In the midst of this economic turmoil that has shaken the world; we have witnessed gold bounce above $1000 and dip as low as $700 in the same period. Concerns have risen and arguments have been increasing as to the effects of this economic turmoil. It is widely believed that the current contraction facing the US and many global economies is a depression, for the mere fact that the billions of dollars being spent is not enough to create the optimism to jumpstart the economy to the upside. Commodities have taken a major hit in this time period, with the CRB index falling more than 40% since its peak in 2007.
Metals have also taken a major hit in this crisis period. The main question at hand is if these prices would rise again? Clearly commodities across board have impaired fundamentals, the current cost of producing most commodities are currently above the prices at which they are sold, and though demand may have slowed, if prices continue to be this low, the world faces a major food crisis within the next 5 years. Another fact at hand is the likely rise of inflation in the world, most especially the US. The US who seems to be taking probably the largest hit from this downturn has gone into a state of frenzy in trying to stop a complete meltdown of the financial sector and the economy as a whole. The Treasury department has not hesitated much in throwing billions of dollars in tax payer’s money to ailing financial companies. Most famous is AIG who is getting a fourth revision of their bailout package from the government, after declaring an astounding loss of $61 billion. There’s also the talk of US government stimulus to the tune of $800 billion for 2009/2010.
So why is the spending of this money of any concern? Given the fact that the US is not making a lot of money currently, the government will have to issue bonds, increase taxes and/or print the money to fund these projects outlined. From the current increase in interest rates of T-bills, we can infer that the demand for government bonds have slowed down, a part of the stimulus plan is to cut taxes, ruling out the second option for raising money, so we’re left with the government having to print this money. If one reviews the Fed’s monetary base, we will see this chart taking the form of a hockey stick, pointing to the fact that a lot of money has been printed so far to loan to foreign governments, fund internal projects, and make purchase. We will see that the Fed’s monetary base has increased more than fivefold in the past one and a half years. Now except one believes that the government will print “just enough money” that’s needed to revive the economy, then we need not have any concern, however from the past behavior and observed prior behavior, this is never the case. The government has clearly displayed its inability to manage cash wisely (just by reviewing the AIG bailout).
With more cash injected in the system than what is needed, the US dollar will lose its value and the US will be faced with the plight of double digit inflation. Deflation/deflationary pressures is probably the main scare now, but if one takes time to review the fundamentals, especially in commodities which are mainly used as raw material input, with increased availability of cash, prices will have to rise swiftly in order for the fundamentals to align.
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Observing the chart of the gold comex futures, we can spot a clear bull market for gold. Like every bull market, there are huge corrections in the price of the commodity; however something that can be clearly seen is a clear uptrend line. Some may argue that with a recovery in the economy, the concern to hold gold as a safe haven will be reduced, this will be true if it is also expected that US GDP will be able to provide an equivalent strength in supporting the US dollar. However careful research and analysis shows that the fundamentals of the US dollar are currently flawed, and the current spending pattern of the government will push the US into inflation, which will in turn make the dollar extremely worthless, at which point demand for gold would rise given that there is less than 3 ounces of supply of gold for everyone currently in the world, fundamentally, the economics supports the price, expected inflation will also act as a buoy.
For as long as we see corrections in the price of gold, we should probably welcome these as opportunities.