Why Gold Will Continue Its Plunge

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Have you been long gold or silver since 2008? If so, you might remember how long it took for quantitative easing, or QE, to sway these precious metals to the upside. 

As the Federal Reserve created more money, you waited and waited for gold to move higher, unconsciously clenching your fists whenever you looked at the ticker, and frantically chasing fantasies of financial freedom in your mind. It was a logical investment, yet nothing transpired. Finally, after about one year, gold and silver gathered momentum, and acted as unstoppable freight trains for years -- only to eventually smash into a steel wall.  

Gold now remains a mystery to many people. But if you look at it from a logical perspective, it’s not difficult to figure out. 

Upcoming gold and silver movement

Even if you’re long and strong SPDR Gold Shares (NYSEMKT: GLD) or iShares Silver Trust (NYSEMKT: SLV), take a moment to step outside the situation and look at it objectively.

The gold trade is more based on fear of upcoming events than actual economic catastrophe. People are confused about precious metals and their potential because they’re anticipating hyperinflation. But the Federal Reserve has been fighting against deflation, not inflation. In a deflationary environment, gold will decline along with almost everything else -- including all commodities, stocks, real estate, gas prices, and food prices. At least the latter two are positives.

Since it’s only a matter of time before the effects of Federal Reserve monetary stimulus wear off, deflation is inevitable. Believe it or not, this is a good thing for the long-term economic picture. Most people want the economy to grow naturally and sustainably. All propping up of markets by artificial stimulus and speculation must come to an end in order to get to that point. As deflation becomes a reality, gold will continue to plunge. 

Important points

Deflation is the key to gold’s downward movement, and that’s why it’s such an important point in this article. For anyone unfamiliar with deflation, it pertains to a decline in demand for goods and services. 

Even if Ben Bernake sees the stock market getting hammered and opts to re-enter the game by announcing more stimulus measures, another important point must be considered. Many companies now cut their employees in order to increase profits, putting their cash toward stock buybacks and dividends instead of hiring. These companies are looking to take care of their shareholders, as opposed to their employees.

If so many companies continue to regard employees as expendable, then how will the consumer strengthen? A resulting decline in consumer demand could lead to deflation and lower commodity prices. 

What’s the solution?

Taking a logical look at the current situation, investors should consider investing in the U.S. dollar. This can be done through PowerShares DB US Dollar Index Bullish (NYSEMKT: UUP), a good option for conservative investors. UUP trades slower than an elderly snail, but it’s great for capital preservation, and it’s an excellent way to play deleveraging and deflation.

If you’re not a believer, simply take a look at how the U.S. dollar traded in late 2008 and early 2009,  the only deflationary environment this country has seen since The Great Depression. The United States Dollar Index, or DXY, reached 90 in early 2009.     


If historical deflationary environments are any indicator, deflation is likely to last for five to 13 years prior to natural economic growth taking place. Therefore, gold is not where you want to be.

However, when this natural economic growth eventually happens, it’s likely to come with a massive amount of inflation. The effects of Bernake’s monetary stimulus programs won’t be felt until there is true economic growth. In that environment, gold and silver will have a good chance to break their record highs. But for now, the U.S. dollar looks to be the safest and wisest investment.  

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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