Why Gold Is Down (But Probably Not Out)

The recent collapse of gold prices is stirring a lot of conspiracy theories. Are the bars in Ft. Knox just painted bricks?

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The constant mystery around gold makes for some great stories, especially when the price is falling, as has generally been the case for the past month. Gold briefly touched $1,900 and has since fallen to around $1,650. Gold investors, having lost a quick 13% amidst the kind of economic uncertainty that should be good for the metal, have a range of theories — many of them of the conspiratorial sort.

One is that there is actually no gold left in Ft. Knox, or that foreigners own what is there. No kidding. Congressman Ron Paul is among those who have asked for a full accounting. Another is that the U.S. will outlaw direct ownership of gold, as it did during the Great Depression. Either theory, if true, would send gold prices lower by flooding the market in the first case and by removing buyers in the second.

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The most persistent conspiracy theory, though, is that the government is manipulating gold lower through the use of derivatives. Why would officials do that? Gold is seen as a hedge against economic uncertainty, which is why many believe the price should be going up right now, not down. Economies are stumbling around the world. We have riots in Greece. We have potential rioters in a growing number of U.S. cities as part of the Occupy Wall Street protests. Soaring gold prices fan these flames because they suggest economic chaos.

Chris Powell of the Gold Anti-Trust Action Committee says that the Fed has long had an interest in controlling gold prices. He writes:

“Central banks recognize that gold is a primary determinant of the value of their own currencies and interest rates. Even future U.S. Treasury Secretary Lawrence Summers, as an economics professor at Harvard, acknowledged as much in an academic study published in 1988. The study, titled ‘Gibson’s Paradox and the Gold Standard,’ implied that governments could grasp their Holy Grail, control of interest rates and bond prices, if only they could get control of the price of gold. … Gold price suppression is conspiracy theory only to those who refuse to examine the documentation.”

Warren Buffett has even sounded off on gold. He doesn’t mention anything about a conspiracy. But he does suggest that the metal is fickle and ordinary folks should stand clear. From a recent CNBC interview:

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side. … It would be worth at today’s market prices about $7 trillion dollars. … For $7 trillion dollars … you could have all the farmland in the United States, you could have about seven Exxon Mobils, and you could have $1 trillion dollars of walking-around money. … If you offered me the choice of looking at some 67 foot cube of gold … call me crazy, but I’ll take the farmland and the Exxon Mobils.”

If the conspiracy theorists are wrong, as seems likely, what is behind the recent tumble? Well, the answer is probably a relatively mundane one: There has been a lot of talk that gold prices had soared to bubble-like levels, so some selling was to be expected, says Erik Strid of Strid Wealth Management. This selling seems to have been fueled by margin calls on some big hedge funds that were both highly leveraged and hit by enormous losses in the stock market, forcing them to raise cash by liquidating gold, where they had a profit.

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Nevertheless, Strid believes the bull market for gold is intact. (And in fact gold has ticked up over the past week.) He notes that the price has yet to surpass the inflation-adjusted 1980 peak of $2,287. “The world is facing severe economic problems,” he says. “Eventually countries will decide that the only way they can solve their problems is to print more currency.” That means inflation, and on that front gold is considered the ultimate hedge.

Personally, I like Buffett’s view. Gold pays no dividends and produces nothing that can be sold for a profit. It just sits there and basks in its scarcity value. That’s worth something, but it’s hard to know how much.

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