Why Are Gold and Silver Falling?
By - September 17, 2008

On August 11, the price of gold collapsed: down over $30. So did the price of silver, platinum, and palladium. A lot of people are asking why. On my site's page on gold's daily price, I make available a five-day chart of gold's price. On that page, you will find my commentary on gold. Beginning on the 18th of March, and posted on the 19th, I wrote that I believed gold had probably entered a bear market. That call looked as though it was way too premature, since gold's intra-day high had been $1,037 on March 17. In the very early morning of March 17, I ran an article on my site on how to short gold to protect your position in coins. Here is what I posted on my gold price page. If you have visited my page, you should recall this. I think gold has entered a bear market. I posted this article on March 19, 2008: Just for the historical record, here is what I wrote on March 18 and published on March 19.

Gold could fall. I expect it to fall. So, you may pay a price for owning gold coins. I expect to. If you are not willing to pay the price, you should sell all or part of them, or short gold bullion to compensate you for the loss. In short, count the cost. This is a universal rule (Luke 14:28-30). I think the precious metals are a bubble market today. It is ending. Here is a crucial sign that it is ending. India is not buying. When Indians stop buying gold, they must be replaced by new buyers. Who might they be? … One day's move should not be regarded as a definitive turning point — not after a seven-year run. But there are signs that the run is over for now. It is time to think about recession and even price deflation. As I have said for months, the FED is deflating. We should expect prices to follow. Silver and platinum also fell on March 18. They are moving together in lock-step, up and down, yet the economic fundamentals for the three are completely different. So, something is driving them that cuts across individual markets. But what? I think it is the last of Greenspan's bubbles: the commodity bubble. I think the bubble is about to end. But what about oil? Yes, even oil. But the rate of declining prices will be less than with other industrial commodities. I think this will also be true of gold. I believe in the Austrian School's theory of money, including the business cycle. I have written a short book on this. I am not so committed to a position proclaiming the ever-rising price of gold that I am willing to abandon Mises' theory of the boom-bust cycle in order to hold such a position. Gold is ideal for Mises' inflationary crack-up boom, although not as good as a home with a garden in the country and a few thousand gallons of diesel. This is not the crack-up boom. There has to be monetary inflation for a crack-up boom to occur. Today, there isn't any. I was convinced on March 18 that the recession caused by the Federal Reserve's relatively tight money policy would lead to a fall in the price of all commodities, especially the precious metals. I believed that the commodity market was the last of the bubble markets. The real estate market popped in 2006, and had continued downward. I was convinced that the last market of Greenspan's bubble economy was the commodities market. Investors go from market to market, trying to find the next market that is going to boom. This chase proves to be futile. They chase bubble markets; they get killed by bubble markets. I was convinced that commodities were going to fall, and that this was the end of the road for the bubble markets. In July, the commodities market did begin to fall. I think this publicly marked the end of the commodity bubble. One thing could bring it back: war with Iran. – Dr. Gary North

Dominant Social Theme: The Fed giveth and the Fed taketh away.

Free-Market Analysis: We are big fans of Dr. Gary North, and this is an interesting article that we have excerpted above. Dr. North now seems to believe that the best days of the gold (and silver) bull market may be past and that the future holds only gradual deflation. Wow. That's pretty "heavy" as the hippies used to say.

Hm-mm. He may be right. Or maybe not. Here are some arguments against this thesis. (We'll leave aside the war argument which is fairly obvious and not entirely monetary. Besides, he already makes it, and grants it.) Here goes …

1. The commodity bull market is only half done, if that. Commodity bull markets apparently come about (no one has had the last word yet) because too much money has been printed, causing inflation which manifests itself in rising tangible asset prices. A previous commodity bull market in the 1970s lasted over a decade from perhaps 1970-1982. During this time gold rose to about US$850 an ounce and silver to more than US$50 an ounce.

2. There is substantial room for gold and silver prices to move up within the current commodity cycle. You would probably have to double the previous denominations to figure out an analogous market peak for today: US$1600 an ounce for gold and US$100 an ounce for silver. As of today, gold is at about $785 and silver around $11.

3. Commodity cycles tend to elongate within a historical fiat-money environment. This one therefore should probably run longer than the last one. Predicting these things is an art not a science, but as fiat money's corrosion of the economy becomes worse, the imbalances grow greater and the time to work them out grows longer.

4. The Fed and other central banks may not be actively tightening. It is kind of hard to see active and policy-oriented tightening taking place when the American Fed especially is taking over Wall Street firms right and left and providing boatloads of cash to other banks and now insurance entities (today alone, AIG – US$85 Billion) and mortgage entities as well.

5. Current deflation is the result of greatly ballooned prices for certain assets – but not necessarily gold or silver. This is a recognition, as we've pointed out, of the misallocation of resources. The market has recognized this misallocation finally and is in the process of re-allocating those assets properly via deflation. It can be interpreted as central bank tightening but perhaps it is not.

6. The reallocation of assets and structural deflation does not necessarily presage the collapse of metals' prices. The prices of gold and silver are a function of the amount of money that central banks inject into the market over and above what is necessary. Too much, and a bubble is created which inevitably leads to a bust. But it does not necessarily follow that a bust automatically brings with it lower gold and silver prices.

7. Gold and silver prices can feasibly rise even in the face of deflationary pressure. Just because the prices of houses are collapsing and seemingly draining the economy of excess money doesn't mean that gold and silver prices will fall hard, fast or for a long period of time. Remember stagflation? Stagflation implies that the economy is in a recessionary environment while inflation continues and even escalates. Indeed, it is because inflation is a monetary phenomenon that this is possible. Likewise, just because housing prices are collapsing does not mean that the Fed will cease to pursue a loose monetary policy or that other areas of the economy will cease to inflate.

8. Gold and silver prices are likely manipulated and the manipulation must someday cease to be effective. Dr. North believes that precious metals prices are not being manipulated because the prices of other commodities fell when gold and silver fell hard recently. But does this mean that gold and silver have not been manipulated in the recent past, or that the manipulation is not ongoing? After all, the only way the confidence game can continue to support the ongoing fiat monetary system is if propaganda and manipulation occurs on both sides of the mental equation.

9. Money metal price-manipulation indeed may be ongoing. It is difficult to see how, given the shortages faced by the US mint of gold and silver and other announced and unannounced shortages, that the market prices for gold and silver are a fair value of what is happening regarding supply and demand. There are obvious questions about short-selling and central bank manipulation of the precious metal to keep prices down. The motive is clear: Central banks look on gold as a gauge of satisfaction with fiat-money. The higher the price of gold, the more discontent there is with fiat. Central banks, which are manufacturers of fiat, would therefore prefer to keep the price of gold – and silver – repressed.

10. The lack of demand stated in the above excerpt is contradicted in other literature. Here is an excerpt we picked at random from the Web. We could have selected others presenting similar sentiments. "Back at UBS the Bank states that it has seen "unprecedented" gold demand from India, from European consumers and from other Asian clients, that demand is very strong in Turkey and the Middle East and that it should pick up in Italy as of early September as the holiday season draws to a close. UBS is not alone in seeing this interest, with some Indian jewelers having to turn away clients and, with the Wedding and Festival seasons imminent, demand is expected to remain robust for the next few weeks. Diwali (the Festival of Lights, which is a very important Hindu Festival, the largest gift-giving and shopping festival in India and most popular for gold purchases, falls this year on 28th October." (Posted on MineWeb on August 10, 2008).

After Thoughts

As we stated before, we have a soft spot for Dr. Gary North – and "much respect" for such a tireless fighter for free markets. He may well be right in his latest analysis. But we seem, perhaps, to have some differences. Most importantly, we believe the world, and especially the West's economy, is likely more complex than any single index – even one so powerful as a money supply level. Sure, the Fed (other central banks, too) may wish to tighten as a matter of policy, but given the recent financial chaos, that's a bit hard to believe right now. The Fed did leave the rate unchanged yesterday, but that may be because there is so much more bad news to come that the Fed is "keeping its powder dry" rather than beginning a lengthy tightening process.

Of course, both the EU and probably the Fed might like to tighten, but tightening does not have a whole lot to do with rates anyway, which are something of a cosmetic signal. What central banks DO, however, incessantly and for a variety of reasons, is print too much money. They print too much money in the good times and they print too much money in the bad. Occasionally, they print less. But those occasions are fairly few and far between. So the betting here is that the gold and silver bull market still has a ways to run. Perhaps it's taking a breather. Perhaps that breather may last a significant length of time. But forecasting the beginning and end of a bull market is a perilous business. And the expansion or contraction of a given money measure may not tell the whole story. Let's wait and see. We'll buy on the dips.

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