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Gold No Longer a Safe Haven

Justin Wade
Friday, 21 Oct 2011 | 10:24 AM ET

With gold hitting a two-week low yesterday, reaching $1,607.06 in mid-day trading, maybe it's time to revisit a traditional argument on where it's headed. In August, FINRA issued a warning to investors to be on the lookout for gold scams. This was a prescient signal of the metal's recent weakness, the underlying causes of which may render it incapable of playing its traditional role as a fear indicator for the remainder of this period of tumult in the markets.

Although gold has always fundamentally been the ultimate bubble because it does not generate cash flow, the bubble within the bubble may have finally popped. Interest from unsophisticated retail investors, the target of these scams FINRA was warning about, were a huge contributor to gold's run-up to over $2,000 per ounce. While the majority of retail gold investors were not scammed, per se, FINRA's warning served as a signal that retail investors had reached critical mass in their purchasing of gold. If it's not a given that the presence of retail investors increases volatility, here's a recent paper on the topic (Foucault el al.).

The irony of retail investors piling into gold is that they're not only fearful of the markets in general, they're fearful of losses regardless of the asset class, including gold. They don't view gold as a flight to safety, but rather as a means to capital appreciation. At the first sign weakness, many of these investors would have grown disillusioned and bailed, as many more are apt to do once their anxiety level over the future price of gold reaches a point of intolerance. Gold will not act as a reliable hedge against inflation until most retail investors dump their holdings of it, which will drive the price lower and cause nearly all of them to feel as if they were scammed.

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