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Gold Sizzles as Economy and Financial Markets Stumble

August 8, 2011

Jeffrey Nichols - Senior Economic Advisor to Rosland Capital
Managing Director, American Precious Metals Advisors

In case you hadn’t noticed, gold prices have been surging to new all-time highs. At one point today (Thursday, August 18th) the yellow metal touched a record $1,830 an ounce.

Whether gold continues to skyrocket, settles into a new trading range around recent levels, or plummets as high prices discourage buyers and encourage profit-takers is anyone’s guess.

At some point, however, we will see a correction, perhaps a sizeable one. After all, even strong bull markets never move up in straight lines. I would not be surprised to see gold stumble – falling back $100, $200, or even $300 – before prices begin working their way higher once again.

My advice to gold investors is to use sell-offs, when they occur, as opportunities for scale-down buying. And, those who are underweighted or own no metal should gradually acquire physical metal with their focus on long-term portfolio protection rather than short-term profits.

Adding to my short-term caution has been some price-related relaxation of physical demand and the appearance of increased quantities of gold scrap returning to the market, especially from India and other price-sensitive national markets.

I’m confident gold’s long-term uptrend will continue in the months and years ahead, ultimately reaching a multiple of today’s record level.

Seasonal Demand

In any event, gold will soon begin to benefit from increased seasonal demand, demand that should support the yellow metal’s price right through New Year’s Day. There are three distinct sources of seasonal demand: (1) Western jewelers step up fabrication demand ahead of Christmas gift-giving late in the year; (2) Indian dealers begin stocking up ahead of the late summer and autumn festivals and wedding season; and (3) in December and January, the approaching Chinese lunar new year triggers another sharp rise in gold demand.

For sure, irrespective of the season, Asian demand – principally from China and India – for physical metal will continue to underpin these markets and limit downside risks.

So too will bargain hunting by a number of central banks eager to raise their official gold holdings without disrupting the world gold market by increasing upward price volatility.

Bullish Economic Forces to Continue

There is no reason to believe that the forces and factors pushing gold higher – in the past weeks, months, and years – are simply going to disappear anytime soon. I’ve been talking about many of these for years . . . and, I expect I’ll still be talking about these same pro-gold forces for years to come.

The recent rush of gold buying is, in large part, a rational response to rising uncertainty, anxiety, and fear that the U.S. and European economies are stumbling badly . . . and world financial markets are increasingly vulnerable to an epileptic seizure, or worse.

In recent days, signs of renewed recession on both sides of the Atlantic and Europe’s worsening sovereign-debt crisis are raising expectations that the Federal Reserve and European Central Bank (ECB) will both be compelled to pursue evermore stimulative monetary policies beginning with a new round of quantitative easing in the United States and stepped-up ECB purchases of sovereign debt and/or interest-rate cuts in Europe.

These policies – and the implications for future inflation and monetary debasement – are like steroids for the gold market, causing investors and central-bank reserve managers to seek the protection of gold.

In any event, whatever happens in the U.S. and European economies, it is hard to imagine a realistic scenario that won’t push gold prices significantly higher.

Central Bank Acquisition: More Important Than You Think

Importantly, contributing to gold’s recent swift rise has been the growing interest and stepped-up acquisition of gold by the official sector.

This was underscored by the Central Bank of Venezuela’s recent announcement that it was repatriating much of its official gold reserves from foreign custody. Statistics from the Bank for International Settlements (the BIS) suggest that a number of other countries have, in the past year, repatriated gold rather than store it in the custody of the Bank of England, the New York Federal Reserve Bank, or in the vaults of other central banks.

While these are not purchases of gold affecting the world market supply/demand balance, the trend toward repatriation illustrates the special role gold plays as an asset of last resort among central bank reserve managers.

Increasingly, central banks are buying gold: South Korea announced a couple of weeks ago that it had purchased 25 tons over the past two months, almost tripling its central bank gold holdings. Thailand’s central bank, too, has been an important buyer, recently adding nearly 18 tons to its official gold stocks. Even the Banco de Mexico bought 100 tons earlier this year, joining China, Russia, India, and Saudi Arabia – all of which bought large quantities in recent years. Russia continues to buy gold regularly from its domestic production – and, we think, China does likewise though it chooses not to report its purchases.

News of central bank gold repatriation – and, even more so, outright purchases – is likely to encourage more central banks underweighted in gold to begin or continue buying. Even more so than many private investors, central bankers are apt to be purchasers for the long haul, holding gold as a diversifier and insurance policy against what they perceive to be the growing risk of U.S. dollar depreciation and debasement.

I expect the rising trend in central bank interest and accumulation of gold will be an important force in the market for many years to come. In the meantime, bargain hunting by a number of central banks eager to raise their official gold holdings without disrupting the world gold market will help limit downside risk.