Rethinking the Bubble in Commodities/Precious Metals

I have talked a bit before on why gold isn't in a bubble, just overbought.  Judging by recent precious metals activity, I still hold my original position but am beginning to reexamine the kind of fundamentals that drive the price of gold.  Now after Bernanke defied most expectations and decided to not expand the monetary base to deal with what seems like a slowing economy, the price of gold and silver fell.  Mish attributed this to a few factors:

Four Reasons for Metals Plunge

1. Fed did far less than expected
2. Mutual fund redemptions
3. Margin calls at hedge funds
4. China growth story fading

Some attributed it to a CME margin hike which now looks like it came too late.  And yet this all falls under the paradigm of the Austrian Business Cycle Theory.  It doesn't take a genius watching Gordon Liddy commercials to realize that central bank money printing drives the price of gold.  The recent financial crisis was met with the Fed injecting trillions into domestic and foreign banks alike.  Take a look at what this did for gold prices:

Now following the dot-cum bust in which Alan Greenspan dropped interest rates to record lows, hence inflating a housing bubble, the monetary base grew:

See a pattern?The Fed has been meeting crises with money printing since the time of Paul Volcker.  This isn't anything new and the market seems to have accepted this notion.  Thus with Bernanke announcing that no new money printing will occur, the market appears to be reacting in a way to say that it expected more money printing.  One can look at the boom in commodities that occurred once QE2 was announced to see the kind of affect Bernanke has on the economy even if the newly created money remains as excess reserves stored at the Fed.  As Peter Cohan of Forbes observed back in May:

After keeping interest rates near 0% for years, the amount of free debt flying around is exceptionally high. And rather than funelling the cash into job-creating businesses, traders have been using the money to buy commodities futures contracts while selling short the dollar.

It is clear that the recent climb in commodity prices and subsequent drop can be attributed to the Fed's low interest rate policies, typical Austrian Business Cycle theory.  While gold may have fallen into this trap for the time being, money printing around the world will resume and the price will once again begin rising.  I plan on elaborating more on this in an article, so stay tuned.

To further illustrate my point, see the latest CNBC interview with Marc Faber:

"Gold is quite oversold and I would consider buying some gold in the next two days... We overshot on the upside when we went over $1,900. We're now close to bottoming at $1,500, and if that doesn't hold it could bottom to between $1,100-$1,200. "Both equity markets and gold markets have become very oversold, and I think a rebound is occurring. Following this rebound, which I expect to get underway this week, there will be a longer slowdown."

Also see John Tamny's article in Forbes today on why gold is a good indicator of the dollar's strength:

Over the last ten years the price of an ounce of gold has risen 595%, and over that same time frame the S&P 500 has gone up a paltry 2.9%. That's right: If investors had purchased a scarce metal with very limited industrial uses ten years ago they would have wildly outperformed an index loaded with America's most promising companies.
The last ten years are not unique. In the 1970s gold rose 1,355%, while the S&P essentially went flat over the same decade with a return of 16%. Conversely, in the 1980s gold fell 52% and the S&P zoomed upward by 222%. In the 1990s gold's decline continued by 29% and the S&P roared, up 314% for the decade.
Gold is a great predictor of our economic health because as the most constant, objective measure of value in existence, its price is the single best measure of the value of the most important price in the world: the U.S. dollar. Put simply, a fall in the price of gold signals a strengthening dollar, and a rise in the yellow metal signals a weakening one.

I will end with some comic relief, check out this ballsy trader talking about the Euro crisis:

"The collapse is coming...and Goldman Sachs rules the world."

This guy is never gonna appear on television again, he is spilling too many beans.  For a brief summary of the Euro crisis, see this chart: