I was asked by a reader if there was anything that would make me sell gold. Yea, I’d sell if I thought the secular uptrend in gold had changed or if gold stocks became vastly overpriced relative to not only where the metal was but also where it could go in the near future. This is exactly what happened to most gold stocks in 2003 when I sold them all after having ridden them up since 2000. I don’t use leverage in my long only portfolios, so while I may trade around during a decline like this to try and limit losses, I can’t be carried out. So John Maynard Keynes' quote of the markets staying irrational longer than anyone can stay solvent doesn’t really apply to me. As the market recovers (and it will, just like it did last year from its July-August panic), I’ll still be here and will have been able to add to my positions at absolutely fantastic prices.

It’s probably going unnoticed by most, but even with spot gold plunging below $800 overnight, the gold shares indices (AMEX Gold Mines Index (GDM), AMEX Gold Bugs (HUI), etc) aren’t making new lows like the metal has. That’s a positive divergence. It also indicates that all of the leveraged guys have been blown out of the stocks at this point. The metal obviously still had some levered guys in it apparently, which may or may not be now finally cleaned out. Hence, gold traded the way it did last night as margin clerks effectively took over and the December futures actually traded at a momentary discount to spot due to the intense level of selling in the paper gold market. One thing is for sure though; any leverage that existed in the precious metals is going to be washed out completely as a result of this decline.

Meanwhile, the disparity between the physical market for gold and silver and the paper market in the futures continues to widen, as physical demand for gold and silver continues to explode. Many US dealers are apparently out of inventory, and pandemonium continues to break out overseas to buy the dip.

Also note, commodity cargo fees increased the most since January 30th last night in Asia. The Baltic Dry Index advanced 323 points, or 4.6 percent, to 7,420 yesterday on speculation Chinese demand for raw materials will increase after the Olympics.

Shipping rates are climbing while commodity sellers puke? How long can that last? Five trading days now remain until the Olympics end. The lack of Chinese buying over the past month in the commodity complex due to shutting down for the Olympics (to clear the air) has had a huge impact on demand for commodities, and anybody leveraged in them is now being cleaned out as a result. When China returns to the buy side, it’s going to have a huge impact on prices, especially in light of the declines that have occurred over the past 4 weeks, which incidentally also play right into the hands of the Chinese buyers. Neat, huh?

Corrections in bull markets happen. Sometimes you see them, sometimes you don’t. This one has certainly gone a lot further than I ever could have imagined, but then again, I don’t think the perfect storm of the Chinese exiting the commodity markets in mid-July plus coordinated intervention to support the dollar, plus the SEC changing the rules on short selling and the unwind that it would cause were a very predictable combination (nor the chain reaction it would trigger as guys unwound positions that were correctly aligned with the fundamentals: short financials/long inflation).

It is what it is, but as long as the Fed is forced to keep real interest rates negative in order to prop up the crippled U.S. banking system and U.S. economy then global inflation is going to continue to accelerate (especially if foreign central banks begin to ease as well), and that’s bullish for gold. As I have said repeatedly since last August, if the Fed and other central banks want to keep the financial system functioning in the wake of the housing bust, their only option is to inflate, period. That’s what they have done, and that’s what they will continue to do (no matter what they might “say” to the contrary). That’s the long-term trend to keep your eye on.