GOLD ANALYSIS

Remedies for ‘Stuck in mud' U.S. economy will drive gold much higher

With the U.S. economy ‘stuck in the mud' or even likely to move into downright recession, Fed likely to implement more easing, but how much and when will dictate gold price path.

Author: Jeffrey Nichols
Posted: Saturday , 28 Jul 2012

NEW YORK - 

Disappointing news for the U.S. economy is good news for gold investors. Recent economic data show an economy that is "stuck in the mud," to quote Fed Chairman Ben Bernanke.  And, in response to signs of a slowing economy, the U.S. central bank is, sooner or later, likely to embark on another round of monetary easing.

In fact, the recent gold-price rally that took the yellow metal back over the psychologically important $1,600 an ounce level reflects rising market expectations that the Fed will announce further economic stimulus following the July 31-August 1 Federal Open Market Committee policy-setting meeting.

Aggressive action by the Fed - in the form of another round of quantitative easing (QE3) or a reduction in the interest rate paid to banks on reserves deposited with the central bank - could give gold another quick boost and trigger the resumption of a durable bull-market advance.

On the other hand, if the Fed fails to adopt aggressive monetary stimulus at next week's FOMC meeting gold could quickly sink back under $1,600 an ounce.  This is a less-likely outcome . . . but it would offer investors another opportunity to buy at lower prices in advance of the next big move up.

In any event, it is fairly likely that the economy will remain stuck in the mud - or, worse yet, slump into an outright recession.  With Congress suffering from arterial sclerosis, the economy seems likely to lurch towards a "fiscal cliff" with tax increases and spending cuts leaving the Fed as the last line of defense against a catastrophic economic collapse.

Whether or not the Fed initiates further stimulus in the days ahead, we face an extended period of economic stagnation and recession-like business conditions . . . and an extended period of increasingly stimulative monetary policies that will drive gold prices significantly higher.

Higher gold prices are not just a monetary phenomenon or wholly dependent on U.S. economic prospects. In addition, there are a number of other factors and forces that will contribute to higher gold prices in the years ahead.  We've discussed these at length in past reports and will have more to say in the future.  Briefly, these include:

·         Continuing long-term growth in jewelry and investment demand from both China and India as well as from other gold-friendly Asian countries - even if economic growth slows in these economies . . . and despite short-term resistance to higher prices as we have seen lately in India.

·         Rising participation and gold ownership by retail and institutional investors in the United States and Europe as more savers and investors recognize the legitimacy and benefits of gold.

• Continuing official-sector gold purchases from central banks underweighted in gold (particularly China and Russia), uncomfortable with their excessive U.S. dollar exposure, and no longer comfortable accumulating euro-denominated reserves.
• Further monetary stimulus from the European Central Bank as recessionary business conditions worsen - and the likely exit from the Eurozone of one or more periphery nations that are socially and politically unable to endure the consequences of austere fiscal policies.

Jeffrey Nichols is Managing Director of American Precious Metals Advisors - www.nicholsongold.com and Senior Economic Advisor to Rosland Capital - www.roslandcapital.com