Gold prices have fluctuated wildly in the last week as jittery investors reacted to the meltdown in the financial markets and the government’s bailout proposals. Ed Bugos says gold’s fundamentals remain strong, however. He says the recent correction was a mistake by the market and that the outlook for rising inflation and a tumbling dollar makes a strong case for gold. Ed says investors should take advantage of short-term price dips to buy the shiny metal on the cheap.

The ink had hardly dried on the U.S. Treasury’s socialization of Fannie (NYSE:FNM) and Freddie (NYSE:FRE), and thus half of the U.S. mortgage market, when it realized it would have to reconvene over whether Lehman (NYSE:LEH) was too big to fail the following weekend. Apparently, it was not, and so began the filing of the largest bankruptcy in U.S. history.

Then the dominoes really began to fall. Merrill Lynch  was taken out, and then speculation turned on AIG, Goldman (NYSE:GS), Morgan Stanley (NYSE:MS) and many others. The Treasury ended up taking control of AIG, but not before giving rise to fears about the exposure of “safe” assets, like money market funds, to Lehman or AIG or whatever failing counterparty might be guaranteeing this or that in your portfolio.

The events reminded investors that there is nowhere to hide, except, perhaps, in the one asset that is “no one else’s liability” — gold. The government is grabbing at straws. The Federal Reserve’s balance sheet is wearing so thin that the Treasury is raising money for it on Wall Street now. Talk about wash trades. It is not just the U.S. markets. Loan markets are stressed all over the world. Russian markets froze. The Chinese central bank cut rates and its government kicked off a plan to start buying stocks for its sovereign wealth fund to stem the bearish tide.

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Despite fluctuations in expectations, the fundamentals have remained bullish for gold. The events have generally confirmed gold bulls’ warnings, and all but guarantee future inflation.

Evidence of soaring demand in the physical space has been oft reported throughout the correction.

The amount of contracts closed on futures exchanges dwarfs the real ounces liquidated by the bullion trusts in this time. On the COMEX alone the amount of contracts outstanding shrank by 10 million oz, compared with just two million ounces for the streetTracks GLD bullion trust.

Stay the Course

This move in gold does not look like a bear market rally. It looks real. In fact, it suggests that the decline through $850 last month was a mistake…that the market was wrong, as we suspected. That is, the market was wrong to think the bust was over, that central banks were capable of any kind of “tightening” or that the problems for the dollar have passed.

My general suggestion is to buy the dips and corrections. Don’t chase the breakouts. The reason is that it is not yet a slam-dunk that the Fed will inflate. We have to adopt a wait-and-see attitude.

Source: Bear Patrol