GOLD ANALYSIS

Gold still has a glorious future - bull market nowhere near over

But, the yellow metal is certainly vulnerable to the possibility of a substantial price setback after registering new all time highs repeatedly in the past few weeks

Author: Jeffrey Nichols
Posted: Thursday , 11 Nov 2010

NEW YORK (ROSLAND CAPITAL) - 

Having registered new all-time highs over and over again in the past few weeks, gold is certainly vulnerable to a price setback, and a substantial one at that. 

The influx of speculative buying that has contributed to the upward price spike will inevitably lead to profit taking and possibly a sizeable price correction.  Much hinges on the strength of physical demand in key world markets, which through Monday has remained firm in the face of higher prices. 

Short-term prospects could also be affected by developments at the G-20 meeting later this week and by the re-emergence of European sovereign debt concerns.  But even if gold takes a big hit in the days ahead, don't think the bull market is anywhere near over.  We expect gold has a still-glorious future with much higher prices likely in the next few years.

Underpinning our bullish outlook for gold has been the belief that the U.S. economy would continue to disappoint -- and, in response to persistent recession-like symptoms, America's central bank would respond with increasingly stimulative monetary policies.  Certainly, we've seen this chain of events (beginning with a weak economy, followed by monetary stimulus, leading to higher gold prices) over and over again in recent years and in the past week, and we will see it again as gold continues to move higher this year and beyond.

Each successive dose of monetary ease has cheapened our currency.  And each time, gold has responded.  As the economy continues to struggle along, future monetary stimulus assures much higher gold prices ahead. 

So far, the Fed has reduced short-term interest rates practically to zero, executed its first round of quantitative easing (QE1) to the tune of $1.75 trillion, and last week announced a second round of quantitative easing (QE2), promising to print another $600 billion in new money by mid-2011. 

And, more than anything else, it was the launch of QE2 last week that set the gold market afire, driving up both long-term investment and short-term speculative demand in anticipation of higher U.S. inflation and a weaker dollar abroad.

This week's rise in commodity prices to multi-year highs and increasing discord in world currency markets are also by-products of the Fed's promise to print more money.  Both are adding more fuel to gold's fire by giving investors additional reason to seek the safety and security of gold. 

The U.S. Congressional election results last week -- as they relate to prospective monetary policy and increase market uncertainty -- have also contributed to the current bout of gold-price strength. 

The newly elected Congress will likely be at loggerheads with the Obama Administration about tax and spending policies -- so there is little hope that sensible fiscal initiatives will deal effectively with America's economic malaise for the next year or two. 

Without some help from fiscal policy, U.S. business conditions next year and beyond will be even more disappointing -- and the Fed will feel the need to print still more money.  As we have seen in recent years and again in the past few days, this is a sure-fire guarantor of higher gold prices. Comments from World Bank president Robert Zoellick about a prospective role for gold in a new world monetary system also gave the metal quite an upward kick this week.

In an op-ed piece in Monday's highly respected Financial Times, Zoellick said, "Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today."  And he said the leading economic powers should consider making gold part of a new "cooperative monetary system." 

These comments coming from the World Bank president immediately triggered still more investment demand and speculative buying as the trading week got underway.  From a longer-term perspective, they enhance gold's legitimacy and stature, as an official reserve asset and, undoubtedly, will encourage more central bank purchases in the future. 

Jeffrey Nichols, is Managing Director of American Precious Metals Advisors www.nicholsongold.com and Senior Economic Advisor to Rosland Capital www.roslandcapital.com  , and has been a leading precious metals economist for over 25 years.