As you probably already know, gold suffered a historic collapse this week.
As surprising as it may sound, this could actually be good news for commodity investors.
But I am not about to tell you to enter into the gold market now that prices have fallen. I actually still think we haven't seen the last of this gold selloff.
But there is a silver lining. I'll discuss this more in a second. First, let's hash out why gold fell so much...
Gold had already sunk below $1,500 per ounce in a 5% rout last Friday, but the selling really intensified at the opening bell on Monday. The metal was in a near free-fall for much of the day, losing more than $30 in a matter of minutes as big institutional investors exited in droves. By the end of the day, it had retreated another 9% to close all the way back at $1,360 per ounce.
This was the steepest two-day decline in more than 30 years.
So what triggered this stampede? Actually, it was a perfect storm of negative factors that all collided with freakish simultaneity.
Here are the five main culprits:
1. A key gauge of wholesale prices registered a sharp drop on Friday, quashing expectations that inflation was gaining steam (rising inflation boosts demand for hard assets like gold).
2. Retail sales and other economic data strengthened the U.S. dollar, exacerbating the exodus from gold (which typically moves inversely to the dollar).
3. After acting as a commodities tailwind for much of the past two years, the Federal Reserve's quantitative easing program looks to be winding down. Traders are reacting to the possible end of the Fed's powerful monetary stimulus.
4. China disappointed the market by posting an underwhelming 7.7% growth rate in first quarter GDP. Analysts were expecting growth to accelerate to 8%.
5. The cash-strapped country of Cyprus is being asked to sell $525 million worth of gold bullion to pay down debts, and concerns are growing that other weak European nations might also have to dump their holdings to raise funds or satisfy bailout requirements.
That's a remarkable confluence of events. Moreover, these developments run counter to the same bullish arguments that had propelled gold to a peak above $1,900 per ounce.
Central banks around the world had been hoarding gold by the ton -- now they're selling.
The Fed's loose monetary policies have been a major ally for gold investors -- now they're tapering off.
Retail investors had been flooding gold ETFs with billions in cash inflows -- now they're making withdrawals.
The SPDR Gold Trust (GLD) had to sell 22 metric tons just last Friday to meet redemptions.
Hedge funds and other institutional investors have started to head for the exits. There are unconfirmed reports that one large Wall Street brokerage unloaded 4 million ounces in early morning trading Monday, which may be what sparked the panicked selloff. And once it started, the falling prices triggered margin calls, which led to more selling as positions liquidated.
Prices stabilized somewhat Wednesday, but they're still at a dicey point. This sudden pullback from above $1,600 to below $1,400 could turn out to be a buying opportunity. But the factors that caused the sell-off aren't going away anytime soon. And if the status quo remains, this 12-year streak of uninterrupted gains may come to an end in 2013.
So what does this mean?
During the run-up, I exposed myself to gold only sparingly in my Scarcity & Real Wealth portfolio. Before selling two gold stocks this week [New Gold (NGD) and NovaGold Resources (NG)], gold miners represented just 3.2% of my portfolio assets.
It's not that I dislike gold. In fact, I'm still holding on to one gold miner, Goldcorp (GG), which has the strongest balance sheet and most visible growth trajectory of the bunch. I simply favor more useful commodities underpinned by demand and not just speculation. And now that the speculators are running away, there's little support for gold prices right now.
To be sure, gold will always be coveted as long as governments pursue reckless policies that devalue paper currency. But unless and until inflation picks up, I will have limited exposure.
The silver lining?
Along with gold's fall, other commodity groups have been hammered despite solid (and in many cases improving) fundamentals. Platinum, aluminum, oil, grains and other resources have been unfairly punished and could snap back sharply once the panic subsides.
And with ballooning government debt and the Federal Reserve printing more and more money every day, it's important for investors to have exposure to real, tangible assets like oil and natural gas.
Risks to consider: Of course, commodities are volatile... and any number of events can send prices down (or up). But by investing in solid producers that are pulling important, yet dwindling, materials out of the ground, investors maximize their potential to get huge returns from these tangible assets.
Action to Take --> Indiscriminate sell-offs like this week's create truly exceptional buying opportunities -- so I'm keeping some cash on the sideline while I search for the best entry point.
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