Worries about inflation caused by the Federal Reserve's printing over $1 trillion a year and the increasing U.S. national debt sent gold soaring from its low of $255.55 an ounce in 2001 to a high of $1911 an ounce last August.
Gold has fallen sharply over the past month and from the beginning of the year to April 24, 2013 by over 14%.
Why Has Gold Fallen So Quickly:
China: China reported this week that it's Gross Domestic Product (GDP) for the first quarter of 2013 slowed to 7.7% from the previous quarter's 7.9%.
Cyprus: The Central Bank of Cyprus, the island nation enduring a banking crisis, has been pressured by the Germans and European Central Bank to sell off much of their gold reserves as part of the bailout agreement. Investors fear that forced sales by Greece, Portugal or Italy could follow over the next two years to help raise cash to finance their bailouts.
Institutional & Hedge Fund Gold Sales: According to the Comex Exchange, there were several huge gold sales early this week with sellers dumping 53,000 gold future contracts each worth 100 ounces of gold. Many of these hedge funds had bought gold on margin with borrowed money and were facing margin calls requiring them to sell quickly to cover their loans.
According to the World Gold Council, the overall gold market is relatively small in that there is only about 170,000 metric tons of gold in the world.
A few very large sales by a Central Bank or a large hedge fund can easily cause prices to drop precipitously, and that is what seems to have happened.
Many analysts believe that "capitulation selling" often marks the bottom or end of the previous downward cycle.
Gold could go lower in the short-term, but (1) the long-term fundamentals for gold remain in place and are still positive, and (2) history has shown that when gold sells off for the wrong reasons, it usually bounces back strongly.
I believe the sell-off appears to be an overreaction to the recent events outlined above.
Gold Needs To Be Viewed As Portfolio Insurance
Gold should be looked at as "portfolio insurance" for the "Black Swan" political and economic risks we can't foresee. I believe all investors should maintain at least a 10% asset allocation of gold in their portfolios.
Like all insurance, it is better to have it than to panic later.
When one looks out at the world you see the IMF and European Central Bank demanding that countries confiscate a percentage of their citizen's money in private bank accounts in order to receive bailouts and one can't help but think that Italy and Spain may be next.
The U.S., Japan and the European Central Banks are printing money at unprecedented amounts that will eventually result in inflation.
There are the problems in North Korea, the Middle East and then there is always the possibility that Israel may bomb Iran's nuclear facilities and that could cause a global energy crisis if the Gulf is closed off to oil shipments.
All of these events could individually be a catalyst for sending gold straight up.
Has gold hit bottom and finally starting to recover? No one knows the answer to that question, but after the capitulation selling of last week, I believe gold (NYSEARCA:GLD) is undervalued and gold mine stocks that are profitable producers located in politically stable countries, are at historic lows compared to the price of gold (GDX, GDXJ).
Disclosure: I am long GLD, GDX, GDXJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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