The Savage Truth on Money by Terry Savage

Gold has plunged $175 an ounce in the past two trading sessions, falling into severe bear market territory and closing late Monday around $1,357 an ounce. What happened?

Traders would tell you that the avalanche was initiated when huge and aggressive selling was triggered by the central bank of Cypress needing to raise cash and acknowledging it was thinking of selling its store of gold.

Margin clerks would confirm that additional selling piled on when speculators needed to raise cash to maintain their futures positions. Hedge funds might have been similarly leveraged, and forced to dump their positions in bullion and gold mining stocks.

Mutual funds likely also became sellers to raise cash for shareholder redemptions.

Chartists will tell you that it was obvious all along that lower prices were to be expected as a result of the recent trading pattern of lower highs and the inability of gold bullion prices to break out to the upside on the tepid rallies of recent weeks.

And fundamental analysts point to signs of slowing global growth, especially in China, taking some of the froth out of the global economy — and diminishing the need for gold as a hedge against inflation.

Whatever the reason, or combination of reasons, when a market panic happens, it is never wise to judge whether prices have gone "too low" or "low enough." As is often repeated on Wall Street: "Never try to catch a falling knife."

Where, and when, will it all end? That's impossible to say. Just as gold can soar based on popular opinion, it can — and has — lost its luster for many years at a time. That happened between 1980 and 2000 — when gold plunged from $850 an ounce to just over $200 an ounce. And it lingered at those low levels until just a decade ago. In 2003, gold was still below $400 an ounce.

It's worth noting that a major change in fundamentals kept gold prices low for those two decades.

First, Fed Chairman Paul Volcker promised to stamp out inflation by raising interest rates until the prime rate hit 21.5 percent and the economy plunged into recession. Then the United States committed itself to sensible tax and monetary policy, leading to a balanced budget. And finally we had huge growth in productivity brought on by the tech revolution.

Only when those sound fundamentals changed in 2003 did gold start its ascent — which moved slowly at first. But as it became apparent that the government was creating one asset bubble after another, gold prices took off. And after 2007, as government financed banking system rescues with newly created credit (TARP, etc.), courtesy of the Federal Reserve, gold prices soared to over $1,900 an ounce in August 2011.

In fact, the incredible increase in the U.S. "monetary base" has been the fundamental reason given for the increase in the price of gold that took place in recent years. Those fundamentals haven't changed. The Fed is still creating $85 billion a month out of thin air.

And the Japanese central bank has joined the party — promising to create more of its currency to devalue the yen, and make its exports appear less expensive to the rest of the world. Plus, it's quite clear that the European Central Bank will also be creating more credit to bail out the troubled nations — and potentially banks — of the weaker members of the European Union.

So one day, and at some price, the smart money will remember that countries can print (or electronically create) all the paper money and credit they want. But they can't create gold. And that's The Savage Truth.

Terry Savage is a registered investment adviser and is on the board of the Chicago Mercantile Exchange. She appears weekly on WMAQ-Channel 5's 4:30 p.m. newscast, and can be reached at www.terrysavage.com. She is the author of the new book, "The New Savage Number: How Much Money Do You Really Need to Retire?" To find out more about Terry Savage and read her past columns, visit the Creators Syndicate Web page at www.creators.com.

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