The
days and weeks ahead could be tumultuous for gold with the yellow
metal’s price primed to move one way or the other depending on news from
European finance ministers, the European Central Bank, the Greek Parliament
and, last but not least, the Fed’s FOMC policy-setting committee and
Chairman Bernanke’s news conference later this week.
Technically,
gold remains range bound with good support, as we saw last week, between
$1515-$1522 and overhead resistance in the $1545-$1555 range. A break
out in either direction, perhaps triggered by news of a more fundamental
nature, could signal a bigger move. Should prices fall, we would view
this as a “scale-down” buying opportunity.
Zoned Out
Eurozone
finance ministers meeting over the past week-end once again could not agree
on a bail-out package for functionally bankrupt Greece, which runs out of
cash to pay its debts in the next few weeks . . . and even if they could
agree the European Central Bank (ECB) threatens to declare a Greek default if
private lenders don’t share the burden with Greece’s
public-sector creditors.
The
chief risk is that a number of major French and German banks would have to mark
down the value of Greek debt on their books, leaving them undercapitalized
and in need of recapitalization by the ECB to remain solvent. Moreover,
as credit ratings decline for all of the peripheral countries, their rising
interest costs to refinance maturing debt make it all that much more
difficult to keep their heads above water.
Quite
possibly the Greek parliament in a vote of confidence this week for Prime
Minister Papandreou will accept more austerity measures as part of the deal
to win Eurozone funding . . . but even this “favorable” outcome
will only provoke more rioting in the streets of Athens by public-sector
workers unwilling to accept more of the burden of adjustment and a further
erosion in their living standards.
Chances
are the Eurozone finance ministers and European Central Bank will find a way
to postpone the hard decisions that will ultimately end Europe’s failed
experiment with a single currency. But, sooner or later, whatever
happens, it is difficult to imagine a scenario in which gold does not emerge
the winner, even if the immediate short-run reaction is a sell-off in gold,
as we have seen at the start of past financial panics (think Lehman Brothers)
as investors seek the liquidity of cash.
Eyes on the Fed
Meanwhile,
U.S. and world stock markets are now undeniably in a downtrend if not a
full-blown bear market . . . and incoming economic indicators are pointing to
a second phase in what is quickly becoming a double-dip recession.
So
far, most Washington politicos and Wall Street bankers are in denial,
refusing to see the worsening signs of renewed recession. Instead, they
are arguing for restrictive economic policies that, if enacted, would
exacerbate the developing downturn . . . and which the history books would
liken to the policy mistakes of the 1930.
The
Fed also fails to see, at least publically, the writing on the wall - and is
preparing to end its program of monetary easing through the purchase of
government bonds, a program that both creates new money in an attempt to
liquefy the economy and finances the Federal debt at low interest rates
without having to go hat in hand to our foreign creditors.
All
eyes and ears in the gold and world financial markets will be focused later
this week on the June FOMC meeting and Chairman Bernanke’s press
conference for the Fed’s assessment of the economy, inflation and
employment prospects, and any hints of forthcoming adjustments to Fed policy.
If
the Fed, indeed, ends its program of quantitative easing at month-end as
scheduled, it will - in my view - soon be forced by rising unemployment and
sluggish business activity to resume monetary stimulus in one form or
another. Perhaps not QE2 - a second round of quantitative easing might
be difficult to swallow - but a rose of some other name.
We
think the only viable and politically acceptable means for America to dig
itself out of its unbearable burden of excess debt - federal, state and
local, housing, and other private-sector debt - is to pursue a policy of
higher inflation that will deflate the ratio of outstanding debt to nominal
gross domestic product (GDP) to historically acceptable and manageable
levels. Indeed, under Chairman Bernanke’s lead, the Fed is
already quietly pursuing this policy of targeting somewhat higher U.S. price
inflation.
Pursuit
of a mildly inflationary monetary policy will not however excuse the Congress
and Administration from developing a responsible believable program of
long-term spending restraint and deficit reduction. However, now is not
yet the time to impose these restrictions on an ailing economy - though
articulation of a realistic bi-partisan plan for long-run deficit and debt
reduction would help calm world financial and currency markets.
Adjusted
for consumer price inflation, using official government data (data that tends
to seriously underreport actual inflation felt by American households),
suggests that gold should be selling today for at least $2500 an ounce . . .
and considerably more if we were to account for the government’s underreporting
of actual inflation.
Paper Tiger
Europe’s
troubles and the collapse of the euro as we now know it will make the dollar
look good by comparison . . . and a rising dollar against the euro could
briefly dent gold as traders fall back of the historical inverse relationship
between gold and the U.S. dollar exchange rate vis-a-vis competing currencies
in world foreign exchange markets.
But
a rising dollar would be nothing more than a “paper tiger” soon
to be deflated by America’s budget mess, sagging economy, and renewed
U.S. monetary stimulus. As noted at the outset of this brief essay, a
setback for gold should be greeted by investors as another buying opportunity
as it surely would by those central banks wishing to build gold holdings
without disruptively sending gold prices higher.
Hot Summer Ahead
Most
gold pundits are anticipating a traditionally quiet summer of the yellow
metal. Historically, gold prices have exhibited strong seasonality -
with relative weakness in the Northern Hemisphere summer months and maximum
relative strength late in the calendar year. To a large extent, this
seasonal pattern has been a reflection of culturally determined buying habits
in the major gold-consuming countries and regions.
For
example, India - often the biggest gold-consuming nation - usually enjoys a
pick up in gold buying in September when harvests boost income and spending
in the agrarian sector, a sector with a high propensity to buy gold for
jewelry or saving with any excess income that comes their way. Around the
same time begins a string of festivals that continue into May, festivals that
are propitious for marriage, hence requiring gold dowries. These
festivals are also believed by many Indians to be a lucky time to buy gold as
an investment.
Also
in September, in the United States and other Western nations, jewelry
manufacturers begin stocking up and fabricating gold jewelry for the December
Christmas gift-giving season followed closely by the February 14th
Valentine’s day, which is also accompanied by much gold jewelry
gifting.
Around
the same time, the Chinese or Lunar New Year occurring in January or February
heralds in a period of gold demand for jewelry fabrication and gift giving
across Greater China . . . and is also seen by many as a propitious time for
gold investment.
But
these seasonal factors are diminishing - largely because investment demand,
which knows no season, is growing rapidly in importance and, to some extent,
displacing jewelry demand. First, there is the expansion of secular,
long-term, hoarding demand for gold reflecting the growth in incomes in
Greater China and India. As incomes rise, so does demand for gold
jewelry and investment bars, in these countries - which increasingly occurs
independently of seasonal, festival, marriage, or gift-giving considerations.
In
many countries, too, we are seeing an increase in official or central bank
buying: In recent years the list of gold buyers has included China,
India, Russia, and a host of other countries for whom seasonality plays no
role whatsoever in the decision to accumulate gold reserves and diversify
away from the U.S. dollar.
And,
importantly, powerful economic and geopolitical forces that also exhibit no
seasonality are now increasingly governing short-term investment and
speculative trading demand for gold. The extent to which the typical
summer “doldrums” for gold will be overwhelmed by unfolding
economic and political events remains to be seen.
But,
clearly, gold-price direction and volatility will be affected in the weeks
and months ahead by the economic developments discussed above, namely U.S.
monetary and federal budget policies as well as Europe’s sovereign debt
crisis and the coming disintegration of region’s common currency.
Moreover,
what we haven’t talked about the potential for events across North
Africa and the Middle East to trigger a rush into gold - because instability
spreads to Iran and/or Saudi Arabia; because Afghanistan or Iraq deteriorate
into all-out civil war; because democratic reform in Egypt or Tunisia is replaced
with new tyrants less friendly to the West; because regime change in Libya,
Syria, or Yemen herald in worse; or because oil supplies and prices become
less secure.
Clearly,
events in this region are not proceeding as first imagined by Western powers.
So,
it remains to be seen if the coming summer will be a period of calm and
relative stability for gold . . . or a period of great “sturm und
drang” with sharply rising prices and greater volatility. Odds
favor the later.
Whatever
the immediate future holds in store, we remain firmly committed to our
bullish gold-price forecast with the metal trading at or close to $1700 later
this year with still higher prices in the years ahead.
Jeffrey Nichols
NicholsonGold.com
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