Gold's Deflation Fear Trade Is Over ... for Now

 | Feb 20, 2013 | 6:00 PM EST
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Gold broke down below $1600 per ounce this morning and is trading at about $1,581 as I write. The last time I discussed gold was last December when it broke below $1,700 in the column Gold Primed for a Another Fall.

This column is essentially an extension and update to the issues discussed in that column and I suggest reading it in conjunction with this one. 

In general the trend I discussed in December is continuing. The speculators who had been moving into gold on expectations that investors would continue to buy for fear of losses in other asset classes and deflation in the economy have accelerated the reversal of that position as the economy has stabilized and other asset classes, especially stocks, performed very well. 

This most current move is most probably indicative as well of the beginning of the fear driven investors themselves beginning to become less fearful. 

As these investors withdraw support though economic activity is still far too weak for investors or speculators to begin to buy in anticipation or fear of imminent inflation. 

The result is that gold has no natural market support from either fear and thus no reason for speculators to try to game those fears and cause exaggerated moves in price.

Spot gold prices have now declined by about 16.5% from the peak almost 18 months ago and are approaching the next level of support in the $1,500 to $1,550 range. 

If that level is broken the next level of based on volume of transactions is in the $1,000 to $1,100 range. 

I know that may still sound outrageous, although perhaps less so than when I discussed it a few months ago. What speculators and investors should be mindful of now and watchful for is a recurrence of the 1975 to 1976 pattern for gold prices at almost exactly one tenth the nominal price points of the current era.

Gold prices peaked at $185.25 on Feb. 24, 1975 and then began a steady and spectacular grind lower to $103.50 on Aug. 25, 1976; a loss of 44% in 18 months. 

It did immediately reverse from that bottom though and begin an accelerating rate of price increases only briefly interrupted by short term corrections over the next three years before peaking at $850 on Jan. 21, 1980. 

But backing up for a minute, after gold tanked in 1976 it didn't get back to the previous high of $185.25 until March 7, 1978; three years after the decline began.

In another column I will address the similarities and differences between the economic events of the early 1970s and the monetary policies followed versus what is happening today. The punch line though is that there are more similarities than not.

For now the immediate issue for investors to watch for is the support in the $1,500 range. As I wrote last December though that support is weak and I expect that a decline to the $1,000 to $1,100 range is more probable than not.     

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