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Can Gold hold $600? Today is a benchmark day for gold as traders have been counting on a crisis in Iran to maintain the fear premium (approximately $100) that has been slowly working its way out of the commodity since it peaked at $730 on May 12th.

This fear premium, skillfully maintained by oil traders as they pump their little commodity for all its worth, has been undeservedly bestowed upon gold, even though there is no threat to the gold supply.

The fact of the matter is there is simply too much gold coming out of the ground and if speculators stop snapping it up, we will move quickly into a glut.

World Gold Council reports show that supply hit 1,045 tons in Q4, 15% more than in Q3, while demand decreased from 891 to 850 tons. Much like the USO ETF (NYSEARCA:USO), had it not been for the StreetTracks Gold (NYSEARCA:GLD) and similar funds, which took possession of over 158 tons of gold in Q4 alone, close to 300 tons of unwanted gold would be finding its way onto the spot market.

Jewelry demand is down to 590 tons, the lowest since 2003 when gold was fetching just $350. Jewelry accounts for 71% of total global demand for gold! This is why strong GDP data trumped falling interest rates to give gold a small boost today — there are not enough speculators to support a lack of consumer interest.

As we expected, according to the AEMQ report, central banks liquidated 662 tons of gold in 2005, taking advantage of inflated prices to rebalance their holdings.

2005 scrap recovery hit a record, and this trend continued as gold climbed in Q1-06, but in the first quarter, supply was artificially reduced as miners used excess production to reduce hedged positions. A reverse of this process (more hedging) could drive supply suddenly up.

In Q1-O6 speculators snapped up 196 tons of gold at record prices, a situation that did not abate until mid-May, close to the end of the second quarter. While miners attempted to cut back production, 305 tons of scrap metal were turned-in during Q1 alone, forcing the central banks to cut their selling by 50% in order to maintain market prices. The CBs have until September 26th before their sales quota resets, and then it may be game-on for gold bears!

According to the Quebec Mineral Exploration Association's President:

"As soon as central banks start selling again and speculators take their profits, we think that we will see a strong correction. Demand from the fabrication sector is very weak and the high price will surely help producers develop new mines or extend their actual reserves so that the supply of gold will increase during the next quarters. Will speculators be able to absorb all these surpluses? We don't think so."

That's coming from a mining group!

The entire CRB index is down 10% from May 11th on a really ugly chart, and it is really gold, nickel and copper that are supporting a much greater downturn.

Reuters/Jeffries $CRB Index Daily Chart

With the BHP Billiton (NYSE:BHP) strike winding down, gold could find itself caught in a sector sell-off that could move quite rapidly. In their latest newsletter, StreetTracks states that open futures contracts dropped from a peak of 50.5M ounces in May to just 37.4M ounces in July. The exchange credits a slew of short covering in June for keeping the price from eroding below the $542 low it hit on June 14th.

With no such cushion available on this round, gold has the potential to go into freefall if it breaks below support at $590.

According to the very people who sell you the contracts it is, "hardly surprising — investment and speculative activity are dominating the physical market, which is traditionally quiet in the Northern hemisphere summer months."

Gold ETF demand has climbed 70% over 2005 levels while demand for bars, coins and other gold products is up just 3%. Someone is on the wrong side of this game by a factor of 20!

So far, it looks like the speculators may have it wrong, with futures interest dropping 20% in 2 months and jewelry demand down 28% from last year. Ignore the 3 week spike over $650 in July, and 20% gets you neatly down to $510 — pretty much exactly the $100 terror premium down from here.

While we can't expect the entire fear factor to evaporate overnight, the danger is that the speculators lose their nerve and start selling, or that central banks engage in a little dumping while the price is relatively high, or that $600 ruins demand during Asia's peak buying season (now).

Too many negatives weigh on this market. We made a nice in and out play shorting Newmont Mining (NYSE:NEM) this week, and we may take it again if silver or copper initiate a sell-off. The 10 year note dropped to 4.76% today, and that will be very painful for those who look to gold as an inflation hedge.

Let's keep an eye out for the end of this little "crisis" with Iran, but if we maintain cooler heads while the next round of bagholders bid gold up, we may find ourselves with a very nice short opportunity!

Source: Gold - Don't Be Left Holding the Bag