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Why Gold Is Crashing

NEW YORK ( TheStreet) -- If you want to understand the recent fundamental and technical catalysts that have sent gold prices crashing you need to read my article entitled Gold Is Entering Its Liquidation Phase. However, if you want to understand the deeper underlying cause of this ongoing crash in gold prices, continue reading here.

The Framework

Economists that follow the so-called "Austrian School" of economics are fond of saying that the causes of a crash in asset prices are to be found not in the indicators that are coincident to the crash (as those are mere symptoms and not root causes).

The root cause of a crash in asset prices is actually to be found in the factors that led to the exorbitant rise in asset prices that preceded it.

And while many analysts of the Austrian persuasion may not necessarily feel all warm and fuzzy having their own well-worn analytical insight applied to the yellow metal they tend to be so fond of, it probably provides the best general conceptual framework for understanding what is happening right now in the gold market.

The root cause of the current ongoing crash in gold prices is to be found in the factors that led to the exorbitant rise in gold prices that preceded the crash.

The Cause of the Parabolic Rise in Gold Prices

The explanation for why gold prices went parabolic between 2004 and 2011 can be spelled out in exactly three letters: E-T-F.

Roughly $150 billion flowed into the gold market via Gold ETFs such as SPDR Gold Shares (GLD), PowerShares DB Gold (DGL), ProShares Ultra Gold (UGL) and Direxion Daily Gold Miners Bull 3X Shrs (NUGT) between 2004 and 2011.

This phenomenon of ETF purchases of physical gold has been the #1 key to the rise in the price of gold since 2004. Without the advent of ETFs -- a.k.a. "paper gold" -- the parabolic rise in the price of the yellow metal would never have occurred as it did.
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NUGT $103.26 -8.50%
DGL $42.05 -0.26%
GDXJ $36.77 -3.10%
GDX $24.64 -3.00%
UGL $42.97 -0.51%


Chart of I:DJI
DOW 17,750.91 -140.25 -0.78%
S&P 500 2,063.37 -18.06 -0.87%
NASDAQ 4,763.2240 -54.37 -1.13%

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