Gold Prices Crushed

Includes: GLD
by: Zecco

By Paul Quintaro

Gold has been experiencing a notable sell-off in recent weeks, as the price of the precious metal has pulled back from about $1,800 an ounce in mid-November to the high $1,500s just last week.

The reason for gold’s sell-off has been attributed to a variety of things. Commentators have cited everything from the bursting of a bubble in the commodity market, to the political rise of Ron Paul.

On CNBC Monday morning, Jim Cramer cited increasing interest rates in India. India is a major importer of the precious metal, as it is used extensively in Indian cultural customs, particularly marriage ceremonies. If interest rates are dampening the ability of Indians to demand gold, the price may be expected to fall as demand declines.

Yet, perhaps most salient may be the strength of the U.S. dollar and events in the eurozone.

Although the U.S. dollar index traded slightly lower early Monday, the index has been on an upward trend in recent trading sessions, moving from about $78 to just over $80 today—a relatively large increase in terms of currency trading.

Although gold may trade on a variety of vectors, one of the most significant one may be as an alternative currency.

As central banks around the world have increased efforts to boost liquidity, gold prices have tended to rise in turn. After the Federal Reserve implemented the second round of quantitative easing (QE2) last November, gold began its tremendous run, leading some to allege a bubble was forming in the asset.

The recent pullback in the price of gold may represent the bursting of that bubble—if one existed.

Gold supporters may defend the recent pullback as a natural, healthy correction in an otherwise strong bull market.

Ultimately, a play on gold may be a play on inflation, and if inflation is not coming, the attractiveness of gold may diminish.

While central banks have been aggressive in the past, and arguably continue to be so—the recent dollar swap may be evidence of this—markets have not been as shocked by any activity as aggressive as QE2 since late last year.

Operation Twist, while much hyped, has largely been overshadowed by activity in the eurozone.

Although the European Central Bank (ECB) has engaged in limited bond purchases in recent months, ECB policy makers have consistently pledged that these purchases would be limited in nature.

Many may doubt the sincerity of the ECB’s promises, but should the ECB fail to monetize the debt of troubled eurozone nations, the situation could spill over into a major financial crisis.

That crisis could prove massively deflationary and crush the price of gold still further, as gold fell in the wake of the 2008 financial crisis.

Still, if the ECB and other central banks turn to printing in the wake of a European financial calamity, that could support the price of gold and raise it higher still.

At any rate, it remains to be seen whether it is the proper time to increase positions (or establish new ones) in gold after the recent pullback.

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