $300 an ounce in 2002 to a high of $1,900 an ounce in late 2011. A great number of speculators with unrealistic expectations of making a fast fortune had jumped onto the golden bandwagon. Gold was ripe for a significant pullback.
A number of investment banks sensed gold’s vulnerability and published sell recommendations – no doubt after having established large short positions for themselves. Then, newspaper began to report last week that the central bank of Cyprus might sell 10 tons of gold to alleviate its banking crisis. That seemed to be the straw that broke the camel’s back. Panic selling took hold. At that stage, it is entirely possible that the Fed, which feels threatened by gold’s rise, gave it a kick on the way down. On Friday April 12th and Monday April 15th, gold experienced its worst 2-day selloff since 1983.
Gold is now 23% off its September high and 28% below its all time high set in late 2011. But it was the suddenness of its plunge over the last week that has so badly stunned the market. Investors large and small have been hit hard. The Financial Times reported that billionaire hedge fund manager John Paulson has personally lost at least $1.5 billion on his investments in gold so far this year.
So, what now? Can the price of gold fall further? It very possibly could. There is a large community of gold investors out there that has had its breath knocked out. Some who bought gold on margin have been or will be forced to sell. Many others, who believed the price of gold could only move higher, now know better. Faith in gold has been dealt a terrible blow. It could take years for confidence to be restored. Therefore, the possibility that the price of gold will fall further cannot be ruled out.
It should not be forgotten, however, that paper money creation on a vast scale is at the core of the government policy response to the global economic crisis. The Fed, the Bank of England and the Bank of Japan are aggressively monetizing government debt. The European Central Bank has made unlimited liquidity available to fund European banks. And many of the other central banks around the world are printing money on a very large scale to manipulate the value of their currencies through foreign exchange reserve accumulation. Unprecedented and worldwide, this central banker bacchanalia seems bound to continue to debase the value of paper money relative to hard assets such as gold and land for as long as it continues – and, as of now at least, there appears to be no end in sight for this paper money printing binge.
In conclusion, here is my opinion about gold as an investment. I believe that most investors should have a broadly diversified portfolio; and that, in most cases, it makes sense to hold gold as part of that portfolio. I believe that the price of gold will eventually move higher again, even though I would not be surprised if it continues to fall in the near term. Keep in mind, I could be wrong about this. No one knows with any degree of certainty what the future holds – not the average guy on the street, not the billionaire hedge fund guy and not me. Every individual’s financial situation is unique and every individual must be responsible for his or her own investment decisions. Gold’s principal flaw is that it does not generate cash flow. Therefore, I personally view gold more as an insurance policy than as a retirement plan. Nevertheless, it is an insurance policy that is – and will remain – part of my investment portfolio. Whether or not it should be part of your investment portfolio is something that you must decide for yourself.
Finally, one word on a different subject: I would like to let everyone in the Rich Dad Community know that I have recorded a two-hour video Course called Capitalism In Crisis: The Global Economic Crisis Explained. It is broken into 15 short lectures and is available on an on-line teaching platform called Udemy. To watch the Course, please click on the following link: