Warning: gold price can still fall significantly

March 21st, 2007

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If you share the same conviction as us on the wisdom of accumulating gold (see What should be your fundamental reason for accumulating gold?), you may feel the impetus of wanting to do so as soon as possible. While we cannot advise you on your individual circumstances regarding gold, we feel that we have to at least let you know that it is very much possible for gold to fall significantly in price in the short term.

As we said before in What should be your fundamental reason for accumulating gold?, our reason for accumulating gold is not due to the higher future ?price? we believe it can fetch in terms of fiat money. The point is that gold will function as money when there is an ultimate loss of confidence in fiat money as it always do so historically. Thus, we believe that in the long run, it will not make much of a difference regardless of our timing in procuring gold?as long as we do so before the masses decide to make a desperate grab for it as a result of the loss of confidence in fiat money.

However, in the short term, gold prices can rise or fall according to the whims and fancies of the market. In fact, it may even fall in price. That alone does not invalidate the fundamental reason for accumulating gold. To understand why, we will have to recap our earlier article, Inflation or deflation first?:

Now, faced with the threat of a deflationary recession, what can the Fed do? Politically, it is impossible for them to allow a recession run its full course in order to clean up the prior excesses of the bubble. They will do anything and everything to ?prevent? another recession. The only way for them to do that is to do what they always did?pump even more liquidity into the economy (a.k.a ?print? money)… The effect will be the ultimate loss of confidence in paper money.

Gold will prove its value when people lose complete confidence in fiat money, which is manifested as hyperinflation. Hyperinflation can only occur as a result of disproportionate monetary inflation (i.e. excessive printing of money). The only reason why the Fed will want to print a great quantity of money (Ben Bernanke had already said that the Fed will fight deflation by printing money) is because that is the only method it knows for maintaining solvency in the financial system due to a dangerous contraction of liquidity i.e. deflation (see Spectre of deflation).

When the inevitable liquidity contraction occurs, gold price will fall as well. On that day, we will be ready to swoop in with cash to buy even more gold.