By Jonathan Chen
Normally when stocks are getting crushed, as they are today, gold is a safe haven.
Right now, however, gold is plunging, down another $50 an ounce today,hovering just above $1,800 an ounce.
This begs the question - why?
There are two schools of thought on this. One is that investors are beginning to see that the problems around the world are not as bad as they have been made out to be, and risky assets should be seeing inflows soon. Most, if not a vast majority, are not in this school, as Europe did not just suddenly solve its problems. Just look at Greece.
It is barely hanging on by a thread, but most likely will default by the end of the year, if not sooner. The yield on Greek 1 year debt is over 100%, and there is little chance that this situation can sustain itself for more than a few weeks. Prime Minister George Papandreou claims the country will not default, but given its economic state, very few believe him.
So if this is the case, and Europe is still a financial disaster, then why is gold plunging?
The other school of thought is a recession is around the corner, or perhaps something even worse. Depression, or the big "d" word is being thrown around.
All the economic signs are there for gold to go higher, perhaps as high as $2,000 an ounce by the end of the month as some have claimed.
However, if the situation in Europe is worse then many are letting on, including members of the European Central Bank, Angela Merkel and Nicolas Sarkozy, there may a situation like we had in 2008. Every asset, including precious metals, and other commodities, were sold at fire-sale prices, as investors tried to get whatever they could for them. Oil was sold down to $30/per barrel, and the S&P fell as low as 666. If you look at this chart, gold was also a victim of the asset sales. Gold peaked around $1000 an ounce early in 2008, then along with every other asset class, fell 20% from these highs.
If and when Greece topples over and defaults, it is going to be catastrophic. How catastrophic it will be has not been determined yet. Some have said it could be as bad as Lehman Bros., while others think it may be like Bear Stearns. If this happens, no asset class is safe, and gold could be subject to sharp sell off, as hedge funds, and other institutional investors will sell anything to lock in a profit.
Right now, there is a rumor going around that China may come in and save Italy. It is no secret that China and Europe are joined at the hip, with a significant amount of Chinese goods being shipped to Europe. If Europe collapses, China goes down with it, as does gold. Everything is inter-connected now.
Traders should keep an eye on the spot price of gold, and forget all of the surrounding noise.
- Add to SPDR Gold Trust ETF (NYSEARCA:GLD) and PowerShares DB Gold Double Long ETN (NYSEARCA:DGP) if you believe gold is just in a small correction.
Traders who believe that gold is selling off for far more ominous reasons may consider alternate positions:
- If we begin to see gold really sell off, that could be signaling everyone is moving to cash, for fear of another recession, or perhaps even a depression. In this case, short gold, shorting the above mentioned securities.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.