Are gold prices dropping for good?

Gold prices have dropped 20 percent since September, and some experts think it's time to give up on the gold market as prices continue to fall. But if another financial crisis hits, investors will once again be clamoring for gold.

A stitch in time…

Okay… We have left 2011 behind. We are rid of it forever. It won’t come back. Never. Not even if the universe lasts a million years, we will never see it again.

Or will we? One of the intriguing discoveries of 2011 came the giant particle accelerator in Switzerland. Those clever scientists set up a race, from Geneva to a finish line in Italy, 730 kilometers away. It was a race of neutrinos against light. Who do you think won?

The smart money was on light. Einstein said it was the fastest thing in the cosmos. Nothing could be faster, he believed. That’s why planets are “light years” from Earth. For example, other scientists discovered a couple of distant planets — many light years away — that were about the right size and the right distance from their star. They could have liquid water…and water-based life. But what we “see” of these planets is already 950 years old. That’s how long it took the light to reach us.

So, if you want to see 2011 again, you could theoretically race ahead of light and watch it all over again. That is, if it were theoretically possible to go faster than light, which it wasn’t…until a few months ago.

When the scientists released their neutrinos in Geneva, the little critters quickly took the lead and then zipped along, beating light to the finish line. Barely. It was a photo finish. And some scientists think the photo was fumbled.

But unless we can hitch a ride on some souped-up neutrinos, 2011 is gone forever.

Will 2012 be better…or worse? We don’t know.

From our point of view, there was nothing wrong with 2011. It did pretty much what it was supposed to do. We are in a Great Correction. The year just ended felt like a Great Correction is supposed to feel. High unemployment. Falling high prices. Financial crises. Stock prices losing ground. What more do you want?

On that last item, The Financial Times adds detail:

“$6.3 trillion wiped off markets in 2011.”

The FT cites a Bloomberg calculation that tells us the global stock markets lost a little more than 12%, dropping to total capitalization of $45 trillion.

While stocks lost 12%, gold rose about 10%. For the 11th year in a row (we’ve lost track) our “sell stocks/buy gold” formula paid off. Between falling stocks and rising gold there’s a spread of 22%. Not bad.

Dear Readers deserve full disclosure. Towards that end, we didn’t make money on both sides of the trade in every single year. Gold went up every year. But stocks didn’t go down every year. Stocks haven’t had a losing year since 2008. That means they were going up…alongside gold…for 2009 and 2010. And it means that selling stocks wasn’t such a hot idea those years. You could have made more money by buying stocks and buying gold.

Still, if you had followed our approach you would have made solid money every year — even when other investors were getting killed. Let’s hope our good luck continues!

But today, we’re writing not about the known knowns of the past but about the unknown knowns of the future. We don’t know where prices are headed in 2012 — and we know it!

Still, we don’t mind taking a guess. And let’s begin with our favorite investment — gold. Apparently, the smart money thinks gold’s run is over.

George Soros, the billionaire who two years ago called [gold] the “ultimate asset bubble,” cut 99 percent of his holdings in the first quarter, Securities and Exchange Commission data show. Hedge fund managers John Paulson, Paul Touradji and Eric Mindich also sold bullion this year. While speculators in New York futures are the least bullish (.MMGCNET) in 31 months, the median estimate in a Bloomberg survey of 44 traders and analysts is for prices to rally as much as 39 percent to $2,140 an ounce in 2012.

The divergence of views is widening after prices declined 19 percent from a record close of $1,900.23 on Sept. 5, or 1 percentage point away from a bear market. As some investors retreated to cash amid a $10 trillion slump in global equity values since May, others bought more metal, taking holdings in exchange-traded products to an all-time high two weeks ago. Bullion’s 8.1 percent gain in 2011 means it’s on track to beat stocks, bonds and the dollar for a second straight year.

“It’s done its job this year of protecting investors,” said Michael Cuggino, 48, who helps manage about $15 billion of assets, including $3 billion in gold, at Permanent Portfolio Funds in San Francisco and correctly predicted in February that prices would keep rising. “Gold has been all over the place. If you bought gold at $1,800 then you aren’t too happy. Some people will get out of gold, but the longer-term investors will remain.”

Dennis Gartman, the economist and author of the Suffolk, Virginia-based Gartman Letter, said Dec. 13 that traders were witnessing the “death of a bull.” He sold the last of his gold the previous day and said Dec. 23 his outlook was neutral. The “megatrend” in bullion is “in all likelihood near the end of the road,” Markus Mezger, co-founder of Zug, Switzerland-based Tiberius Asset Management AG, which manages about $2.5 billion of assets, said in its 2012 outlook report on Dec. 23.

Well, what about it? The smart money thinks gold is washed up. It thinks the bull market in gold is over. The smart money is selling. It’s moving on.

But what about the rest of us? What about those of us who cherish good looks more than brains…virtue more than money…a good drink over a good deed? What do we think?

We don’t remember our bad guesses. But we remember our good ones. And you may recall too that when gold got to $1,900 we thought it had gotten ahead of itself. After all, we’re still in a Great Correction. And as near as we can tell, the correction is intensifying. Prices don’t go up in a correction; they go down. Investors don’t fear inflation; it’s the lack of it that makes them sweat.

Besides, it looked to us like gold was over-priced.

In the 1940s, gold sold for $35 an ounce. A new Buick cost about $750. Without putting too fine a point on it, you could get your new wheels for about 20 ounces of gold.

Today, a new Buick will set you back about $26,000. Divide by $1,550. What do you get? About 16. This tells us that an ounce of gold is worth more today than it was then.

How about oil? In 1940 you could get a gallon of gasoline for about 10 cents. Last week, it was $3.50 cents. An ounce of gold would have bought you 350 gallons in 1940 and 414 gallons today.

Conclusion: gold is not too cheap at $1,500. At $1,900 it was too expensive.

So we warned that gold would go down too. Since then, it’s lost almost 20% of its value.

But we’re looking ahead. And ahead what we see is more of the same…more or less. Gold will eventually shock everyone by rising far above $1,900. When the real crisis hits…the crisis coming in the US bond market…gold will be the money that nobody doesn’t want.

But what we learned in 2011 was that when a Great Correction pinches, the dollar is the salve of choice — not gold. When investors fear losses, they turn to the dollar for protection.

Eventually, when they begin to fear inflation, the gold bugs’ day of glory will be at hand.

In the meantime, we’ll probably see a further correction in the gold price…perhaps down to $1,200. Or, perhaps it will stop at $1,400. We don’t know. And it doesn’t matter. Buy gold on dips; sell stocks on rallies.

This strategy may or may not pay off in 2012; but gold is insurance against financial disaster. And one is coming…

Regards,

Bill Bonner