At What Moment Does Gold Suddenly Become Too Illiquid?

by: Streetwise Blog

By Tim Kiladze

There is a lot of irrationality in the markets these days. But if there’s one investment that should be going up, it’s gold. At least if you buy into what the gold bugs say.

Gold has been touted as the ultimate investment because it is a "store of value." Scared that the markets will stay sour? Gold is bound to keep going up as volatility rises, the gold bugs pronounce. So now that markets are tumbling, why is gold on its steepest three-day slide since February, 1983?

The main narrative disseminated by economists and market watchers is that people are flocking to cash as panic spreads across Europe. To get cash, they need to sell their gold holdings.

“It shows you that at times of extreme stress, there is not a suitable substitute to liquidity and although gold is liquid by metal standards, in comparison to Treasurys, when you get this kind of flight to cash, then it really is cash that counts and that means U.S. dollars,” Credit Suisse analyst Tom Kendall told Reuters.

The point is valid, but it also makes no mention of profit-making. It has been well documented that in recent years gold has been traded as an investment opportunity, rather than a store of value. So while retail investors where buying into the long-term strategy, big hedge funds and commodity traders were simply waiting for gold to hit a breaking point, just as they waited for metals such as silver to hit a breaking point back in April. As soon as one fund starts to sell, many more do.

As a reporter, you get inundated with people trying to tell you that gold is going to the moon. And the people who pitch this story are never satisfied until you jump on board their rocket ship.

But it’s situations like this that prove, yet again, that gold isn’t the ultimate safe play. It also demonstrates why some people say they never want to touch gold, because they don’t understand how or why it moves.

If you buy the liquid asset story, at what moment does gold suddenly become too illiquid, forcing everyone to run to cash?