04/16/2013 09:16 am ET | Updated Jun 16, 2013

What Happened to Gold?

Gold has plunged $175 an ounce in the past two trading sessions, falling into severe bear market territory and closing late Monday around $1,352 an ounce. What happened?

Traders would tell you that the avalanche was initiated when huge and aggressive selling was triggered by the central bank of Cypress needing to raise cash, and concern that Cyprus was thinking of selling its store of gold.

Margin clerks would confirm that additional selling piled on when speculators needed to raise cash to maintain their futures positions, or were forced to sell. Hedge funds might have been similarly leveraged, and forced to dump their positions in bullion and gold mining stocks.

Mutual funds likely also became sellers of gold stocks to raise cash for shareholder redemptions.

Chartists will tell you that it was obvious all along that lower prices were to be expected as a result of the recent trading pattern of lower highs, and the inability of gold bullion prices to break out to the upside on the tepid rallies of recent weeks.

And fundamental analysts point to signs of slowing global growth, especially in China, taking some of the froth out of the global economy -- and diminishing the need for gold as a hedge against inflation.

Whatever the reason, or combination of reasons, when a market panic happens it is never wise to judge whether prices have gone "too low" or "low enough." As is often repeated on Wall Street: "Never try to catch a falling knife."

Where, and when, will it all end? That's impossible to say. Just as gold can soar based on popular opinion, it can -- and has -- lost its luster for many years at a time. That happened between 1980 and 2000 -- when gold plunged from $850 an ounce to just over $200 an ounce. And it lingered at those low levels until just a decade ago. In 2003, gold was still below $400 an ounce.

It's worth noting that a major change in fundamentals kept gold prices low for those two decades between 1980 and 2000.

First, Fed Chairman Paul Volcker promised to stamp out inflation by raising interest rates until the prime rate hit 21-1/2 percent and the economy plunged into recession. Then the United States committed itself to a sensible tax and monetary policy leading to a balanced budget. And finally we had huge growth in productivity brought on by the tech revolution.

Only when those sound fundamentals changed in 2003, did gold start its ascent -- which moved slowly, at first. But as it became apparent that the government was creating one asset bubble after another, gold prices took off. And after 2007, as government financed banking system rescues with newly created credit (TARP,etc.), courtesy of the Federal Reserve, gold prices soared to over $1,900 an ounce in August, 2011.

In fact, the incredible increase in the U. S "monetary base" has been the fundamental reason given for the increase in the price of gold that took place in recent years. Those fundamentals haven't changed. The Fed is still creating $85 billion a month out of thin air.

And the Japanese central bank has joined the party -- promising to create more of its currency to devalue the yen, and make its exports appear less expensive to the rest of the world. Plus, it's quite clear that the European Central Bank will also be creating more credit to bail out the troubled nations -- and potentially banks -- of the weaker members of the European Union.

There are those who say that the huge drop in gold prices can be blamed on the U.S. government conspiring to sell its gold in order to distract those who view the metal as a hedge against excessive money creation. Why else, they ask, would Goldman Sachs have issued its sell signal on gold last week, if it wasn't already short, and working in concert with the government's massive selling to drive prices down?

Whatever the reasons for the drop, a loss is a loss. And it is no less painful to know that markets are ignoring fundamentals in an irrational plunge. Another lesson of Wall Street: "Markets can stay irrational far longer than you can stay solvent."

One day, and at some price, the smart money will remember that countries can print (or electronically create) all the paper money and credit they want. But they can't create gold. And that's The Savage Truth.