This is just the scenario that the gold bugs anticipated. But the commodity is not playing along.

For many years, gold's biggest boosters have warned that mounting debt and sketchy lending practices would bring ruin to the U. S. financial system and leave gold as the much-needed safe haven.

The thesis ended up being exactly right. So why is gold in a downward trend and holding below US$800 an ounce as the U. S. banking system unravels?

According to the gold bugs, hedge fund selling and central bank intervention have put a temporary lid on the commodity. But the recent financial upheaval has made them only more bullish in the long term.

On the surface, they point out that all the factors seem to be in gold's favour: market turmoil, a shortage of gold coins and other fabricated products, and soaring costs for mining companies that make it tough for them to make money at these prices.

But in the short term, they said all of that is being superseded by hedge funds that are desperate for cash and are selling all their liquid assets.

"The financial meltdown has brought some people into gold as a safe haven. But for everyone coming in, there's somebody going out who needs to liquidate to raise money for other things," said Peter Grandich, editor of the Grandich Letter and one of the most bearish commentators on the U. S. economy.

He said he is unconcerned about gold's current weakness, because the soaring physical demand for the commodity indicates the paper price will eventually catch up.

Gold bugs have long complained about central banks selling bullion to allegedly prop up their currencies, and many believe that it has happened in the past few weeks. "[Central banks] particularly do not want a rising gold price when the system is melting down because it would be a warning that there are deep problems within the financial system," said James Turk, founder and chairman of GoldMoney.com.But he added the U. S. dollar has stalled and appears set to go down again. To counter the financial crisis, the Federal Reserve and other central banks have poured hundreds of billions of dollars of liquidity into the system. That is ultimately inflationary and makes the gold bugs even more bullish on bullion's prospects.

On the mining side, they expect that gold should receive support from soaring costs and weak grades that are stalling some production. Goldcorp Inc., for example, recently delayed its Pamour mine in Ontario.

John Ing, president of Maison Placements Canada, calculated that cash costs in the industry are hovering around US$625 per ounce of gold produced (not including byproducts) and that production in low-cost South Africa appears to be in steep decline. Add it all up, and the gold

bugs are certain it will be above US$1,000 and much higher in the months ahead as it re asserts itself as the one safe haven.

pkoven@nationalpost.com