GOLD's Summer Consolidation


"Bull market alive and well."

Gold prices have fallen sharply in recent weeks from their all-time high over $1,265 on June 21st in New York. By mid-July, gold was briefly below $1,180—a drop of some 7%.

Fainthearted gold investors need to remember that bull markets never move straight up. When they do, it's called a "bubble". . .and bubbles do burst.

Instead, this market is moving up—and will continue to move up—in a stepwise pattern with occasional high volatility and big corrections on the road to much, much higher prices in the months and years to come.

For the most part, this summer's gold-price weakness reflects two recent developments: First, the reassessment of U.S. economic prospects by some gold traders and investors. . .and, second, an abatement in perceived European sovereign risk.

The economic news in recent weeks (particularly indicators of retail sales, consumer confidence, business inventories, housing starts, home prices, residential construction, etc.) is prompting rising expectations of an intensified U.S. economic downturn—the so-called "double dip"—and with it we are seeing renewed and growing concern about U.S. consumer price deflation.

Meanwhile, across the Atlantic, a successful refunding of some Greek government debt brought a collective sigh of relief from world financial markets. . .and the rush from Euros into safe-haven assets, namely the U.S. dollar and gold has, for now, abated.

None of this has, in any way, reduced our long-term bullish view of gold-price prospects.

In fact, the recent selloff—and any further short-term price decline that may occur in the next few days or weeks—simply makes gold that much more attractive to long-term investors.

Double Dip to Stagflation

Unlike mainstream economic forecasts—and indirect opposition to the public predictions of Fed Chairman Bernanke, Treasury Secretary Geithner, and the Obama Administration's economic minions—we have long expected another U.S. business-cycle downturn followed by years of sub-par economic growth for the U.S. economy.

As readers know, we've long held the view that the U.S. economy would sink back into recession or, at best, a long period of sluggish growth insufficient to produce any meaningful gains in employment.

Longer term, we see years of "stagflation" for the United States and European economies—with sub-par economic growth, unacceptably high unemployment, and a troubling rise in inflation led by higher prices for many commodities, much like we saw in the 1970s.

For more on our U.S. economic forecast, see our recent post Gold and the Double Dip.

More Inflation Ahead

And, unlike most mainstream economic forecasts, we see accelerating inflation—NOT deflation—on the road ahead.

Inflation is the flipside to the monetization of Federal government debt, rapid money growth, and a loss of confidence in fiat money. As the supply of U.S. dollars continues to grow more rapidly than the demand for money, each dollar becomes worth less (or some would say "worthless") and the general price level rises.

Not only is the demand for dollars growing less rapidly at home due to sub-par business activity, high unemployment, a rising savings rate, and a loss of confidence in the economy and those in the economic driver's seat. . .but the demand for dollars from America's chief financiers, especially foreign central banks and in particular the People's Bank of China, is also slowing—and this, along with a weakening U.S. economy, will push the Fed into a still-more expansionary and inflationary mode.

Deflationists and inflation doves say that we needn't worry about inflation—because with so much slack—idle capacity and unemployment—in the economy, there's plenty of room for rising economic activity and money supply growth without inflation.

What they have forgotten is that throughout thousands of years of recorded economic history most periods of persistently high inflation have occurred not when the economy was growing vigorously but when the economy was sluggish or sinking. . .and confidence in money was eroding.

Today, we are witnessing a loss of confidence in the dollar both at home and even more so abroad, which is capable of driving inflation higher even in the absence of high rates of capacity utilization and low rates of unemployment. This loss of confidence has already contributed to the rise in gold prices over the past few years. . .and will continue to drive gold still much higher in the years to come.

Back to Europe

Returning to the causes of the current gold-price correction, we also think the abatement in perceived European sovereign risk has nearly run its course. Rejoicing that Greece completed its latest sovereign debt refinancing without a hitch will soon be replaced with new worries as other countries come to the financing trough and find the markets less accommodating.

It went without much notice last week when Portugal was again downgraded by one of the debt rating agencies. And it went with even less notice this past weekend when Hungary's talks with the IMF and the European Union over financial aid and debt reduction broke down in disagreement.

Europe's sovereign debt crisis will soon heat up as other countries are downgraded by the rating agencies, as German remains recalcitrance to bail out the more profligate euro-zone nations, and even more unwilling to help other EU members that retain their own currencies, like Hungary and Poland, bridge their sovereign financing requirements.

Indeed, Germany is calling on other European nations to tighten their own fiscal seatbelts by cutting spending and raising taxes. This is a roadmap to slower economic growth if not outright recession—and is likely to lead to a worsening of the sovereign debt crisis, continuing downgrades by the ratings agencies, and further capital flight into gold by Europeans and others seeking protection from increasing difficult times for Europe's economy and common currency.

Jeffrey Nichols
Managing Director, American Precious Metals Advisors &
Senior Economic Advisor, Rosland Capital LLC

GOLD: Summer Consolidation—Bull Market Alive and Well

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