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The Frightening Spike in the Price of Gold

The price of gold has been hanging near its historic highs, selling for more than $1,000 per ounce. In times of crisis -- the terrorist attacks of Sept. 11, 2001, the collapse of Bear Stearns in spring 2008 -- gold has spiked, as fearful investors grabbed for something they could hold onto.

But that's not the case today. The U.S. is technically out of its Great Recession, Fed Chairman Ben Bernanke recently said. New jobless claims unexpectedly fell last week. The stock markets are riding a 50 percent rally since March. And yet, gold keeps going up.

That means a growing number of investors, traders -- and, most troublingly, foreign governments -- don't believe in the strength of the U.S. dollar, analysts warn. People buy gold when there's fear.

"It's not the fear of an event of some sort," such as a terrorist attack, said Peter Boockvar, equity strategist at Miller Tabak, whom I spoke to this week. "It's the fear that the piece of paper in your pocket you call money will devalue over time."

To stave off a liquidity crisis last year, Bernanke's Fed turned on the money spigot, flooding the system -- and world -- with dollars. In the short term, that helped avert a second Great Depression. But in the long term, with each new dollar introduced into the system, each dollar you hold becomes worth less. That's more than just inflation, which we think of as simply rising prices. That's debasement of not only our currency, but the globe's reserve currency. And that makes countries like China -- which holds the greatest percentage of U.S. debt -- very nervous.

"It amazes me that any self-respecting central banker is not alarmed that gold is over $1,000 and the dollar is trading at all-time record lows," Boockvar said.

Let's back up here for a minute and consider gold itself. It's a complicated metal, and people buy it for a lot of reasons that have nothing to do with what it's worth.

Gold is a commodity, just like soy beans or wheat. But soy beans have no romance, no feeling of permanence, no surprising heft when you lift them. Spanish conquistadors did not pursue the New World's soy. There was never a James Bond villain called Wheatfinger. Gold is freighted with more meaning, really, than value.

People who want something to pass down to their grandchildren, for instance, buy gold coins.

People who want to diversify their investments buy gold.

People who fear inflation buy gold as a hedge.

But when foreign nations that hold billions of dollars in U.S. debt start buying gold because they fear the value of the dollar will go down, that's when the rising price of gold becomes more than a novelty.

The massive economies of China and India, as well as several emerging economies, are increasingly hoarding gold, said Michael Dudas, gold analyst at Jefferies Asset Management, whom I spoke to this week.

The argument shared by China and by other investors who have been loaning money to the U.S. during this crisis is simple, Dudas said: "They're looking at us and saying, 'If you keep printing too much money, what you owe me is not worth as much.' "

In periods of intense crisis, it's probably best not to use a gold price spike as a barometer, as people do not act rationally in a crisis. But in non-panic situations, such as the one we're in now, gold is a more useful barometer. And here are two readings from the barometer: The U.S. Mint has actually sold out of gold products in the past year. More importantly, non-commercial net long positions on gold are at an all-time high, the Commodities Futures Trading Commission said recently. Translation: Investors think the price of gold will continue to rise.

You can buy gold in a couple of different ways. You can buy jewelry or gold coins or actual gold bullion and store it in a physical location -- a safety deposit box, buried in your back yard, hidden under your bed. But that kind of gold is heavy and hard to move, which limits your use of it. For instance, there was $104 million worth of gold bars in vaults below the World Trade center, which could not be recovered until several weeks after the 9/11 terrorist attacks.

Physical gold is mostly for hoarders, and that's one kind of gold-lover: the person who fears the monetary system will break down one day, either from calamity or chaos, and paper money and wealth will become worthless. Some of the more extreme of these folk foresee a barter economy as an inevitability.

Most investors, however, buy gold through gold certificates, or in exchange-traded funds (ETFs), or buy options on gold, which let you trade the precious metal with the ease of stocks but theoretically with the security of gold. These investors tend to be less apocalyptic in their thinking but still like the idea of something that will hold its value simply because of its physical nature and scarcity, like diamonds or expensive art.

But there's a dichotomy at the heart of gold: Even though there is a finite amount of it that has been mined and is still buried in the earth, there is a massive oversupply of the metal.

Only 158,000 metric tons of gold have been mined in all of history, the World Gold Council estimates, 65 percent of which has been mined since 1950. Production is currently down and analysts expect it to remain flat for years to come, owing to the absence of major finds in recent years. (Consider the "rushes" of 1848 in California and 1886 in South Africa.)

About 3,000 metric tons of gold are produced each year, through mining and scrapping (melting old gold into new).

The world's central banks, such as the Federal Reserve, hold about 20 percent of the world's above-ground stock of gold, or about 30,000 metric tones. Here's where the massive oversupply kicks in: If the central banks decided to sell their gold, it would flood the market with a 10 to 1 supply to demand. And that would crater the price of gold. (The European central banks have been slowly selling their gold since the adoption of the euro.)

So that's something to keep in mind if you're thinking about becoming a gold investor: Unlike many other commodities, whose value depends on how much is farmed (soy beans) or drilled (oil), the value of gold is largely dependent on how much of what already exists is put into circulation. So there's an extra influence on supply and demand. (It's true that oil cartels "park" tankers full of oil to drive up the price per barrel. But nowhere near 20 percent of the world's supply. Further, there's a lot more oil in the world than gold, with massive new finds popping up frequently.)

Industrial production -- gold used in spacecraft and semiconductors, for instance -- accounts for only about 10 percent of all annual gold use. So if you're buying gold thinking a lot more of it is going to be used in the future to build things, that'd be reaching.

If, however, you want to buy gold because you're worried about the fate of the dollar, then you're in smart -- and worried -- company.

-- Frank Ahrens
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By Frank Ahrens  |  September 24, 2009; 12:27 PM ET
Categories:  The Ticker  | Tags: Fed, Federal Reserve, gold  
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Don't assume that a second Great Depression has been averted yet. We have a slight uptick thanks to government spending programs like Cash for Clunkers and the tax break on mortgages, but many other economic indicators are very bad. Unemployment is still very high. Much of the stock market rally has come on the trading of stocks from Fannie, Freddie, and a few large banks, but the solvency of many of these is still questionable. The FDIC is lining up $500 billion in loans to help cover anticipated bank failures in the coming year, and the lack of faith in the dollar is disturbing. If China and others begin to pull back from the dollar, the dollar will plummet even more than it already has. While this will help exports, America imports more than it exports, so the net effect will be chilling on the economy. The stock market rally over the last few months, too, may be largely a sham created by Fed policy. The Fed made money available to loan for cheap, but most individuals and businesses were too skittish to take the money. Instead, much of that "liquidity" injected into the credit market was grabbed up by hedge funds and investment firms, who took the cheap loans and dump the money back into stocks. Yes, stocks have rallied, but on borrowed money that does not actually reflect investor confidence.

In other words, what we have now may be a last-gasp bubble created by the Fed's and Treasury's bailout policies, and not a true recovery. The coming year will tell, but it is entirely possible that any positive signs now are a blip on what may prove a long decline. If this is the case, then those betting in gold right now are doing so with good reason, and the dollar's recent declines against other currencies already justifies the move to gold. Especially if China begins to move to drop significant portions of its dollar holdings, then being invested in commodities or more stable foreign currencies will be the only way to survive.

Posted by: blert | September 24, 2009 2:49 PM | Report abuse

People see the endless printing of money and thus the soaring debt!!!! That's why.

Posted by: Jimbo77 | September 24, 2009 2:51 PM | Report abuse

Why I don't believe a word Bernanke says:

Posted by: robparisblog | September 24, 2009 3:06 PM | Report abuse

when and what was known publicly at the time

September 24, 2009 by JaxMax

1. Team Obama issues an illegal gag order through HHS (Sebelius) against Humana Insurance company for daring to criticize ObamaCare.

Prior restraint without a wimper from the Media.

This is the beginning of overt destruction of the First Amendment through Govt action.

The Republicans stood tall and denounced this from the floor of the Senate.

The Media were a profile in cowardice.

Team Obama is desperate to achieve the totalitarian Govt control over individual Americans only Govt Healthcare can provide.

2. Team Obama has now surrendered the US Dollar as the world reserve currency as they are ignorant of the horrific effect on the US economy.

Geithner surrendered publicly before the CFR just after he was confirmed. Gold will soar as disgust and contempt for Obama Dollars will grow.

3. Team Obama appoints numerous Czars who are not subject to Senate confirmation and who are derelict rogues accountable only to Obama.

4. Police in Los Angeles have to hide their identity in gang raids. Illegal immingration and lawlessness in CA reach third world levels like Mexico in which police are masked for their protection.

Team Obama takes no action to secure the border as Napolitano is inept, incompetent and incoherent.

5. Israel needs to take action against Iran nuke threat soon.

Iran "lost" their sole AWAC this week. Must just be a bad coincidence for the Iranians........

5. Team Obama backed off the criminal persecution (not prosecution) of Robert Lay in Pensacola Florida for praying before he ate.

Mr. Lay, the Principal was acquitted of criminal contempt on September 17, 2009 in Pensacola Florida in a case widely watched in the Christian community and therefore ignored in the Wash Po and NYT.

Christians could still worship publicly as of September 2009 under the Obama Administration.

Posted by: JaxMax | September 24, 2009 3:42 PM | Report abuse

Well, I've read a lot of reactionary stupidity in my life. So I would classify this article as mere hor5e5hit that can be found in any field - in comparison to high grade bull5hit, which is actually quite rare.

For starters, the writer omits the relevant benefits of inflation - old, dollar denominated, debt becomes much cheaper to pay off. And wages typically spike up during inflation.

The writer also ignores the FACT that the CPI is actually DROPPING year-over-year which would indicate DEFLATION and not inflation.

But hey, ignore the facts at your peril and keep buying overpriced gold.

Let me know how that works out for you scaredy cats.

Posted by: Heerman532 | September 24, 2009 3:48 PM | Report abuse

Remember what happened in the depression:

1929: crash

early 1930: stock market up by 50%

late 1930: stock market down 50%

The next great depression has not been averted. Spin, which is all what this year's "recovery" is, can only go so far.

The next crash will come within 5 months. Mark my words

Posted by: JOlsson1 | September 24, 2009 3:51 PM | Report abuse

By the sound of Heerman532, a true stock market bull. How did that work out for you in 2008?

Posted by: JOlsson1 | September 24, 2009 3:55 PM | Report abuse

Do I understand this correctly: Investors are buying gold at near historic high prices because they fear devaluation of the dollar, while the Federal Reserve and other central banks could decimate the market price of that gold by selling off part of their gold reserves? This is called investing? If the central banks did that would it strengthen the dollar or simply cheapen gold?

Posted by: filmlab | September 24, 2009 4:37 PM | Report abuse

The article is a sound one except for the last caveat about the central banks selling their gold. History shows all fiat currencies go to zero eventually. The central banks need to hold gold because in times of crisis, it is the only accepted international currency. They need to hold gold because it gives them legitimacy.

Let the central banks sell all their gold. The private market will MOP IT UP. Then we can be rid of Bernanke and his crooks for good.

Posted by: badkid | September 24, 2009 4:41 PM | Report abuse

@jax max, you really know how to stink up a place.

Posted by: lostinthemiddle | September 24, 2009 4:42 PM | Report abuse

It's the Carter era redux.

Posted by: EvreeMan | September 24, 2009 4:46 PM | Report abuse

Gold futures = Apocalypse with TiVo.

The only thing Wall St. seems to have learned from the Great Depression is that there were unconfirmed reports of fatalities elsewhere.

Posted by: gannon_dick | September 24, 2009 4:48 PM | Report abuse

It was my understanding that the bailout was not financed by the creation of newly created (and thus value deflated) dollars. I have only read that the money is borrowed. Borrowed money has to be repaid. Increasing the M1, M2, or M3 by flooding the economy with newly created (though inflated) dollars devalues the gold, however if only borrowed existing dollars are introduced to stimulate waht is called the "velocity" of capital flow, then ther should not be this effect on the price of gold.

Posted by: tharriso | September 24, 2009 5:26 PM | Report abuse

Sorry, was interrupted during my writing. Post should have read:

It was my understanding that the bailout was not financed by the introduction of newly created (and thus value deflated) dollars. I have only read that the money is borrowed. Borrowed money has to be repaid. Increasing the M1, M2, or M3 by flooding the economy with newly created (though inflated) dollars drives up the value of gold, however if only borrowed existing dollars are introduced to stimulate what is called the "velocity" of capital flow, then there should not be the stated effect on the price of gold.

Posted by: tharriso | September 24, 2009 5:32 PM | Report abuse

Only the media (with a few exceptions) believes the contrived baloney spewed forth by The Annointed One and his minions. And just because Bernanke says it's so, doesn't mean it is.

It's the debt, stupid!

Posted by: JAH3 | September 24, 2009 6:12 PM | Report abuse

$1,000 an ounce for gold hardly qualifies as a "spike." In the hyperinflation of the early 1980s gold rose to over $800 an ounce in then-current dollars. Think of $2,500 an ounce now.

Posted by: AppDev | September 24, 2009 6:14 PM | Report abuse

AppDev Wrote: $1,000 an ounce for gold hardly qualifies as a "spike." In the hyperinflation of the early 1980s gold rose to over $800 an ounce in then-current dollars. Think of $2,500 an ounce now.

Find something to hang on to, AppDev! The ride has just begun.

Posted by: JAH3 | September 24, 2009 6:20 PM | Report abuse

Will be happy to exchange a $2,000/oz 30-day put with anyone willing to put money where mouth now is.

Posted by: AppDev | September 24, 2009 6:27 PM | Report abuse

Gold is not the great investment it is marketed to be. Over the past 50 years, the average return on investment has averaged a tad over 4%. And history reveals that when an economy fails, gold is not used. Rather, a black market barter system crops up, where people trade something that can be used for some other basic item or service. Maybe a skill or article of clothing, tank of gas, even food. The day is coming, in the not too distant future, when you will see people throw their money (including gold) into the streets due to it's lack of value. Those who put their trust in material possessions will be miserably disappointed.

Posted by: dales_mail | September 24, 2009 6:46 PM | Report abuse

What is the definition of a peak? When the greatest number of fools think it has to keep going! What is a bottom? When "everybody" thinks it's going to get worse!

It's probably way too late to buy into the gold rally. Owning international stocks will hedge your dollar risk.

Posted by: rwolf01 | September 24, 2009 6:50 PM | Report abuse

Or...the reason for recent higher price of gold could be that old Wall street favorite, the pump and dump.

Posted by: rkerg | September 24, 2009 7:10 PM | Report abuse

In response to dales_mail comment above I can cite at least two historic first person accounts from the Civil War that contradict your statement. Here is one - During the last months of the Civil War when confederate $$ were not being accepted - gold and silver *were* accepted as payment. In fact General Longstreet proposes to R.E. Lee that gold be seized because it is the *only* way left to pay for the war... - the public being reluctant to accept paper money because of its perceived worthlessness.

Posted by: hnsbro | September 24, 2009 8:29 PM | Report abuse

i think we all need to pray. the dollar falls, the stock market falls, gold stock falls, all you have left of value is a handfull of gold and silver coins. i dont think they will last long, then what? i hope everyone is wrong and we come out of these uncertain times. like i said, pray before you go to sleep. we have to have something to believe in.

Posted by: dshare | September 25, 2009 8:59 AM | Report abuse

"But in the long term, with each new dollar introduced into the system, each dollar you hold becomes worth less. That's more than just inflation, which we think of as simply rising prices."

While this is true, the writer doesnt mention a much more powerful creator and destructor of money, CREDIT. With fractional reserve lending, many dollars are created with every loan made. And those dollars are destroyed when credit is defaulted on. This is what is happening now with every mortgage default, credit card default, etc..

Also, tho the Treasury and the Fed have released money into the system, if it doesnt have the multiplier effect of loans being issued, it wont lead to much if any inflation. The number of loans being made is way down. Until credit defaults go back to historical averages, and the amount of money lended does the same, inflation is not coming knocking. And I dont see the current situation changing very soon.

Posted by: apeirond | September 28, 2009 11:58 AM | Report abuse

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