Gold got clobbered yesterday, down $36 for June contracts. It was one of the largest one-day drops in many years. The metal has lost about $100 from its high. Many people already think the bull market is over. The final spike of speculative fever, they say, took gold up to $730. Now, it is downhill from here on. As the price falls further - as it well may - more and more latecomers to the gold market will be discouraged. They will drop out along with the price. Even Daily Reckoning readers will begin to wonder. Maybe the dollar is for real and forever. Maybe the world economic system really is remarkably robust and flexible. Maybe gold really is a relic of the past.

Thus is our faith tested. Not our faith in gold. We know what we think of gold - it is nothing but an inert metal. It says nothing. It performs no tricks or miracles. It never disappoints us. Nor does it ever really do anything to delight or entertain us. It just sits there like a cop in a squad car. He is of no particular use most of the time, but critically important occasionally. No, it is not in the metal that we put our faith; it is in man himself, generally, and central bankers and politicians in particular. We have an abiding faith that when temptation is set before them, they will do what such men have always done - they will go for it.

When George W. Bush moved into the White House you could buy an ounce of gold for only $266. At the time, we thought the man from Texas was a conservative. He said he was. Little did we know he'd become the biggest spender of all time.

Even if Bush had turned out to be a sensible president, gold would still have entered a bull market. These things are cyclical, after all. A 20-year slump is bound, in the course of things, to turn around sooner or later. At the bottom of the slump, gold was a great bargain at $266. But now, with a boom underway, is it still a bargain at $637? That's what we are going to find out. Our guess is, yes and no. Maybe not compared to the price at which you may be able to buy it two months from now, if the correction continues. Maybe so, if the bull market storms ahead as we believe it will.

If the correction follows the pattern of the price correction in the '70s bull market in gold, the price could even fall back to the $500 level. That would wipe out about half gold's rise from the day the neo-cons took over American government to the peak of gold hit two weeks ago, at $720.

Five-hundred-dollar gold would still represent a solid profit for those who bought six years ago - it would double their investment. Our guess is that it would mark the frontier between two stages of a bull market, too. And finally, it would give those whose faith is strong one final opportunity to buy at a bargain price.

You will recall how easy it was. From under $300 an ounce up to $500 an ounce, accumulating gold was simple. We set target prices, raising the hurdle $25 at a time, and buying whenever gold dipped back to hit the target. It was like climbing a set of stairs. But then, when gold rose above $500, it quickly left us behind. We kept waiting for the price to drop back to our target so we could buy more. Instead, it rose even higher. We missed $100 of gain, and then another $100 of gain. We felt like idiots. We had seen it coming, and still missed it. And then, when gold soared above $700, it looked like nothing could stop it. We worried that it would go all the way - all the way to $1,000 or $2,000 without ever giving us another opportunity to buy at a discount. What to do, we wondered in these pages. Close our eyes and buy, counting on the long-term bull market to erase any timing errors? Or, sit on the sidelines and risk missing the best part? We had no answer.

"Buy," was said, with a gulp and a prayer. It is better to be in than out, we reasoned, even if we are not getting in at the best price. Yet, we could not bring ourselves to buy either.

And the price rose...

And then, the financial world shuddered. The frisson originated in Japan, we believe. After 16 years of deflation and slump, the Japanese economy is finally pulling itself together. And Japanese central bankers are now beginning to tighten down on the monetary valves. The money supply in Japan is actually falling. For many years now, speculators - largely hedge funds - have been able to borrow money in Japan at once-in-a-lifetime low rates. This gush of easy money flooded markets all over the world - from India, to Jakarta, to the United States - and most recently, to gold itself. And when, all of a sudden, the cash was not so forthcoming, investors panicked. For the first time in years, storm clouds appeared in the speculators' paradise. Emerging markets dropped last week. The Dow wobbled, too. Commodities - including gold - took a beating.
 
Tempests are never welcome, but they are most regretted when you are least prepared for them.

Sooner or later, now or in the future, fierce weather is inevitable. Debt begets repayment. Boom begets recession. Bull markets beget bear markets. Stability begets instability. Any day now, China could implode, the housing boom could collapse, foreigners could drop the dollar. Our guess is that all those things will happen. If only we could tell you when!

All we can tell you is how to protect yourself. For that, we turn to no less of an authority than Alan Greenspan himself (we can't think of any less of an authority) who said in 1999: "Gold still represents the ultimate form of payment in the world. Fiat money in extremis is accepted by nobody. Gold is always accepted."

When the wind blows hard - that is to say, in extremis - everything begins to flap, flutter, and fly away. People look for something solid to hold onto.

So far, gold has gone up no more than base metal. Since 2001, gold is up 249%. Lead has risen 240%. This tells us that people have not even looked at the barometer yet. Meanwhile, the Bush administration says it no longer intends to continue the "strong-dollar policy," under which, the dollar lost about half its purchasing power. We can't wait to see what happens under a weak-dollar policy. And all over the world, people have built up huge piles of dollars, yen, euros, and pounds - and staggeringly large claims and counterclaims against them, including a trade in derivatives that is now close to $300 trillion per year. Against all that, the current stock of gold is a mere pittance, a tiny island in a vast sea of paper money. When the winds really begin to howl, our guess is that there will be many people who want a piece of it.

*** Is the commodity boom over? Probably not. In real terms, commodity prices are only about 35% of what they were in the last peak, in the '70s. What we are seeing looks to us like a normal correction in a bull market. "I'm not selling any commodities," says our old friend Jim Rogers, "even if they go down 30% - 40%, because they will be going back up later."

*** The glory days for hedge funds are over. The jig is up. The problem with them is that they are not really hedging risk, but adding to it. Typically, they take advantage of cheap liquidity - such as that made available by the Bank of Japan - and place it in more rewarding, but more volatile, places including Dubai, Jakarta, and Bombay...not to mention U.S.-dollar debt. The trick worked well enough for a long enough time to mislead investors. But now, the world's central banks think they are fighting inflation. They saw the boom in commodities and decided to stiffen their backs. It's gotten harder for hedge funds to perform. The Times of London reports:

"Richard Oldfield, chief executive of the fund managers Oldfield Partners, said that investors would gradually become disillusioned by poor returns over the next ten years. 'It will end with a whimper, not a bang,' he said, adding that the target returns of 12, 15 or 17 per cent routinely conjured up by hedge funds were 'totally fanciful.' He said: 'We will look back and realize this was a barmy ," adding that some hedge funds were walking a difficult regulatory line: some were close to acting as concert parties in bid situations and some were coming very close to front-running - the practice of trading ahead of one's clients.

"'My message is that hedge funds are a con,' he said.

"Andrew Clare, Economics Professor at the Cass Business School, said that the industry was hitting capacity constraints. 'There must be a limit to the number of smart guys you can crowd into the same small space,' he said."

*** We received this note from our traveling vagabonds, Joel and Greg:

"Despite its recent volatility, we remain long term gold bulls. So when a nondescript gas station in the middle of outback Missouri presented us with an opportunity to make a little gold investment, we jumped at the chance.

"One 'Gold Bar' lottery ticket, please, ma'am," we said to a well-fed, mustachioed cashier as we piled the counter high with energy drinks and beef jerky. 'Have you seen any decent returns on gold recently?' we asked.

"'Oh, sure,' came the hoarse but enthusiastic reply. 'The first weekend these gold tickets came out I sold one for $600 and another for $400.'

"'Wow. That's some serious profits on a $5 lottery ticket.'

"As we reached over to choose our lucky penny from the community tray, another, slightly more homely attendant quietly sauntered over. 'We'll tell you what,' we said, 'if we bag anything close to that, the four of us are going to the races.' We shook the penny as if it were dice and held it out for the ladies to blow on. They obliged.

"The first of three rows of numbers yielded nothing. Tension mounted. Second row...nothing. The suspense was palpable as the promised day at the races hung in the balance. We drew our lucky penny across the final row and everyone held their breath, tense with anticipation.

"'Gold bar! Gold bar!' the wobbly ladies were practically leaping out of their floral muumuus. 'That means you get four times the amount shown under the - the gold bar, under the gold bar. Scratch under the gold bar!' We had the feeling this was the most excitement this gas station had seen for a while.

"Four times five makes for a crisp twenty dollar note headed our way. That's a 300% profit in less than ten minutes. Once again, gold comes through with the goods.

"We stashed our winnings in our pocket and bid farewell to our fair ladies. Perhaps if we were ever at this gas station again we'd crack the $600 mark and enjoy that day at the races.

"It wasn't until we arrived at Hayes, our eventual rest stop for the night, that we realized the true cost of our lottery ticket delay. Some sly vagrant had busted into the unattended U-haul cab and fleeced us of a camera and a cell phone for a loss of $400. Less the fifteen dollars in winnings and we were looking at a net loss of $385. Then and there, we decided no more lottery ticket gambling."

Bill Bonner is the President of Agora Publishing.  For more on Bill Bonner, visit The Daily Reckoning.