Should Investors Expect a Bailout if the Gold Bubble Bursts?

Wells Fargo (NYSE:WFC) is warning investors that the gold (NYSE:GLD) bubble is about to burst and big hedge fund managers are taking their profits. When the gold bubble bursts, will the government bail out the losers? That depends on who is president when it happens.

Gold (NYSE:GLD) has certainly done better than stocks over the last decade. For example, gold futures have risen 26% in 2011, following 10 straight annual gains, according to Bloomberg. And gold’s price peaked at a record  $1,817.60 an ounce on Aug. 11. In the last decade, the S&P 500 (NYSE:SPY) has lost 7% of its value.

But this has not stopped Wells Fargo’s (NYSE:WFC) Dean Junkans from sounding the alarm bell about how it’s time to get out. As he told Bloomberg, “There could be substantial risk to gold once the fear that the world is coming to an end subsides. We are worried about the downward risk.”

For more analysis on our support levels and ranges for gold and silver, consider a free 14-day trial to our acclaimed Gold & Silver Investment Newsletter.

The hedge fund honchos are mixed in their views. George Soros and Eric Mindich cut their holdings in the SPDR Gold Trust (NYSE:GLD), an exchange-traded fund, in the second quarter as prices rallied. But John Paulson maintained the largest stake in the fund.

Will the general public take a huge hit if the gold bubble bursts? As I wrote in December 2010, the SPDR Gold Trust (NYSE:GLD) launched a marketing innovation back in 2002 —  convincing the NYSE to sell gold-back securities to the masses — that has brought in enormous quantities of individual investor money along with that of these hedge fund billionaires.

By August 8, holdings in exchange-traded products backed by gold rose to a record 2,217 tons — to put that in perspective, last December the SPDR Gold Trust (NYSE:GLD), the largest of such ETFs, held 1,299 metric tons of gold — but that figure had dropped to 1,272.89 metric tons as of Aug. 11.

Gold (NYSE:GLD) is a lousy long-term investment if you go back far enough. For example, Wharton’s Jeremy Siegel notes that total annual real returns for gold are just 0.6% since 1802 — stocks, at 6.6% are much better investment performers, as are bonds at 3.6% and bills at 2.8%. And gold is trading well below its inflation adjusted January 1980 peak of $2,226.

So what will happen if the gold bubble bursts? Will the government bail out the losers as it did when the mortgage-backed securities bubble burst in 2008?

If Rick Perry (R-Texas) becomes president in January 2013, it just might. After all, Perry is not a fan of the Fed — he recently suggested that Fed Chair Ben Bernanke’s actions to stimulate the economy were “treasonous” and that he would get ugly treatment if he dared to set foot in Texas.

And rage against the Fed is the fuel that’s driving the public’s desire to invest in gold (NYSE:GLD). So you might think that Perry would favor gold and even want to go back to the gold standard as fellow Texas politician, Ron Paul (R-Texas), does.

But to be fair to Perry, he has not suggested going to the gold (NYSE:GLD) standard. If he thinks the Fed is treasonous, would he abolish it if elected president? If he replaced the Fed with the gold standard, what would he do if the gold bubble burst?

Depending on how America votes, we may never have to find out.

Peter Cohan is president of Peter S. Cohan & Associates and a contributor to Forbes.

For more analysis on our support levels and ranges for gold and silver, consider a free 14-day trial to our acclaimed Gold & Silver Investment Newsletter.

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