By Alexander Green, Investment U Chief Investment Strategist

Investors worldwide have watched gold take a precipitous plunge in recent weeks. And, for reasons I'll explain, the selling may not be over.

But the longtime gold bulls never change their tune. Here's why...

Ten years ago, I made a strong case for buying gold. I pointed out that the dollar was weakening, inflation was rising, jewelry demand was surging in India and China, there were supply constraints in the industry, and the trend was definitely our friend.

Two years ago, though, I started making the bearish case for gold.

I pointed out that the dollar was likely to rise against the euro and the yen (and it has), inflation was not a problem (and it isn't), supply constraints have been replaced by new mines and more efficient extraction, and the trend was no longer our friend. That's doubly true today.

I've gone to great lengths to explain in recent columns why gold prices are unpredictable in the short term. However, there is one reason to believe the bias is toward more downside ahead: Hedge funds.

Hedging the Hedges

Gold has been under heavy accumulation by hedge funds and other institutional investors over the past several years. After all, gold was rising when stocks and real estate were plunging. It offered excellent diversification and good returns.

But now stocks and real estate are in an uptrend and gold is falling.

Trust me, hedge fund managers are not long-term investors. They are not going to hold or buy gold all the way down. And that is bearish for the metal in the short term, especially if the price continues to fall.

You have to remember that hedge fund managers do not think like mom-and-pop investors.

For instance, my friend and colleague Mark Skousen often asks at financial conferences for a show of hands of the people in the room who own gold. Typically, every hand in the room goes up.

Then he asks the attendees how many of them have ever sold any of their gold. And you know what? Virtually every hand in the room goes down.

Many folks think of gold as their "forever investment."

They bought it as an inflation hedge, a portfolio diversifier and a lifesaver if everything else goes down the tubes. It is their ultimate insurance policy. I don't think they're wrong about that.

But the first question I would ask a sober-minded investor is this: Just how much insurance do you need?

Yes, you need an inflation hedge. But, first off, there are other inflation hedges like real estate and Treasury Inflation-Protected Securities (TIPS).

Also, the world may not go to hell in a hand basket. After all, previous forecasts have been wide of the mark for, oh, the last 3,000 years or so. So while you need an inflation hedge, you also need a deflation hedge (bonds).

And how about a prosperity hedge, like stocks?

Calm Down

I've known a lot of gold bugs over the years, and I've found that many of them have a particular bias. They are absolutely convinced we are going to see the kind of financial collapse that makes the Great Depression look like a stroll in the park. And when that happens, they say, gold is going to soar... perhaps to $5,000 or $10,000 or more.

Is this possible? Absolutely.

Is it probable? Not really.

Why? Because despite the many flaws in our democratic and free-enterprise institutions, capitalism is built on the most durable of foundations: rational self-interest.

I'll also add that the pundits who make these doomish forecasts ? and you know who they are ? are almost without exception the same folks who have been saying these things for not just years but decades. They've been wrong about the sky falling for 10, 20, 30 years or more... and yet they are still gaining converts ? and making good money ? by scaring the pants off of people.

Some perma-bears are quite frank about it in private. "My job," one told me, "is selling gloom and doom to grumpy old men."

Hmm. If you are being sold an Armageddon scenario... and you're feeling glum... and you are a gentleman who has (ahem) reached a certain age, you may want to check your sources. The truth is you may be getting played like a fiddle.

In my view, when someone's investment analysis is wrong for 20 or 30 years, they're not "early." They're wrong.

Good investing,

Alex

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