First, last week’s Federal Reserve FOMC meeting did not produce a plan for further expansion of the Fed’s balance sheet. Some investors in gold clearly expected such a development. The aggressive selling of gold began on Wednesday after the FOMC statement was released.

Secondly, as the debt situation in Europe continued to deteriorate, European securities fell sharply, forcing European gold holders to liquidate in order to reduce leverage. Much of the selling pressure on gold over the past week has originated in Europe. Widespread reductions in Euro Zone growth estimates and open disagreement and confusion over the next tranche of Greek bailout funding contributed to an abrupt downturn in markets. Gold performed its traditional role of providing emergency liquidity.

Perhaps most importantly, investors began to anticipate a disorderly Greek default and interpreted it as a possible Lehman moment. Investors, like generals, tend to fight the last war. All of us remember that, in the fall of 2008, the authorities let Lehman go into an unplanned bankruptcy with immense unintended consequences. Gold fell in response. When the Troubled Asset Relief Program (TARP) passed Congress, it recapitalized the banking system, contained the Lehman contagion effect and gold began to recover, closing higher on the year. Would a Greek default or the failure of a major European bank trigger a similar crisis of confidence in the financial system? And would a dysfunctional Euro Zone be able to produce a TARP response quickly enough? Anticipating that gold could fall in such a circumstance before effective money printing could be implemented, gold was sold.

It looks to us as if gold is waiting at the cross-roads to see what happens in Europe. The key question is...do we get a Lehman event followed by TARP or TARP followed by Lehman? The Euro zone probably needs several weeks to complete the passage of the 440 billion euro European Financial Stability Facility (EFSF) and structure the proceeds into a vehicle to stabilize the banking system. Then, we will likely get a controlled Greek default, within the Euro, with a EuroTARP limiting contagion. Do we get a Lehman moment before the TARP architecture is in place? AND are the Germans willing to lever up the EFSF commitments as required? (440 billion euro is not enough). If 'Lehman' comes first, gold could take another hit (although this may already be priced into the market)...therefore western players wait to buy while Asians feast on the low price for physical gold. If TARP comes first, we think gold explodes to the upside. We believe that the Euro Zone will not allow any defaults until the EuroTARP is in place.

In the short term, aggressive physical gold buying among Asians appears to be balancing western fears of disorderly default. A growing number of central banks are also buying regardless of higher prices. Newswires this morning report that, in August, Thailand bought 300,000 ounces of gold, Bolivia purchased 225,000 oz, Russia added another 118,000 oz and Tajikistan bought 60,000 oz. In the longer term, the “solution” to the unfolding debt crisis will, in our view, be more money printing and a higher gold price. That’s the way central banks have dealt with every similar crisis in the past. Why would this time be any different?