Why The Sun Is Setting On Gold

Six weeks ago, I wrote a column advising short-term speculators to sell their gold. Since that time, the metal has drifted lower. But the brunt of the decline is likely still ahead. As I’ve said before, gold is difficult to value under the best of circumstances. It pays no interest, has no earnings, provides no rent. What gold will be worth next week or next month is whatever buyers will pay for it at the time. And that, in technical terms, is a guess. I’ve heard gold bugs make their case. Some are based on emotion. Others are based on political fantasies about the Federal Reserve turning us into the Weimar Republic circa 1923, or modern-day Zimbabwe.

What I rarely hear them talking about is pedestrian stuff like supply and demand…

When Buyers Become Sellers, Look Out Below

Billions of dollars have been spent building gold mines over the last few years, so it’s not inconceivable that supply could begin to outstrip demand.

Of course, demand itself is fickle.

In 2005, investors made up just 16% of total demand for gold. Today, it’s more than 40%. Gold ETFs have taken in more than $50 billion since 2004.

What will happen to the price of gold when these buyers become net sellers, as many will when it becomes clear that the party is over? Paulson & Co., a hedge fund, now holds more than $4 billion in the SPDR Gold Trust ETF (NYSE:GLD). I wouldn’t want to be standing in front of his eventual liquidation. And, like most hedge fund managers, Paulson is not a “buy-and-hold” investor.

Some bulls justify buying gold at these levels because it briefly traded at more than $800 an ounce in 1980. And they say if you simply adjust for inflation, gold should be trading at $2,300 today.

That’s weak. Here’s why…

Don’t Be Blinded by the Gold Light

Gold badly underperformed inflation – not to mention stocks, bonds, real estate and burying your money in a hole – for 20 years after 1980. Why is it suddenly destined to catch up now?

Or look at it another way: On August 25, 1999, gold traded at $252.55 an ounce. Adjusting for inflation, gold should be trading at $339.65 an ounce today.

Granted, my starting point is the 30-year-low. But then, a calculation based on the 1980 high is just as arbitrary.

It’s understandable that gold spiked during the 2007-2009 financial crisis. Gold is an excellent barometer of investor anxiety. But that crisis is over. The recession – defined as two straight quarters of negative GDP growth – ended in June 2009. And inflation is running at just 1.2%.

So why is gold still in the stratosphere?

What to Do With Your Gold Holdings Now

Yes, I know the price of food, gasoline, health care and college tuition are all going up much faster than the official inflation rate. But let’s also concede that the price of cars, computers, appliances, electronics, furniture and, not insignificantly, homes – the biggest asset most consumers will ever buy – is coming decidedly down.

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