US NATIONAL DEBT

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Gold Rallies Sharply on the First Trading Day of 2010

January 4, 2010

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors


Gold rallied sharply on the first trading day of 2010 – in part, mirroring a weaker U.S. dollar . . . but also reflecting the reestablishment of long positions by some funds and speculators who, despite their bullish view of the market, sold metal in December to realize profits earned from the rising price trend over the course of last year.

Gold and Silver Price Expectations

I expect the yellow metal will hit $1,500 an ounce – or higher – during the New Year, a gain of more than 35 percent from its December 31st close.

And looking further ahead, gold’s bull market will likely continue for another few years, carrying the metal to a cyclical peak of at least $2,000 and quite possibly much higher.

At the same time, silver could very well outperform gold, rising from $17 an ounce at the end of last year to an annual high of at least $25 sometime during 2010, a gain of more than 45 percent from last year’s close.

While silver’s advance will mostly reflect strong cyclical growth in both industrial and investment demand, gold will benefit not only from cyclical forces but also from a rising secular expansion of investor participation, central bank reserve diversification (which is only just beginning), and an irreversible erosion of the U.S. dollar as the single dominant reserve asset and denominator of much world trade.

As a result of these secular developments, over the next decade and beyond, the long-run average price of gold (stripping away the major cyclical bull and bear market swings) will be considerably higher than past experience would suggest . . . and considerably higher than many analysts and investors would dare imagine.

Buying Opportunities

In the meanwhile, both gold and silver will continue to stumble from time to time with continuing high price volatility. As in the past, changing expectations about U.S. interest rates and Federal Reserve monetary policy as well as other international developments that may benefit the dollar exchange rate will trigger reversals in the prices of these metals.

Economic statistics indicating a more durable recovery or accelerating price inflation at times may lead some to believe the Fed will begin tightening policy sooner than later – and this could briefly push the dollar higher and gold lower.

Indeed, tough talk by the Fed or hints of an imminent increase in the Fed funds interest rate – and, even more so, the first step up in this key policy rate – will almost certainly trigger a dollar rally and selling of gold and silver. However, any tightening by the Fed will be too little, too late to reverse the eventual rise in U.S. inflation and depreciation of the U.S. dollar.

Similarly, fear of sovereign debt defaults by one or another European country (or elsewhere) could also benefit the dollar and temporarily hurt gold. But gold is the ultimate safe haven and the dollar, without the support of sound monetary and fiscal policies, is a depreciating asset, tarnished by an erosion in its real purchasing power, so those seeking safety in the greenback will do so at a heavy cost.

As in the past year, these occasional reversals will lead some to believe the party is over for precious metals – but I believe periods of weakness will be opportunities for those underweighted in gold and silver to augment their holdings of physical metal.

No Bubble Here

There continues to be much talk from gold’s detractors that the strong advance in the metal’s price over the past year is nothing more than a speculative bubble ready to burst . . . and, when it does, the price will come tumbling down. But, in my view, gold’s strength is built on solid fundamentals – fundamentals that gold bears, among them a number of eminent economists, fail to recognize.

Very briefly, these positive fundamentals for gold are:

U.S. monetary and fiscal policies will remain extremely expansionary and, ultimately, inflationary. With Federal debt now over $12 trillion and annual deficits projected at over $1.5 trillion for years to come, the Federal Reserve will be forced to buy more Treasury debt with newly printed money, eroding the dollar’s purchasing power at home and abroad.

Strong continuing central bank demand for gold as more countries strive to diversify their official reserve holdings.

Expanding investor interest with more individuals and institutions viewing gold as a legitimate asset class, portfolio diversifier, and insurance policy.

World gold-mine production will continue its long-term decline for at least another five years – or longer without the incentive of still higher gold prices.

Expanding and evolving geographic markets, particularly China, India, and elsewhere in Asia where incomes and wealth are rising means that more people with a traditional cultural interest in gold will be buying substantially more gold jewelry and physical gold investments than ever before.