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Gold has taken a beaten lately to put it mildly as it has fallen about $320 per ounce from a high of around $1,920 to approximately $1,600 in a few days time. This is similar to what we saw happen in March 2008 when gold lost about 30% of its value after trading slightly above $1,000 an ounce. Not even 3 years later, gold rallied to reach almost $2,000 an ounce.

The selloff in gold made sense for a number of reasons. First, gold is about 5x less rare than platinum and much less useful yet it closed above the price of platinum on several occasions recently. Second, the only reason gold was going up (as is the case in any market) is due to the fact that more was being bought than sold/mined and put on the market for sale. Emerging market central banks like South Korea, Russia, Thailand, Mexico, China, to name a few, were buying gold (hundreds of tons worth per quarter as Mexico alone bought 98 tons Q2 2011) in an attempt to diversify out of dollars and euro as their reserve currency and into gold. They wanted to get away from dollars as our loose fiscal and monetary policies were causing (and will continue to cause over the long term) the dollar to decline in value. No one wants to hold something that is basically guaranteed to lose value over time. Gold was one of the few places these countries could look for something that whose value wasn’t projected lose significant value over the next few decades.

Unfortunately for gold, the dollar has strengthened despite the fact that it is as worthless as the euro as investors flee the euro in the short term (the European debt crises is front and center, but ours will follow in the years to come). No one really wants to hold dollars, but there is literally nowhere to go for some large investors and central banks. One of the few safe havens, the Swiss franc, is no longer a store of value as they were not large enough to absorb all the market demand for their currency and essentially pegged it to the euro. Finally, the threat of a global slowdown and deflation stemming from Europe helped kill commodity prices as investors anticipate demand will drop during a slowdown or recession. All of these things combined to kill gold.

Despite the short term strength of the dollar, the dollar is still not a good investment or strong currency. Our debt, deficit, and unfunded liabilities make further devaluations of the dollar against other currencies almost certain. We will have to inflate out of our debt eventually and try to weaken the dollar to boost manufacturing, exports, and trade in an effort to increase employment and grow GDP. Gold, as it has for the past decade, will benefit from the dollar’s decline. Gold may fall another 10% here, but don’t be shocked to see it back at $2,000+ in a year or two’s time. $5,000 an ounce gold makes much more sense than $500 an ounce gold over the next 5 to 10 years.

Source: Gold Is Down But Not Out