Gold and Velocity

After the price of gold fell off a cliff last week, the metal continues to look weak for the short term.  It was down significantly again today after bouncing up yesterday.  Silver has taken an even bigger beating than gold, showing us all why it is better to have the majority of your core holdings in gold.

I would not be surprised to see the metals fall a little further still.  We have to look at it all in context though.  The price of gold has been up every year for the last 10 years.  It is still up significantly for this calendar year.  It was hitting new all-time nominal highs and it should not be surprising that there has been a big pullback.

The current environment looks ripe for another recession, or a continuation of the recession depending on how you look at it.  The Fed has pumped in all of this money in the last 3 years and we still see relatively small price inflation.  The banks have piled up this money as excess reserves and the American people remain fearful (and rightly so).

Since the American people have been more conservative with their money, it has kept velocity low.  There is no actual way to measure velocity, but it seems that there is a high demand for dollars due to fear and uncertainty.  Since money is changing hands less frequently, it counteracts a large portion of the Fed’s loose monetary policy.  In other words, the low velocity keeps a lid on price inflation, along with the massive excess reserves.

When there is fear and a looming threat of recession, people tend to flock to the American dollar.  For a while there, people were flocking to gold.  I expect people will return to gold, but the short term is more questionable.

As far as your investments go, you should maintain a buy and hold strategy of gold and gold related investments for your permanent portfolio.  If your investment portfolio does not include at least 20% in gold and gold related investments, then this is a great time to accumulate more.  If you are a short-term speculator with gold, then good luck because I have no idea what you should do right now.

Don’t let the latest fall in the precious metals scare you.  It is going to be a roller coaster ride.  Nothing goes straight up.  There will continue to be run-ups and corrections.  The low velocity of money may keep things down for a while, but I expect the Fed to start QE3 if things start to look too gloomy.