The move in gold was really unprecedented, unless you can remember back to the early 1980’s.  On Friday, April 12, gold went down significantly.  Its drop was approximately 5% in one day.  Then on Monday, April 15, gold fell by its second largest dollar amount ever, in the course of one day.  It was down almost 10%.  It fell about $140 per ounce in one day.

I am seeing a lot of stories on why this happened.  I think it could be any combination of the reasons I see.  One thing about observing the markets is that you can never really be certain on why something goes up or down in price.  Sometimes there are more obvious things like a Fed announcement or seeing a stock go up after its earnings are released.  But it always comes down to buyers and sellers.  It comes down to the number of buyers and sellers and where they are willing to meet on a price.  In the case of gold for these two days, there were apparently more people who wanted to sell than buy.  For the people who really wanted to get out of a long gold position, they had to come down in price.

There were rumors that the government of Cyprus was selling its gold reserves.  Then there were more rumors that other European countries like Italy would eventually have to do the same.

China came in with slightly lower growth than expected, fueling fears of a coming recession there (hence, less demand for gold).

I continue to believe that we will either see a relatively quick recovery in gold or we will see a deep recession.

If we see a recovery in gold, I don’t necessarily think it will happen in the matter of days.  We will probably see some more volatility, including down days.  We may yet see some new lows (for the last couple of years).  But I would expect to see the price going back up in the next few months.  If we hit July and prices are at or below where they are now, then watch out for a recession.

If the U.S. economy does fall back into recession, then it will be really scary for a libertarian who understands economics.  It means that the Fed’s monetary inflation of $85 billion per month ($1 trillion per year) is not enough to juice the economy.  That means that there is some major malinvestment that couldn’t even be propped up for a while longer with massive monetary pumping.

Even scarier is to think of what the Fed will do.  If we hit another deep recession and the official unemployment statistics get worse again, will Bernanke and company up the ante again?  Will they go for $2 trillion per year in monetary stimulus?

In this respect, gold should be a solid investment over the next few years.  We are likely to see higher price inflation expectations or massive monetary inflation by the Fed.  Perhaps we will get higher price inflation and still get more monetary inflation.  If the Fed thinks the economy is that shaky, we can only guess as to what steps it will take.

One last point that I think is important in all of this is that this is a good reminder of why it is important to have cash (or liquidity).  I am an advocate of the permanent portfolio as described in Harry Browne’s book Fail-Safe Investing.  I have suggested little tweaks if you don’t like holding such a high percentage in bonds.  But this huge drop in gold just shows how important it is to have that cash portion.  With gold down in price right now, it is actually a good time to be adding to your gold position.  If you don’t have any cash, then that is difficult to do.  It also serves to help balance out your portfolio to the allocated percentages.

The two big down days for gold were a good reminder that we can’t predict the future and that we must be prepared for all types of scenarios.  While you may think that gold has to go up, other people may have a different view.  You may lose out in the short run.  In order to claim victory in the long run, it is important to stay somewhat diversified.  This includes having cash or cash equivalents.