Is the Gold bubble about to burst?

Recent weakness in the price of gold would be sending a few jitters amongst those hedge funds that have built huge positions in the commodity.

I must confess that through 2009 and 2010 I actively traded gold. At one point I was fortunate enough to capture a $A163 upward move per ounce in the gold price in only 39 days. I would have captured even bigger profits, however, in recent times, my home currency (the Australian dollar) has largely risen with the gold price and taken out $US profits.

Why was I trading gold? Because it was logical to conclude that quantitative easing and sovereign debt problems would be positive for the gold price. Further, I had noticed that both John Paulson and George Soros had been doing significant buying. I have great admiration for both of them.

However, in recent months I have become less convinced that I can make money from trading gold. I unwound my final position in the week commencing January 24.

The gold price is being held up by three factors: sovereign debt issues in Europe, quantitative easing in the US (accompanied by extremely low interest rates) and ETF buying. The third factor (ETF buying) is creating artificial demand for gold that will disappear very quickly once sentiment turns bearish.

In the absence of another European country needing a bail-out (likely candidates Portugal and Spain), the gold price may well weaken further. And it is by no means a certainty that either of those countries will require a bail-out.

I am also not convinced that the $US will depreciate a lot further. It seems to have already done most of the depreciating it is going to do. It’s just my opinion. But if I’m correct, the gold price is not going to get further easy boosts through an even weaker $US.

The other problem is the massive positions in gold that various hedge funds have built up through ETF holdings. Once they sense that they are going to lose significant paper profits they will head for the exits. And they are likely to do this en masse. Individual investors do not want to be holding gold when that day comes. (And I can’t tell you when that day will come – but it will, unless of course you believe that they are going to hold their non-income producing gold forever).

So all I’m saying is be cautious.