Is Gold about to Bust?

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The consumer price index, which measures inflation, was out this morning and it was down slightly in April. Here’s what Calculated Risk had to say:

The disinflationary trend continues – and with all the slack in the system (especially the 9.9% unemployment rate), it is hard to see inflation picking up any time soon. The high unemployment rate and low measured inflation suggest the Fed will hold the Fed funds rate at the current level for some time.

That all makes sense to me. Here’s what doesn’t make sense to me.

Price of Gold Past Three Years

So gold did fall today based on the CPI number and the Producer Price Index, which was also down. But my question is why anyone would buy gold at this point, and therefore why gold hasn’t fallen more in price, given its three-year price run up.

Gold is traditionally an inflation hedge. But if there isn’t any inflation just what are investors hedging when they buy gold. David Von Drehle had some answers in a recent piece for TIME.

On survivalist blogs and websites with names like Guns, Grub and Gold, they have a term for what will happen next: TEOTWAWKI, which stands for “the end of the world as we know it.” When that time comes, along with freeze-dried food and water-purification tablets and plenty of ammo, a person is going to need some gold in his camouflage pockets. “Tangibles trump conceptuals” is among the key precepts of leading survivalist author and blogger J.W. Rawles. “Modern fiat currencies are generally accepted but have essentially no backing,” he explains. “Because they are largely a by-product of interest-bearing debt, modern currencies are destined to inflation” and ultimately “to collapse.” Rawles advises investing first in farmland, next in “useful hand tools” and finally in precious metals like gold.

Thus, as global finance has grown ever more complex, gold has become a badge of mistrust in the modern political economy. A stack of gold coins in your gun safe, as an online survivalist put it in an anonymous post, signals that you won’t be caught flat-footed when FEMA opens concentration camps, or when the U.N. imposes the new world order, or when terrorists wipe out the grid, or when the Mayan prophecy comes true, or when Israel attacks Iran and World War III ensues. Gold dealers have clearly figured this out; they advertise heavily on the radio talk shows of such doomsday-minded libertarians as George Noory, Glenn Beck, Alex Jones and G. Gordon Liddy.

The problem with that is that fear alone won’t drive prices for gold for long. Eventually that will get arbitraged out of the system, and the real (lower) price of gold will emerge. The problem is gold doesn’t have any really value. Not many industries use gold. And yes it is nice on jewelry, but there is more than enough gold to go around for necklaces. The real demand for gold comes from investors who are worried about losing their money elsewhere. And since there are a lot of worries right now, gold has been going up. But for me the fundamentals aren’t there.

A number of Wall Streeters seem to be coming to the same conclusion. Fortune has a story up today predicting the gold bust is gaining momentum, which was well-timed for today’s drop. Most of their argument has to do with supply. All these gold parties are contributing to a glut of the metal that will eventually be dumped by dealers. Here’s where some Wall Street analysts predicting where gold is headed:

Barclays Wealth in London predicts gold will fall to a fair value of $800 an ounce by 2012, as investors eventually dump it for riskier trades; Societe Generale, the French bank, in April 2009 predicted $800 gold by the end of 2010, though it has reversed its stance since then. Analyst John Nadler of gold deal Kitco predicts gold will fall to $900 in 2011.

That means gold is due to drop in price anywhere from 33% to 50% from a recent $1200 an ounce. Now that is something for the gold scardey cats should be scared about.