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Gold Is in Danger of Collapsing

Tuesday, 25 Jan 2011 01:32 PM

During the past two years, celebrities including G. Gordon Liddy and Glenn Beck (as well as numerous financial-market pundits and many other so-called investment experts), have claimed that the price of gold bullion would “soon” soar above $2,000 because of supposedly rising inflationary pressures.

Some of those “experts” have even forecast gold to rise to well above $5,000 because, according to them, the United States will soon enter a period of hyperinflation.

Those pundits and “experts” have regularly cited the massive creation of money by the Federal Reserve from September 2007 to August 2010 as being the catalyst behind an “eventual” huge increase in inflation rates in the United States.

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Largely as a result of those forecasts, a large number of individual investors purchased gold coins and invested in gold exchange-traded funds (ETFs) during the past couple of years, and gold prices rose sharply as those investors continued to bid up gold prices.

As most people know, the price of any good or service is ultimately determined by two simple factors – supply and demand. For example, if the demand for a product rises, but the supply of that good remains constant or declines, the price of that product will rise. Likewise, if the supply of a good rises, but the demand for that product remains constant or declines, the price of that good will decline. (Interestingly, I’ve yet to hear any of the pundits and “experts” mentioned above discuss demand-related factors that can potentially affect inflation and gold prices).

In light of the fact that the supply of U.S. dollars rose dramatically during the past two years as a result of the Fed’s massive printing of dollars to purchase U.S. government securities, many people expected the “price” of the dollar – the exchange-value of the dollar – to collapse.

Instead, the dollar has traded in a volatile sideways pattern against a basket of other major world currencies since the Fed began to substantially increase its purchases of U.S. government securities during September 2008 – since the Fed began to create a substantial amount of new money.

In fact, the value of the U.S. dollar index, which measures the dollar against six other currencies including the euro, pound sterling and Japanese yen, is essentially unchanged from its close of 79.45 on Sept. 30, 2008 to yesterday’s close of 78.05 – it declined a mere 1.8 percent during the period.

That’s not surprising to me, because the foreign demand for U.S. dollars rose sharply during the past two years, as foreign investors increased their purchases of U.S. Treasury securities.

Meanwhile, most of the new money that the Fed created during the past two years hasn't been borrowed and spent. Instead, most of that money is still sitting in bank vaults at the various branches of the Federal Reserve. That’s because few Americans have been in a position to increase their borrowing and spending since the beginning of the most-recent economic recession during December 2007.

In addition, there have been few catalysts for U.S. businesses to increase their borrowing and spending since the onslaught of the 2007 to 2009 economic recession. (Note: In today’s world, money that the Fed creates is actually accounted for by electronic recordings of that money rather than being held in bank vaults).

In light of the fact that during the past few years American households experienced the worst economic downturn since the Great Depression of the 1930s, and that a large percentage of Americans are still unable to secure a full-time job, I expect Americans, in the aggregate, to continue to keep a tight rein on their borrowing and spending for at least the next 18 months.

Additionally, my research and experience suggest that the recent economic downturn will cause many U.S. households to substantially change their borrowing-and-spending habits for many years into the future.

Separately, my experience suggests that if inflation rates at the household level of the U.S. economy were to rise above 3.5 percent, then the Federal Reserve would take actions similar to the measures implemented during the past few months by China, India, Brazil and several other countries in an effort to combat inflationary pressures in those countries. The Fed would reduce the amount of loanable bank funds and raise lending rates in the United States by selling U.S. government securities.

Such an action, if it were to occur, would likely cause American households and businesses to further reduce their borrowing and spending.

Some investors, traders and speculators that purchased gold during the past few years appear to have come to similar conclusions, with those persons reducing their positions in futures contracts on gold bullion during the past seven weeks.

Although there’s a good chance that persons who think they can now purchase gold at a bargain price might bid up the price of gold bullion during the next couple of days, my research suggests that if gold futures were to break down below a major price-support level of around $1,315 that gold prices will collapse. That’s because many people that have unrealized profits in gold would likely sell their positions in gold stocks and gold ETFs in an effort to lock in those profits.

For the reasons mentioned above, I urge you to stop listening to all of the hype about the potential for the United States to enter a period of hyperinflation and for the price of gold bullion to potentially rise to more than $5,000.

And, I remind you that the last time we heard such talk – during the early 1980s – the price of gold bullion declined 65 percent from $850 per troy ounce during January 1980 to $297 per ounce during June 1982, and gold continued to trend lower during the next 17 years.

Note from Moneynews:

If you’d like to learn more about Mr. Frazier's analysis of the financial markets and how to profit from a decline in gold, try a free sample of his investment-advisory service, The ETF Strategist. Click Here to Find Out More.

About the Author: David Frazier
David Frazier is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He also writes two very successful investment newsletters. Discover more by Clicking Here Now.

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During the past two years, celebrities including G. Gordon Liddy and Glenn Beck (as well as numerous financial-market pundits and many other so-called investment experts), have claimed that the price of gold bullion would soon soar above $2,000 because of supposedly...
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