by Tom Power
Gold has been in a bullish trend this year, up about 12 percent year-to-date. I think the price of gold is likely to hit $1,300 in the next six months as there are many reasons investors find owning gold attractive.
1. The U.S. Dollar is Falling
Investors no longer seem worried about inflationary pressures. They do, however, seem more concerned about the devaluation of the U.S. dollar, and historically gold has been the asset of choice for investors who lose faith in their currency.
Since December 2008, the Federal Reserve has kept its benchmark short-term interest rate at zero to 0.25 percent to counter the recession. During that same time period, gold has seen a gain of more than 50 percent. Market participants anticipate that continued weakness in the U.S. economy will cause the Fed to significantly expand stimulus efforts through further easing measures, and this is likely to cause a further drop in the dollar. This trend has been evident over the last several weeks as gold reached a one-month high above $1,220 an ounce. It appears the positive correlation of gold to the euro is re-establishing itself as the dollar continues to trend lower.
2. Inflation Could Return
Earlier this year, investors feared ongoing fiscal and monetary stimulus measures would lead to rising prices and shrinking consumer power. Many experts had predicted that the stimulus spending of the U.S. government and the Federal Reserve since 2008 would spark a potentially huge rise in prices. So far, it hasn’t happened, but that doesn’t mean that it won’t return eventually.
As the dollar continues to fall, so does our number of jobs, wages, and ultimately, our purchasing power. The huge trillion-dollar budget deficit (and promises of future spending) is spiraling out of control and leading to the steady erosion of the value of our currency. The slightest signal of rising inflation could be enough to send gold to record highs.
Short-term, there is still more concern about deflation than inflation. But the economy hasn’t stabilized, and gold is a good safe-haven against economic uncertainty. So even with a deflationary period in the U.S., I think gold is still a good long-term investment. Keep mind, while inflation is not yet a factor in the U.S., inflation is heating up in emerging economies, such as China, India and Brazil. India’s benchamark index of wholesale prices rose 9.97 percent in July, and had been running in the double-digits since February.
3. Central Bank Buying
The Central banks of India, China, and other developing nations have been purchasing huge quantities of gold, in part to diversify against the U.S. dollar. China is the sixth largest official owner of gold in the world, with just over 1,000 metric tons, which amounts to less than 2 percent of total reserve assets. European central banks in particular have had large stocks of gold as part of a legacy from the Gold Standard days, and have been selling those through central bank Gold Agreement Programs since the late 90s. Their sales have now slowed to negligible levels, and we’ve seen new interest from emerging market countries.
So essentially what we’re seeing is a very important structural shift, both in terms of a slowdown in sales by the Europeans and the emergence of new buyers. If these nations were to boost their gold holdings to 10 to 20 percent of reserves, this would represent a tremendous amount of demand for the precious metal.
4. Futures Indicate Rising Demand
The futures market seems to indicate that investment demand will remain strong in 2011.
According to the latest data from the Commodity Futures Trading Commission (CFTC), the speculative long positions for COMEX gold futures rose for the second week in a row. Gross long non-commercial gold positions on the exchange amount to 747 tonnes as of the first week in August, up 7 tonnes from the previous reporting period. This is the first week-to-week increase in speculative long positions since mid-June.
From a technical perspective, bulls have gained upside technical momentum recently. Gold prices are in a three-week uptrend on the daily bar chart. The bulls’ next upside objective is to produce a close in December futures above $1,250. Bears’ next downside price objective is closing below solid technical support at $1,200. I see first resistance at the high August 16 at $1,229.50 and then at $1,240. Support is seen at $1,220.00 and then at Monday’s low of $1,216.20.
5. Individual and Institutional Investors Chasing Momentum
Nobody wants to be on the sidelines when it looks like everyone else is a buyer! In the U.S., we’ve seen a huge increase in the demand for gold–everything from exchange-traded funds to gold coins. You know there’s something major going on when “we buy gold signs” are popping up at your local convenience stores. In the past year alone, the U.S. mint has sold over a million one-ounce American Eagle coins, which is up 31 percent from 2008.
There are many different ways for you to take advantage of opportunities in gold, but I believe it will be the futures contracts that give you the purest play, and allow traders the most amount of flexibility to take either bullish or bearish positions. Ideally, I would recommend look for a pullback to recommend buying, but corrections could be shallow.
Gold futures have been an attractive vehicle for many investors due leverage and volatility. Futures offer the ability to buy or sell a contract for 5 to 15 percent of its total contract value down (known as margin). This leverage provides you with a potentially high rate of return for a relatively small investment. However, substantial risk accompanies this potential for high rates of return. So you will need to monitor your positions closely, or work with a trusted broker who can act as an advisor. Please feel free to contact me if you would like to talk about future opportunities in trading.
Tom Power is a Senior Market Strategist with Lind-Waldock. He can be reached at 800-682-8325 or via email at tpower@lind-waldock.com.
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