The man behind the challenge, Peter Grandich, is not your typical economist. He holds no degree from any Ivy League college. Actually, he couldn’t even make it through high school. Yet in less than three years after he went to Wall Street, Mr. Grandich was the VP of Investment Strategy for a leading member of the New York Stock Exchange.

Mr. Grandich has since managed four hedge funds and a mutual fund in his name. Having graduated suma cum laude from the School of Hard Knocks he has a refreshingly contentious relationship with his peers. This is his gold price challenge:

“I hereby challenge again the first gold bear to accept my $1 million dollar bet that gold will hit $2,000 without first hitting $1,000.”

Peter Grandich is anything but pretentious. The educational bio came from his site. But he clearly is a prodigy, at least in his ability to use unfettered common sense where it is needed most and applied the least. This is his explanation for the challenge:

“I’ve stated that most in the financial industry and the financial media hate gold. They are entitled to that and I have no problem with it. But, I do take great exception when some of the worst forecasters who have been constantly wrong for years and are little more than ‘broken clock’ forecasters go unchallenged in their consistent calls for gold’s demise.”

Every industry – the financial industry more than most – must innovate to stay ahead of the global market. Yet innovation is stifled in the financial sector, which is supremely protective of the status quo. That strategy has failed, and Mr. Grandich bets a million on it.

“The mother of all gold bull markets shall continue … . A true contrarian should be jumping for joy and find gold attractive yet again,” Grandich says. The risk in the gold price “appears to be $100 down and reward $500+ .”

After a mocking dress down of the gold investment industry the author enumerated his reasons why it would “be wise to consider” before buying at today’s gold prices.

Reason #1. “The supply of gold is not constant. New gold mines are popping up all the time and gold is actually now quite plentiful.” The post offers the total of global gold production to date as evidence, but it fails to mention that in 2010, gold demand soared by 20% while production had risen only 3%.

New gold mines may be popping up all the time, but just a very few of those will ever achieve substantial production. New gold finds grow more sparse and deeper into the Earth every year so the cost of production is rapidly escalating. All the gold ever produced before has nothing to do with the gold price today. Basic economic reality is that increasing scarcity and rising costs of production must lead to rising prices in gold.

Reason #2. “Investors hoard gold in tough economic times. And nobody can argue that we have been through one of the toughest economic times in history since 2008 … What will happen to the price of gold once investors realize that things are once again getting better in the world and start selling their gold?” When that happens, it will be time to start backing off on gold. I concur that this is “basic economics.” I also agree that “they WILL get better, no matter what the doom and gloomers tell you.”

Unfortunately the author presents no further enlightenment as to when he thinks that will be, and offers no reason whatsoever that we should believe it will happen any time in the foreseeable future.

In reason #3 the conversation drifts to gold stocks and I lost all interest.

This post, like the majority on both sides of any issue, was argued with mockery and baseless presupposition, devoid of food for thought. None-the-less, there are always grains of wheat in the mountains of chaff. Sifting through the chaff to find them is the meaning of seeking alpha.

The wisdom we glean from those few grains expands our understanding of gold prices and hones our instincts, enabling us to make wiser and more successful investments.

Did somebody open up a safe deposit box and discover that a few coins and bars were missing? Of course not. The gold in that box, assuming none had been sold or bought, is precisely the same amount that was there at the beginning of the year.

Is gold less valuable today than four months ago? Hardly. That would take a shower of golden meteors raining down on us for months.

Is the dollar worth more today than it was on January 1? Believe what you will, but I certainly don’t think so.

No, gold just costs less today than it did a few weeks ago. And that makes it a bargain.

It’s easy to fret about gold prices when all you look at are the short-term charts. That’s why Kitco publishes 5-year and 10-year charts along with those for the short and near terms. For one thing, the scale on the short-term charts is highly compressed – making proverbial mountains out of molehills. More to the point, short-term data is out of context with the big picture.

The 5-year gold price chart is much more revealing. If you make the best straight line fit from November 2008 through today it becomes instantly clear that recent gold prices aren’t so far off the mark. They’re bouncing around more than usual, but that’s to be expected under the present circumstances.

We can use that to our advantage. When the spot gold price suddenly spikes, as it did last summer, we simply hold and wait for it to fall back. It rarely takes long. On the other hand, when the price of gold slumps well below the trend it’s a great time to buy.

The long term gold price trend shows just one thing: that gold has been steadily picking up momentum for more than a decade. No trend that strong can suddenly reverse without an equal and opposite reversal in the drivers of that trend. And no trend that consistent over that long a period can ever be confused with a bubble.

How long gold takes to get back on course is immaterial. It will get there. Regardless of the price paid for gold this year, and regardless of how far the gold price may still fall, nothing material has been lost.

The true worth of physical gold on any given day can’t be found in the spot gold price, but rather where that day falls on the long term trend in the price of gold.

First, consider what really happened: by the end of the session the gold price had fallen a bit more than 1.5%. That’s considerable, but far from catastrophic. The response of serious gold investors was Pavlovian, not one of panic, because the drop in the gold price had absolutely nothing to do with the value of gold.

“People are trying to get out of gold and into cash and the dollar,” Robin Bhar, an analyst with Société Générale told the Wall Street Journal. Ah, out of the pan and into the fire, as it were. But the Journal’s explanation that investors abandon gold and choose “the U.S. dollar as a safe place to park cash” gets harder to believe every day. Something else must be at work here.

The Wall Street Journal clarified the point for those of us left scratching our heads: “cash is seen as a more flexible asset than precious-metals futures.” Ok, I’ll give them that. It’s because the futures trade keeps the gold price dancing on hot coals that we invest only in physical gold.

It works like this, the Journal says: “Declines in stocks and other commodities markets accelerated the selling in gold … as market participants were forced to raise cash to cover losses elsewhere.” Matt Zeman, the trading chief of Kingsview Financial, further explains: “People who would otherwise like to remain long in gold are forced to liquidate those positions to raise cash.”

To summarize: Wall Street traders take a bath in equities, which strips away their cash flow. That forces them to sell off their gold holdings – often reluctantly – so they have the bucks to place their next bet. It has nothing at all to do with parking cash. And the only thing it has to do with physical gold investment is the opportunity it creates.

Even if the gold price were to fall below $1500 due to massive sell offs necessitated by ill-conceived wagers, it would in no way change the value of physical gold. If the traders want to pawn their gold to keep the game rolling, let them have at it.

Investors who look only a bit farther down the road will be more than happy to take gold off their hands for a deeply discounted gold price.

Patel’s discussion is about where on the gold price trajectory he would start thinking “sell.” Patel mentions the work of James Turk and Jim Sinclair, who independently estimated the price of gold has to be in excess of $11,000 to cancel current debt. However, he focuses on “the highly cited Dow/gold ratio, which has a historical tendency to revert to 2:1.”

Before the markets got into action today that ratio was just under 8:1. To get to 2:1 either gold would need to rise above $6,500, the Dow would have to fall below $3,300, or the two would have to meet somewhere in the middle.

Patel suspects the Dow won’t be going anywhere fast so he picked a gold price of $6,000 as a good point to start thinking about selling. That figure coincides with where the gold price would be if rose from its 2001 level at same rate it did in the 1970s bull market. It’s an interesting quirk in the numbers, but that’s about all it can be.

The proverbial fly in Patel’s ointment is the assumption that historical ratios have any relevance. The world has never before in modern times experienced the extreme conditions that exist today. The response by governments has interfered with the free market to an unprecedented extent, so it is highly unlikely that the gold price will gravitate towards any established metric.

That is not to say that such numbers have no value. They give us a reference to where prices could go if the free market regained control. Because that must eventually happen, the numbers suggest the direction the gold price will take somewhere down the road.

In the meantime, there are just too many variables. We cannot think in absolute terms when we the lesser of evils dictates daily price swings. When we step back and take in the big picture, however, the fog lifts considerably.

Turk and Sinclair, I believe, have taken a more meaningful approach. What the global economy needs to settle things down is a broad-based restructuring of all asset classes relative to a stable monetary base. The most likely candidate for that base is gold.

Once considered to be radical thinking, a gold price above $10,000 in the not too distant future doesn’t seem so fanciful any more.

When gold investor sentiment falls, market timers go heavy on short positions – they gamble that prices will keep falling. Hulbert’s Hulbert Gold Newsletter Sentiment Index (HGNSI) has been falling for several weeks is now at it’s lowest point in over three years. Back then gold was trading around $900 per ounce, and we all know what happened next.

Hulbert has been running econometric tests on the HGNSI for three decades and the correlation between the troughs in sentiment and subsequent upswings in the price of gold has been consistently strong within a 90-day window. If the market stays true to form, the next surge upward is almost due.

“The wait could be as much as several more weeks,” Hulbert says. “In the big scheme of things, of course, that’s not very long at all.”

Although I believe the whole business of predicting markets on historical patterns to be iffy at best, those related to investor sentiment are worth watching. Emotions play a very strong role in market movements, perhaps even a much stronger role than that of the fundamentals.

The concept of a ‘wall of worry’ rings true. Individual investors notoriously get nervous when prices languish. When the doldrums last for any significant period they invariably start backing out, holding down prices even more. All the while big money computers silently crunch the numbers.

Sooner or later the gold price falls far enough below the moving average long enough to set off the computers’ triggers to buy. The gold timers spring into action. At first investors are more than happy to sell because they see the renewed interest as their chance to come out clean. But when the gold price keeps climbing they realize they lost a real opportunity.

Those who have been in gold for a long time don’t respond to the mood swings. They hold onto what they have throughout the cycle, knowing the gold price will bottom out, rise to a peak, and then fall back again as it always does. All that matters to them is where the price of gold is headed in the long run.

When the gold price bottoms out, the old timers know it’s just a matter of time before the gold timers move in again. Savvy investors don’t wait for a computer to tell them to buy. They buy whenever the gold price is right, often beating big money at its own game.

In a Sprott Asset Management commentary, Eric Sprott & David Baker give us some insight as to how far out of kilter the gold price has become.

“What would happen if a single country came in from nowhere and increased its oil purchases by a factor equivalent to 30% of the world’s annual oil supply?” Clearly the price of oil would go through the roof. The demand pressure being exerted on gold is no less, and yet the gold price has stubbornly resisted.

In February China imported 40 tons of gold through Hong Kong, 13 times greater than in February 2011. Over the past 8 months China has imported 436 tons of gold compared to just 57 tons for the same period last year, an annualized increase in demand of 568 tons for 2012.

In March Mexico, Turkey, Russia and Kazakhstan led a pack of at least a dozen countries beefing up their gold reserves to the tune of 58 tons. If central banks keep up the pace, they will boost the demand for gold by an additional 256 tons this year.

Together that’s a total increase in demand of 824 tons, which equates to about 30% of the total global production of new gold in 2011. Subtracting out production by countries that are non-sellers – such as China, Russia, and Mexico – the increase in demand accounts for a whopping 38% of available new gold. Adding in the roughly 1,600 tons of recycled gold, the demand increase amounts to more than 20% of the total global supply.

With only a nominal increase in new production on the horizon, and no improvement in sight for the economic conditions that are fueling the growth in demand, something has to give very soon and in a very big way.

Because none of the countries holding the bulk of above ground gold is in a position to liquidate its reserves, there can be but one alternative: the gold price has to rise considerably to bring the market back into balance.

In a three-hour period straddling the press conference gold prices dropped $10, sat there for 30 minutes or so, shot up $15, dropped another $10, then rebounded to finish off the day as if nothing ever happened. That’s because nothing did.

Thursday, reality struck. No news, it would seem, is bad news. So the gold price took off.

Once again Bernanke patted himself on the back for his “bold and aggressive” moves to save the economy, reports the Wall Street Journal. To support the claim, Mr. Chairman offered only that “the Committee expects economic growth to remain moderate over coming quarters and then to pick up gradually.”

The Fed is also sticking to its guns in regards to interest rates, reiterating its intent to hold them at “exceptionally low levels” through much of 2014. As for further easing, Bernanke left the carrot dangling. “We remain entirely prepared to take additional balance sheet actions if necessary,” he said.

The Fed did concede that “inflation has picked up somewhat,” but quickly qualified the remark. “The increase in oil and gasoline prices earlier this year is expected to affect inflation only temporarily.” Rather odd, inasmuch as the Fed excludes energy prices when it calculates core CPI.

Doing nothing different isn’t the same as doing nothing, which is what the Fed should be doing. Absolutely nothing. Shut down the presses and get your paws off the market nothing.

Of course that’s not about to happen any time soon.

To gold, who has seen this sort of thing countless times over thousands of years, all this will pass in the blink of an eye. Gold knows that the end is coming, a time when it alone will determine the worth of currencies.

In the meantime, the price of gold will continue to rise as central banks persist in devaluing their fiat currencies to worthlessness.

Sounds pretty ominous, if you accept the premise that the economy is stabilizing. The article is quick to point out that “gold is down 7% from its peak for the year in late February.” Oh, no! Say it ain’t so!

Actually, well towards the end of the article and past the point at which most readers will have clicked onto something else, it says it ain’t so. “For now, there appears to be enough economic and market uncertainty to give gold an edge. Gold prices are up 6% in 2012, outperforming the Dow Jones Industrial Average.”

The article goes on to mention that gold rose 2% in response to the previous week’s economic reports and that central banks are buying more gold today than at any time in the past 50 years.

So where’s the bad news? Well, if you believe the article it’s that investors now believe “that the world may see years of slow growth but not a collapse.”

Let me see if I got this straight. ‘Years of slow growth,’ which normally would bode very poorly for equities, will somehow overcome ‘economic and market uncertainty,’ causing investors to forsake gold in favor of more risky investments. Somehow the logic escapes me.

I believe that the economic mainstream is greatly underestimating the American people. We tend to be slow on the uptake, and we loathe to change anything that once served us well. But once we get our teeth into something we’re not about to let go.

Like a dog with a new toy we’ll wildly shake the dickens out of it at first, but then we’ll lay down and chew on it for a while. We know in our hearts that the system has failed us; we just need time to think about where to go from here.

Meanwhile, in light of the prospects for several more years of economic doldrums, the 6% rise in gold prices over 4 ½ months (that’s an annual return of nearly 17%) is looking pretty good to me.

If you think that Dodds-Frank has derivatives under control, then the smokescreen is a huge success. In truth, the unabashedly crooked tables at the derivative casino have cranked up the stakes to unimaginable levels.

Derivatives are bets “on future values and performance of practically anything that holds value,” says Demonocracy.com. “The system is not regulated what-so-ever, and you can buy a derivative on an existing derivative.” Derivatives contribute nothing to the economy, they merely transfer wealth from productive society into the pockets of big money insiders.

“The derivatives market has blown a galactic bubble” and is poised to crash, says Demonocracy.com. But because “there is literally no economist in the world that knows exactly how the derivative money flows or how the system works … we really don’t know what will trigger the crash, or when it will happen.”

Of one thing there can be no doubt, however. When the derivative bubble bursts it will send a shock wave of unimaginable proportions throughout an already fragile global economy.

The combined total of derivatives held by just the nine largest banks is a staggering $228.72 trillion. To put it into perspective, that’s roughly three times the entire global economy lying on the table awaiting the next roll of the dice.

Real wealth is not at stake, of course. Hard assets are not being wagered, only fiat money. When the crash comes there will be nothing the world’s mightiest economy can do to bail it out. The big loser will prove to be the dollar, taking down with it everyone whose wealth is locked into cash.

Given the shroud of secrecy surrounding the derivatives market, chances are that individual investors won’t see the crash coming, and when it hits it will be too late to take shelter. It is imperative that we protect ourselves now, while the gold price languishes far below the trend.

Those who don’t would be forced to watch helplessly as their dollar-based wealth vaporizes before their eyes and the price of gold jets into the stratosphere.