Gold gets slaughtered as deflation fears arise

By Alix Steel

Gold prices sank Monday with investors opting for cash as the congressional supercommittee failed to deliver and deflation fears jumped to the foreground.

Gold (-GC) for December delivery tanked $46.50 to settle at $1,678.60 an ounce at the Comex division of the New York Mercantile Exchange. Gold traded as high as $1,727.40 and as low as $1,670.50 an ounce while the spot price was losing $50, according to Kitco's gold index.

Silver (-SI) shed $1.30 to finish at $31.12 an ounce while the U.S. dollar index was up 0.4% at $78.30.

Gold prices were in free fall Monday as budget talks in the U.S. broke down and as borrowing costs for Spain soared. A new conservative government led by prime minister Mariano Rajoy wasn't helping alleviate Spain's 10-year borrowing costs, which were climbing to more than 6.5%. The euro was falling against the dollar, which was pressuring gold by making the dollar-backed metal more expensive to buy in other currencies.

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Gold also plummeted past the key support level of $1,680 an ounce with options expiring on Tuesday, which can trigger a lot of rebalancing and more volatility.

"It looks like the $1,680 area is the biggest open interest," said Stephen Eubanks, director of institutional sales trading at Mr. TopStep. "I don't think that there is any time where you can say it won't be volatile . . . you need a seat belt to trade this stuff." The gold ETF, SPDR Gold Shares (GLD), however, actually added 4 tons on Friday, which signals that a lot of the downward pressure on gold is coming from the futures market.

Further complicating matters for gold is the reality that the U.S. debt super committee, charged with slashing $1.2 trillion from the deficit over the next 10 years, most likely has failed. The Dow Jones Industrial Average ($INDU) was down more than 300 points and investors were dumping gold for cash, fleeing to the perceived safety of the U.S. dollar.

There are worries that a failure to reach an agreement might open the door for another downgrade of the U.S.'s credit rating, as Standard & Poor's cited dysfunction in Washington as a main reason for its negative outlook. During the week after S&P issued its first-ever downgrade of the U.S. at the beginning of August, gold rallied almost 5% on haven buying, but for now the need for cash is winning out.

"It's viewed as a safe haven as a dollar-denominated asset," said Eubanks, "but it doesn't mean it can't go down." Eubanks said there are a lot of investors and traders in the market looking for an upside move, which means they might be the first to bail out when prices tank.

Jim Cramer, on the flip side, wrote that now is the time to stay invested in gold and to be buying. "Yes, it is true that a severe recession in Europe is bad for gold, but we had one here and how did gold do? It went up, not down," he wrote.

Investors dumping gold for cash signals that deflation is more a concern than inflation. Investors fear that the European Central Bank won't be the lender of last resort, that Europe will slip into a recession and that automatic deficit cuts in the U.S. along with the expiration of the payroll tax cut and unemployment benefits will also trigger a recession. Societe Generale wrote that losing stimulus could shave 1 to 1.5 full percentage points off of growth in 2012 and that automatic spending cuts could reduce growth by half of a percentage point in 2013.

With dismal growth forecasts, gold is less attractive to own. However, David Morgan, founder of Silver-Investor.com,​ said he sees a rally starting in the first quarter of 2012 as inflation winds up trumping deflation.

"I am pretty convinced that this is going to be an inflationary bailout and that we are going to have to get back into the market in all sectors," Morgan said.

In the meantime, he is bullish on gold unless prices break below the $1,550 level, and thinks that gold will find some meaningful buying in the $1,600 area as gold bulls buy at "discount" prices.

Gold mining stocks were getting pummeled with broader equities Monday. Barrick Gold (ABX) was sinking 2% to $47.88 while Newmont Mining (NEM) was down 0.8% at $64.91. Goldcorp (GG) was falling 2.3% to $49.40 and Randgold Resources (GOLD) was tumbling 4.3% to $106.21.