Friday, November 19, 2010

$1,420 Gold: Headed for a Crash?

This month, November 2010, saw the nominal price of gold blast itself into the record books with a historic new high of $1,420 per ounce, almost triple the price a decade ago. It's been a remarkable run. Too good to be true?

Before gold bugs get too giddy, it's worth remembering that this year also marks another anniversary, the 141st, of the darkest day ever in American gold trading: Black Friday (September 24) 1869, when the notorious corner by Jay Gould and Jim Fisk climaxed in a spectacular crash that crippled Wall Street for months, bankrupting thousands, freezing the national economy, and spewing scandal to the very door of the White House. It caused an estimated $100 million in financial value to vanish in a wink, worth multiple billions in modern money.

Here's a sketch of the floor of the New York Gold Exchange from that day:

Black Friday was not the only great gold market crash in US history. In January 1980, after spiking to $850 per ounce (about $2,100 in modern dollars, still the inflation-adjusted record), gold lost $200 in two days and then lost a few hundred more, sinking to $480, half its peak value. It would take some 30 years to recoup the loss.

Still, 1869's Black Friday was the ugliest, partly because both the price run-up and crash that year stemmed from the unabashed, garish actions two greedy speculators trying to enrich themselves at the expense of everyone else: James Fisk Jr. (below, left, in his ersatz "Admiral" uniform) and Jay Gould (below, right).

Fisk and Gould pulled off their famous gold corner decades before the battery of modern US financial regulators came on the scene: the SEC, CFTC, Federal Reserve, bank overseers, and even industry self-policing groups like FINRA or NFA. Fisk and Gould lost fortunes when the corner collapsed: Even back in 1869, the market was bigger than any two players, though it took the combined weight of the US Treasury announcing emergency gold sales and a pool of big banks dumping gold on the market to break their stranglehold.

Regulators can help, but commodities are notorious for volatility. Just two years ago, for instance, in 2008, we saw the price of a barrel of crude oil drop from nearly $150 in July to less than $34 in December, a whopping 75% loss, part of a sector-wide reversal.

So today, in 2010, with gold prices at record highs, does anyone really think that another crash can't happen? The cause could be any of these: a swing in market sentiment; a new government policy in China, India, or the European Union; a string of good US jobs reports; a decision by the Fed to drop its QE2 ("quantitative easing") plan; the discovery of unexpected new gold deposits in Africa, Asia, or some other faraway place; or most likely a combination.  It could be months or years away -- these things usually come when least expected, when traders are most giddy, with the retail public fully in the game, and when the up-trend is most steep, that is, when greed takes over and the blinders are on.

Then as now, the saying holds: The best medicine for high prices is even more high prices. And for gold in late 2010, the patient has plenty of medicine already on the table.

For more on the 1869 corner, check out my 1988 classic The Gold Ring.

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