Gold fall herald fears of deflation

The sudden plunge in price of gold was a surprise development last week. Just a week ago, it has been trading around $1,700 with bull traders predicting a crossing of the $2,000 mark by year end. However, it dropped nearly $150 last week, a decrease of 8%. A few factors could go to explain some, if not most of the drop.

The general explanation is that the doom and gloom scenario in Europe is affecting global sentiments. China is looking softer. Emerging countries are growing more slowly. Overall there is less demand for commodities.

Gold has been ‘overbought’ for quite a while and is due for a significant correction as i have mentioned in my previous post. On a technical basis, it has witness a double top with prices stalling around the $1,900 region. Some investors might have been looking to pocket their profits.

The rise of the US dollar which is noted as a safe haven currency, could be another reason why gold prices are weakening since global money tended to flow in one of two directions: US treasury bills or gold. Gold has been especially attractive as a hedge against inflation, a scenario deemed especially likely due to huge government debt and deficits around the world. With low interest rate, concerns that cheap money might inflate the prices of assets are especially real. However the fall in gold prices might be telling us that fear is now switching away from the inflation camp to that of deflation. In a world of deflation, cash is king and gold becomes both expensive to hold and likely to lose value.

We are in the camp whereby we believed that deflation is a greater concern than that of inflation despite the Fed ‘money-printing’stance. Hence, we do believe a fall in gold prices significantly is a real likelihood. Gold price plunging just shows the volatility and unpredictability that 2012 will herald.

The most important factor to global uncertainty is not so much of Europe sovereign debt concern nor US fiscal deficit problems but that of a major slowdown in China. manufacturing output has dropped sharply and its property bubble is bursting. China might have averted a major slowdown in 2008 through massive government spending. Can it repeat that in the current impending slowdown?

What will happen in Europe? Is the Euro breakup imminent?

The third puzzle is that of the US. It is showing some positive sign from recent unemployment claims. However, the high unemployment rate is still a worrying sign. This coupled with political impediment to its current fiscal problems still shows significant headwind for the world major economy. 2012 will definitely be an interesting and volatile year.

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