Commentary: No apparent fundamental reason for gold's drop
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Sell first, ask questions later.
That appears to be what gold traders did earlier this week, when their actions caused bullion to suffer a huge decline — falling more than $30 alone on Tuesday.
Consider whether or not there are good fundamental reasons for gold to have fallen so much.
The default explanation, of course, is that bullion's decline somehow traces back to the Japanese earthquake and the ensuing crisis.
But I'm not so sure why.
Consider what is perhaps the most-invoked rationale for investing in gold: It's ability to hedge against worsening inflation. Isn't that rationale even more compelling now than it was before the Japanese earthquake hit last week?
For example, the crisis undoubtedly will lead the Japanese government into spending a lot more money in coming years than previously planned — both in rebuilding the earthquake-ravaged regions, as well as in maintaining the value of the yen in foreign-exchange markets.
In addition, most analysts now seem to agree, the Japanese crisis makes it all but certain that the Federal Reserve in the U.S. will inaugurate yet another round of quantitative easing — QE3 — following the termination of QE2 this coming June 30.
Other things being equal, this should lead to more inflation, not less.
Another oft-cited rationale for investing in gold: It's a hedge against geopolitical uncertainty. But aren't the horrors we're witnessing in Japan a textbook illustration of just that kind of uncertainty?
Indeed, Reuters has reported, premiums for gold bars in Tokyo jumped earlier this week to $1 per ounce, up from zero last week and a discount in the weeks prior to that. That is just what we would expect, given the desire to hedge against uncertainty — and suggests that it's not reduced Japanese demand that is the culprit in gold's recent plunge.
Drops as big as gold's in recent days, especially when unaccompanied by any obvious fundamental reason, often occur when bullish sentiment rises to excessive levels. And, sure enough, bullishness among gold timers rose earlier this month to its highest level in two years.
Unfortunately for gold, bullish sentiment has pulled back only slightly from those overheated levels. This suggests to contrarians that more downside action may be needed to wring enthusiasm out of the gold traders.
Only then can we expect gold to begin responding more straightforwardly to the fundamentals.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.