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Will Gold Drop Below $800?

NEW YORK ( TheStreet) -- Last weekend I read an interesting article regarding the correlation between gold and inflation. The article, "Gold Could Still Have Further To Fall," by Mark Hulbert was published in the Wall Street Journal and calls for gold to fall into the $700 range.

The idea is based on research done by Campbell Harvey and Claude Erb, in a study called "The Golden Dilemma." According to the study, assuming that inflation doesn't change all that much, gold still has significant downside ahead. Essentially they tied the price of gold to the Consumer Price Index (CPI) and have assigned a long-term price ratio to it.

According to the research, over the long-term gold has a 3.4:1 price ratio to the CPI measurement. Right now, the measurement currently stand at 5.3:1, suggesting that gold would have to go to $780 for the ratio to work its way back down to 3.4.

During the peaks of the gold bull market, the ratio was as high as 11:1 in 1980 and, more recently, 8:1 in 2011.

Of course, gold doesn't necessarily need to decline another $500 per ounce. Inflation could rise as well, driving the ratio lower. Perhaps a combination of the two will eventually get the gold to CPI ratio back to its long-term average.

However, since the world has failed to end, the Federal Reserve has begun to discuss the tapering of its stimulus program and the global economy is still intact albeit rattled, the price of gold does have more than enough reasons to favor the downside.

Many people continue to say gold has likely bottomed at $1,179 per ounce. On June 28 there was a large intra-day rally after the commodity bounced hard off that mark and was able to close slightly above $1,200.

But it could just be a technical oversold bounce. Gold recently had its worst quarter, where it was down 22% in the second quarter of 2013. Off nearly 40% from its highs made just 18 months ago, the yellow metal has yet to see a long-term bottom.
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