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.
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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 - roughly, the decade of the '70s - gold ran from around $40 to over $800. This was one of the great 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. In the event, the correction took nearly half of the gain away...before the bull market recommenced.
Let's see. Gold began this bull market at a bit under $300. It rose to $1,900. That's a gain of $1,600. 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 ways 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. But for thousands of years, gold has been not the only kind of money...but only the best kind. When other kinds fail, gold is still in business. It is the ultimate money.
Some wealth is held in the form of tangible things. Other is represented by paper - bonds, notes, bills, stocks, IOUs, etc. When an economy is growing it is becoming 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, some time in the future, for real goods and services.
When trust in the system slips, so do prices for the pieces of paper. Investors begin to wonder about the people on the other side of the trade. 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, it is called a "panic," which 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 2008-2009 sell-off. When investors realized that subprime mortgage holders couldn't pay, they began to wonder who else couldn't pay. Surely, the banks that held billions 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 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 '70s. Cash was losing value, thanks largely to over-spending by the government and excessively low lending rates from the Fed. Arthur Burns had lent too low for too long.
Again, during the Alan Greenspan era, the Fed lent too at too low rates for too long. Ben Bernanke misread the signs completely. Bernanke called it the era of "Great Moderation." But the stability he saw was a mirage. EZ money functioned 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. It kept bidding up the price of gold until, once again, speculators had gotten 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?
More to come...
Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.