Gold has been one of the stories of the market over the last several years as the global economic crisis and an overall lack of trust in the “system” has led investors to seek a more evergreen store of value.

I personally first began talking about Gold in December 2008 when it was trading at $850/ounce. I felt the technical indicators and a compelling story suggested a move to $1,300-$1,500. Although I did not hold the SPDR Gold Trust ETF (NYSE:GLD), which is my preferred vehicle for trading gold, for that entire run, I traded gold on several occasions within that time frame with much success.

When you have a powerful idea, you must be able to execute it in a way that fits in with your overall trading or investment strategy, and that’s what I have done with gold. In hindsight, do I wish I had bought tier four gold in 2008 after I made that prediction on CNBC, and held it for the entire measured move? Sure, but I have not lost any sleep over it. I feel content that I traded gold in a way I was comfortable with. I have applied my own active, risk averse approach to the gold trade, locking in gains and taking risk off when it seemed appropriate to do so. Depending on your overall strategy as a market participant, customize your approach to trading gold.

How the gold trade has evolved

While the basis for most of my trading decisions comes from strict, prudent technical analysis, there has also been a powerful story to tell about gold apart from the charts.
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Over the course of the last several years, the nature of the gold trade has evolved. Back in 2008, when the price jumped from $850 to $1,000 an ounce, it was the “fear trade.” Amid the global panic of the credit crisis, investors wanted to own something tangible, something they could touch and feel. Gold was seen a safe haven.

Then, in 2009, the gold trade morphed into the “inflation trade” as the world recovered from the depths of the historic recession, as I noted on CNBC in September 2009. As governments raced in to save the day and print money to rescue institutions, investors feared the implications of the newly minted “too big to fail” paradigm. During that time, the reverse head and shoulders pattern formed, sending spot gold from $1,000 to $1,224/ounce.

In 2010, gold shape-shifted once again into the “sovereign debt trade.” Fears of contagion in the Eurozone debt crisis have engendered calls for the end of the Euro and even the European Union. As the year has gone on, the crisis has worsened. Ireland recently joined Greece as the first PIIGS to require a massive bailout. Doubts about the future of the Euro have sent gold from $1,265 to as high as $1,400+ an ounce.

Where are we now?

Now, with 2010 getting closer to the rear view mirror, it’s time to start looking forward to the next leg of the journey. What will gold look like in 2011 and beyond? Well, all indications are that the European sovereign debt crisis will get worse before it gets better. A massive bailout for Portugal seems almost inevitable at this point, and then we start getting into the real big kids on the block. A bailout for Spain, the ninth largest economy in the world, might require more money that the system could tolerate. If a domino of that size were to fall, who knows what could be next to follow?

Many people judge “bubbles” and over-hyped phenomena in the financial world based on when the retail public take notice en masse. Conventional wisdom now says that when the retail public starts hearing the story and jumping on the bandwagon, a top is imminent. With cash for gold ads polluting our television screens, gold vending machines popping up around the country, and gold stories starting to populate the covers of mainstream magazines, it certainly feels like the gold story fits the bill. However, it would be fallacious to blindly judge something only on such a basic level without digging deeper. Each case study, when you are presented with a framework, must be reasoned based on its own merits. In this instance, I believe the facts supporting another surge higher in gold prices outweigh the doubts accompanying this analogy.

There is no substitute for the real thing. The equity market rally could be fool’s gold.

Even without the worst case scenario coming to fruition, gold seems destined to go higher as long as fear remains a part of the equation. Over the last couple months, as the market trudged ever higher, we were lulled into a sense of complacency. The market, once ruled by headline risk and overnight moves, had become more focused on earnings and valuations, but that doesn’t mean things couldn’t return to what they used to be.

The rosy complexion of the market was driven largely by expectations that the Fed would prop up asset prices at every turn, and it could be argued that prices are artificially inflated at current levels. The Fed has taken a “fake it until you make it” approach; continue to prop up asset prices until the economy picks up. If it doesn’t work, at what point are QE3, QE4 and QE5 no longer an option? Over the last week or so we have seen headlines reassert their power, with the Ireland debacle and the Korea skirmish serving as a stark reminder of what can happen. Tinkering with asset prices causes price instability, and investors will not be so quick to fall into the same old trap.

Inflation: There is also the giant elephant in the room: inflation. Many argue that we are currently in a strictly deflationary environment that needs to be fought at all costs, and that if real inflation does appear, the Fed has tools to fight it. Government officials still claim there is no inflation, but as food and gas prices skyrocket around the world, consumers are scratching their heads over such an assertion. We have also seen “shadow inflation”, which can be understood as value deflation. Instead, for example, of getting a 7-ounce bag of coffee beans at Wal-Mart, you can now only get 6-ounce bag that costs the same price, a fact that is not taken into account in the Consumer Price Index (CPI). While a gym is cutting costs or keeping fees stable, for example, they are getting rid of water fountains and turning off the air conditioning. In general, the average investor has grown skeptical of our already discredited leadership.

Nassim Taleb, a renowned expert on understanding black swans and left tail risk, describes the potential hyperinflation phenomenon as trying to get ketchup out of the bottle. Upon the first couple of smacks, little-to-nothing might come out. Smack the bottom of the bottle three or four more times, though, and the whole contents might end up on your plate. The Fed’s QE program is arguably the biggest science experiment of all-time, performed with taxpayer money, and the end result is unclear. Even Ben Bernanke admits that he does not know what the outcome will be given the complexity and ground-breaking nature of his Fed’s bold actions. For all we or they know, all this money printing and monetization of debt could be setting the stage for a period of high and difficult-to-fight inflation. It remains to be seen whether, at that stage, the Fed would have the credibility or the tools to combat runaway prices.

All Likely Scenarios Point to Higher Gold Prices

If all-out disaster can be averted in Europe, and the U.S. economy can continue to grow, gold can still see a slow technical grind to $1,600-$1,800. If Europe starts to falter even more (remember, debts come due over the next several years), which seems likely at this point, gold can really go parabolic to $2000+. We are heading toward an environment in which nobody feels comfortable holding any fiat currency.

Gold, something that cannot be conjured out of thin air and has universally recognized value, would be seen as the primary store of value. Other precious metals like silver, which has outperformed gold handily this year, would likely behave in a similar fashion. The U.S. mint has seen a dramatic rise in demand for silver eagle coins, with sales up 30% since 2007.

The two most likely scenarios for the world economy both offer strong support for higher gold prices. Further deterioration in Europe and the US would trigger an exodus from fiat currencies into gold, and a high-inflation recovery would send gold prices soaring. Gold is both a safe-haven play and an inflation hedge. The only scenario where gold could burst like a bubble is if, against all odds, the economy recovers, budget deficits self-correct as aggregate demand and tax revenues soar, the Fed is able step in to stem the tide of high inflation at just the right time and the world presses on into the 21st century like this little recession never happened. Sorry folks, but I just don’t see that happening.

State Debt Crises: The Story of CAIN and (Un)Abel

In Europe, they were able to come up with a clever moniker, PIIGS, to succinctly represent the most boorish animals on the farm, and its only appropriate the for us Americans to come up with our own distinction as state budget crises becomes more pressing.

I am going to call it the story of CAIN and (Un)Abel. CAIN represents seven of the most rotten pillars of our union, the states with the most urgent budget concerns–C (California), A (Arizona, Alaska), I (Illinois), N (New York, New Jersey)–while (Un)Abel describes the country as a whole. (Un)Abel, as in unable to do anything about the impending crisies. Given the current political climate and implicit anti-bailout mandate of the new Congress, the Federal government might be powerless to do anything but accept painful state defaults. Before we know it, we could all be ancestors of evil.

In April, Congress plans to meet to discuss debt levels, which will include how to deal with individual state crises. Keep in mind, this is the same Congress that has been recently restocked with (supposedly) debt-conscious Republicans who will (presumably) feel obligated to put their foot down on further massive government spending. The possibility of further deficit spending appears remote, if not dead-as-a-doornail. It just so happens that 2011 could be the year that CAIN starts to face some serious trouble, and may need some serious help to avoid killing his brother (Un)Abel.

If large state dominoes start to fall and creditors are forced to the table, it could lead to rehashing of the widespread fears from 2008. California, after all, is the fifth largest economy in the world, and would be a mighty large domino. The non-partisan Legislative Analyst’s Office projected on November 10th that the budget shortfall in California will be $25.4 billion, twice as large as state political leaders had predicted and more than a fifth of the general fund. A default by a sovereign state (and it’s biggest, at that) would affect the credit rating of the United States as a whole. A bailout, if it were approved, with deep cuts for pension holders and other programs would likely be met with angry demonstrations by Californians, much like we have seen in Greece, Ireland and across Europe. Civil unrest would do wonders for the price of gold. As Chris Whalen stated earlier this month, this entire situation amounts to a Federalist crisis for the United States. These issues are not limited to California.

What to do with gold

Gold has a compelling long-term story for higher prices, but what is the best way to approach the trade? For an active approach, you could be long tier one here versus current support of $1,310-1,330, which would be the technical stop-loss on the trade. If nothing else, investors should consider having gold and/or other precious metals as a portion of their portfolio as a risk protection against the possibility of further deterioration of the world economy and high future inflation. We will be looking for more calculated technical areas to potentially add further tiers of gold for the next macro move.

John Darsie contributed to this article.