Global Inflation Rising and Other Pro-Gold Developments


"Recently, the Fed surpassed China as the largest holder of U.S. Treasuries."

Clients and readers of should not be surprised by gold's recent rebound. In late January, as gold was testing recent lows near $1,310 an ounce, we said "the fundamentals suggest much higher prices ahead" with "market activity strengthening the case for a surprisingly sharp snapback and new all-time highs later this year." Indeed, we anticipate gold will retake its all-time high near $1,432/oz. in the months ahead and reach $1,700 later this year on its way to $2,000/oz. in 2012. . .and still higher prices in the next few years. (Readers interested in frequent brief analysis, commentary and insights are invited to follow us on [email protected]).

Global Inflation Rising
One of the key forces contributing to expected gold-price strength is the acceleration in inflation now underway around the world.

It seems that almost everywhere—except here in the United States—inflation is on the rise. We now read daily about the rise in agricultural, energy, and industrial commodity prices from one country to the next—and the consequential acceleration in consumer prices. China, India, Brazil, the United Kingdom and the Eurozone economies make the newspapers because these are the largest economies after the United States and they are the most populous, too.

But, less noticed outside their own borders, one country after the next, is suffering from higher prices, especially for food and energy—and the acceleration of inflation in some countries is beginning to have broader social and political consequences as we have seen recently in Tunisia and Egypt.

Today's global inflation is largely a consequence of U.S. monetary policy and the unbridled flood of dollars into the world economy on the one hand. . .combined with an unwillingness among central bankers in the other big economy countries to allow upward appreciations of their own currencies.

Just as in the United States, central bankers in these countries prefer economic expansion and happy workforces to low inflation with higher unemployment. And, though some—China, India, and Brazil, for example—are raising interest rates and restricting bank lending, these measures are intentionally insufficient to greatly restrain future economic growth and, thus, insufficient to restore price stability in their respective economies.

It's no wonder that smart savers and investors in China and India are buying hundreds of tons of gold a year—and will likely continue to do so even as gold prices move significantly higher.

Anyone worried about inflation should be worried about the fantastic growth in the Fed's holdings of U.S. Treasuries. Recently, the Fed surpassed China as the largest holder of U.S. Treasury securities—and by mid-summer, the Fed will likely hold more Treasury securities than both China and Japan combined.

The explosive growth of U.S. Treasury securities—T-bills, notes, and bonds—held by the Federal Reserve is the flip side of the central bank's policy of quantitative easing. The Fed has now replaced foreign central banks as America's financier, funding our Federal budget deficit by creating new money.

This is a policy that must eventually result in a significant erosion in the greenback's purchasing power brought on through a depreciation of the U.S. dollar in world currency markets and an acceleration of inflation here at home—an acceleration that is bound to occur irrespective of continuing economic slack, high unemployment and low capacity utilization.

Other Pro-Gold Fundamentals
In addition to rising global inflation and inflation-fueling U.S. economic policies, other on-going trends in the world of gold will also contribute to higher prices later this year and beyond:

Continuing strong gold demand for jewelry and investment—even in the face of higher prices—from China, India, and other gold-friendly Asian and Middle Eastern nations. Demand from these countries is driven by rising household incomes and rising inflation expectations—and these trends are likely to persist for some time to come.

Continuing official purchases by China, Russia and other cash-rich central banks with "underweighted" gold reserves. Central banks tend to buy on dips when their purchases are least likely to disrupt the market—and official demand in recent weeks with prices near $1,320 helped stabilize and reverse the short-term price decline.

Expanding investment demand from a small but growing segment of retail investors in the United States and Europe who are worried about rising inflation and currency depreciation. . .and from hedge funds and other institutional investors who understand gold's bullish fundamentals.

Given the relatively small size of the gold investment market relative to world stock, bond markets or major currency markets, a very small shift in portfolio preference away from conventional assets toward gold may have a negligible effect on the stock and bond markets—but a big affect on the gold price.

Easier access to gold through new investment vehicles, especially exchange traded funds, is promoting the growth in gold investment from one country to the next. Even India and China are jumping on the bandwagon with new ETFs denominated in local currencies and weight units familiar in each country.

Imagining the Unpredictable
In addition to these somewhat predictable gold-positive trends, unpredictable geopolitical developments could, under certain circumstances, have an overwhelming affect on the price of gold.
  • What if Egypt sinks into a prolonged period of social and political chaos?

  • What if the Suez Canal is threatened or closed by political developments or by terrorism?

  • What if similar spontaneous revolutions erupt in Lebanon, Yemen or Saudi Arabia, the world's largest source of oil?

  • What if new governments in the region threaten Israel militarily?

  • What if Iran takes advantage of the political vacuum created by these popular uprisings?

  • Or, in other regions. . .

  • What if North Korea launches another, but more serious, assault on the South?

  • What if North Korea launches another, but more serious, assault on the South?
And, closer to home. . .
  • What if Congress and the Obama administration fail to make any significant progress in balancing America's federal budget deficit, triggering a flight from the dollar?
Any of these events are certainly plausible—and there are many others we simply can't imagine—but each has the potential to send gold skyrocketing.

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

Global Inflation Rising and Other Pro-Gold Developments

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