Gold to Replicate Oil's Parabolic Move

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...In this kind of environment, with inflation expectations running high as well as multiple looming bank failures, there really is no limit to how high gold can go. Would it surprise me to see $1500-2000/oz by year end? No...

With multiple bank failures looming and the US government doing nothing but take on bad debt and assets onto their balance sheet, we are looking for new lows in the US dollar as the fundamental backdrop of the US financial system continues to worsen by the day. Inflationary pressures continue to mount with oil and food hovering near their all-time highs, and the US continues to be hardest hit with respect to inflation due to the high cost of imports based on the declining purchasing power of the dollar. Note that while Europe, for example, has to pay the same $145 for a barrel of oil that we do, their currency has also appreciated almost 20% since last year, thereby mitigating some of their inflationary pressure.

Furthermore, with the US posting its sixth straight month of job losses in June, and the employment picture getting seemingly worse by the day, you can expect the unemployment rate to start ticking up toward 6% by year end. Take into consideration that these looming bank failures will definitely lead to large job losses in financial services, in addition to the layoffs recently announced within the energy-sensitive transportation sector, i.e. airlines and car companies like GM (GM).

In essence, what is happening is that the US government is taking on very large amounts of debt at the same time that their revenue base (i.e. tax collection) is declining due to higher unemployment and high inflation, which curbs consumer spending on discretionary items and hence produces slower growth for US corporations and therefore less corporate tax generation. Think of the US as a large company with debt levels climbing significantly and revenue and profit declining. What usually happens in a situation like this? Well, lenders usually begin to become much less willing to lend capital at prevailing rates, and at the same time the debt-laden institution is more likely to want to raise additional capital to maintain sufficient debt to equity ratios (and/or bailout failing financial institutions. The rising debt levels coupled with declining income lead to the perception of higher probability of default (even if slightly), and the higher probability gets priced into borrowing costs in the form of higher rates needing to be paid to lenders...

Now looking at the trades, gold has several things going for it on a fundamental as well as technical basis. First off, we are in a financial storm predicated on worries over the soundness of financial institutions and the inherent value of the US dollar. This is the perfect backdrop for gold, as global investors tend to run to the yellow metal as the ultimate safe heaven in times of uncertainty within the financial system. Secondly, inflation expectations remain high and the dollar continues to weaken. Thirdly, central bank diversification out of US bonds is likely to benefit gold as central banks tend to increase their gold holdings in times of uncertainty and environments where risk aversion is prevalent...

Hence, with fundamentals as well as technicals in place, we believe that gold has potential to become the new oil going into year end, and are looking for a very strong double top breakout over 100 in the GLD very soon.

In this kind of environment, with inflation expectations running high as well as multiple looming bank failures, there really is no limit to how high gold can go. Would it surprise me to see $1500-2000/oz by year end? No. Based on these assumptions, we have been buying the September 100 GLD calls here and will likely sit on these until gold breaks out over $1000...

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