Top Seven Bull Points for Gold

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With economic uncertainties on the rise, many are jumping on the bullish bandwagon.

Just a few months ago, most analysts and market participants disagreed with our forecast that the U.S. dollar gold price would hit new highs by midyear.

Until recently, most analysts and market participants also doubted our prediction that gold would hit $1,500 an ounce by the end of 2010. . .and that prices of $2,000 and even $3,000 were likely in the next few years.

Now, with economic uncertainties on the rise, many who earlier disputed our bullish forecasts are now jumping on the bandwagon.

Here, in brief, are the "Top Seven" reasons we see much higher gold prices ahead:

#1—Inflationary U.S. monetary and fiscal policies: America's humongous federal debt will be monetized. There's no other way out.

Foreign central banks and other institutions that have willingly financed America's debt in recent decades are just beginning to re-think their accumulation of more and more U.S. government debt.

Taxes can only be raised so much (and they will be). But after a point, higher tax burdens only reduce economic growth, so that tax revenues actually fall rather than rise.

Spending can be cut here and there—but Americans are not going to give up government entitlements such as Social Security, Medicaid, Medicare, and all the rest.

Official federal debt, now around $12.8 trillion is only a small part of Washington's actual obligations. Off-budget and unfunded future liabilities are another $108 trillion. . .so we're talking about at least $120 trillion in federal obligations—a growing portion of which will be financed by the Federal Reserve purchase of government debt.

Call it quantitative easing or printing money; the end result is the same—higher inflation, currency depreciation and higher gold prices.

#2—Europe's sovereign debt crisis. . .and the increasing role of the European Central Bank (ECB) in financing the public-sector deficits of its least creditworthy member nations: Like the Fed, the ECB will have little choice but to finance Europe's public debt and unfunded public-sector obligations (pensions, healthcare, vacations, and other social welfare programs). And, like the Fed, the ECB will inflate its way out of the European Union's sovereign debt predicament.

The ECB's loss of anti-inflationary credibility and the questionable future of the euro has diminished the European common currency's appeal as a reserve asset and dollar-substitute in the world economic order. Central banks that were increasing the proportion of official reserves held in euros in order to decrease their dependence on the dollar are beginning to rethink the wisdom of this policy.

#3—Central bank reserve diversification: After two decades of selling, at an average rate of some 400 tons per year, the official sector (central banks, the International Monetary Fund and the Bank for International Settlements) became a net buyer of gold in 2009, adding more than 425 tons to official holdings. And, we expect the official sector will continue to be a net buyer of gold for years to come. This year alone, central banks could easily add another 150 to 300 tons to their reserve holdings.

Last year, the People's Bank of China (PBOC) announced it had been buying gold regularly from domestic mine production for several years—but did not report these purchases in its official reserve accounts.

We believe that these purchases, although unreported for now, continue from month to month. Russia and Kazakhstan also continue to buy gold from month to month from their own domestic mining industry—but unlike China, these two countries have publicized their purchases, perhaps to improve their appearance of creditworthiness in world markets, something that the PBOC need not worry about.

It is likely that a number of other central banks are also buyers of gold from time to time, either directly or through sovereign wealth funds, but choose not to report their holdings, like the Chinese, to avoid the positive "announcement effect" that news of their purchases might have on the metal's price.

#4—Rising private-sector investment demand for gold from across the old industrialized world: Private investors in the United States and Europe, both individuals and institutions, are buying more gold reflecting the same concerns and fears that are driving central banks to accumulate the metal.

They are increasingly concerned about the huge deficits and debt of governments on both sides of the Atlantic. . .and that accelerating inflation and depreciating currencies will eat away at their other savings and investments.

Just as the European sovereign debt crisis has gathered steam, we've seen a substantial rise in physical investment demand across Europe—from Germany, Switzerland, France, the United Kingdom and other countries—like the United States. And, just as we've seen on earlier price advances, mints (like the United States Mint, the Austrian Mint, and others; refineries (that manufacture small investment bars); and precious metals dealers report very strong demand from retail investors, so much so that premiums on small bars and coins have risen in recent weeks.

Importantly, as in earlier big advances in this gold bull market, these are mostly long-term investors—and their purchases, unlike those of traders and speculators, are not likely to return to the market anytime soon.

#5—Rising long-term investment demand from India, China, and other newly industrialized nations: Gold has historically been a preferred medium of savings in India, China and many of the other Asian countries. As incomes rise, as more people enter the middle class, and the numbers of truly wealthy increase, it is only natural to see some of this money flow into gold.

Both India and China, because of their huge populations and the movement of millions of people from poverty to middle class, and from rural areas to the cities, have tremendous potential in terms of the volume of gold investment that will be purchased in future years.

For gold savings and investment demand in these countries to grow requires only moderate growth in personal income. Inflation or financial market uncertainties are not required, though their presence may encourage even more savings-related demand.

We believe the economic outlook for in these countries is propitious for gold. Cautious measures to counter excessive speculation (in real estate or equities, for example), prevent overheating, restrain inflation and will keep these economies growing at moderate rates that will benefit gold demand in the years ahead.

#6 –Developing gold investment infrastructure in many countries around the world: New gold investment products and channels of distribution are making gold more readily accessible to more investors, both individuals and institutional investors.

For example, gold exchange-traded funds, that allow investors to purchase gold via an equity-like vehicle, were introduced only six years ago. Now there are more than 18 such funds traded on many stock exchanges around the world—and a new gold ETF is just now being launched in Japan. Since their introduction, the total quantity of gold held on behalf of ETF investors has grown to more than 62 million ounces, more than is held by the central banks of all but four countries.

Another example: In China, private gold investment was legalized only three years ago after five decades of proscription. Now, not only is gold investment legal, it is encouraged by the central government. Five national banks have been authorized to trade gold and make gold investment products—small wafers, bars, coins, passbook programs and accumulation plans—available across China. In addition to these banks, physical gold is also available to investors at stand-alone gold investment retail shops and at department stores.

Similarly, in India, we are seeing the introduction of new products in the past few years, including a gold ETF traded on the Mumbai Stock Exchange, as well as online physical investment products offered online by a number of financial service firms. Beginning in September the postal service there will begin selling small coin-like medallions at post offices in rural agrarian communities where there is great interest in gold but a paucity of banks and financial firms for savers to purchase the metal.

We believe these new products and distribution channels will result in far more gold investment offtake in the years ahead, so much so that the potential future price is far greater than most analysts and investors today think reasonable.

#7—Declining world gold-mine production: Global gold-mine production has been in a downtrend for decades. Despite a small uptick last year and possibly again this year, the fall in world mine output will continue for at least for the next five years or more.

The ebb in mine production reflects many factors, including the depletion of existing deposits, the continuing drop in ore grades, the decline in operating depths at many mines, the rise in energy and labor costs, the expense and time required to meet increasingly restrictive environmental regulations, unfriendly government attitudes toward foreign investment in some gold-producing countries, and the lack of financing available to many gold-mining exploration and development.

Jeffrey Nichols
Managing Director, American Precious Metals Advisors and NicholsOnGold.com
Senior Economic Advisor, Roseland Capital LLC
[email protected]
[email protected]

Top Seven Bull Points for Gold

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