Gold Hits Fresh Record; Debt Ceiling Stalemate, EU Crisis to Give Tailwinds

   on July 18 2011 9:47 AM
Five-tael (6.65 ounces or 190 grams) gold bars are seen at a jewellery store in Hong Kong in this April 21, 2011 illustration photo.
Five-tael (6.65 ounces or 190 grams) gold bars are seen at a jewellery store in Hong Kong in this April 21, 2011 illustration photo. Credit: Reuters/Bobby Yip

Spot gold prices touched a new record high of $1598.41 on Monday, extending the longest rally in about 40 years.

The latest wind in the tail came from worsening worries of a European sovereign crisis and the painful stalemate in the US debt ceiling talks that has raised the specter of an unprecedented Treasury default.

Natalie Robertson, a commodities analyst at ANZ, told Reuters that gold could go up to $1,650 in the short term on macro concerns and chart strength.

But that is a conservative estimate. There are a lot of people who are more bullish on the yellow metal. According to them the setting is now perfect for an unprecedented gold boom. Some even think gold will now get into a super cycle as its value as a de facto currency is now firmly entrenched.

A whole lot of classic factors are supporting gold all the way, like the demand from China and India, continued worries for the US dollar and the worrisome prospect of sovereign default in some European countries.

There are also more potent short to medium-term factors positively influencing gold boom. Let's have a look:

First, the US debt talks are stagnating and until the issue is resolved there will be residual strength for gold as a safe haven investment.

It is safe to assume that the Congress will indeed eventually raise the debt ceiling, as not doing so will lead to an unprecedented situation of the US Treasury running out of money. If the ceiling has been raised several times in the past, why not again? The end result is a winner deal for gold.

When the debt ceiling is raised, it will lead to more inflation, which will make gold even more attractive.

On the other hand, if the ceiling is not raised, it will result in the US debt downgrade. And that will be a perfect recipe for a gold boom, as the yellow metal will consolidate its position as the favored safe haven.

A Kitco News Gold Survey, in which bullion dealers, investment banks, futures traders and technical chart analysts participated, showed that a vast majority thought prices will go up further. Out of 22 participants, 15 believed that gold prices were set to shoot higher.

Second, the Federal Reserve has kept open the door for another round of fiscal stimulus after the expiry of the second round of quantitative easing. If the Fed pumps more money into the market the US dollar will lose more value, and set the ball rolling for another commodity boom cycle, which will translate immediately into higher prices for gold.

If the Fed wades further into muddy stimulus waters, that will set the stage for a certain gold boom in the short to medium term. Historically, a dollar sell-off has been the biggest force behind a gold boom. If the Fed takes recourse to another round of easing in pursuit of its goal of propping up job creation and real growth, it will inadvertently cause a dollar sell-off and trigger, in turn, a gold super rally.

Gold had zoomed to record highs and held momentum in consecutive sessions when the Fed announced the second round of quantitative easing in November last year. Fed Chairman Ben Bernanke said last week that several untested means could be deployed to stimulate growth if conditions did not improve.

A dollar sell-off in the United States and a sovereign debt crisis in Europe will make a heady combination for gold to zoom into further heights. Some analysts think the situation in Europe is grave, with the Italian debt market turmoil shaking up the European markets in the last week.

“The next few weeks will be crucial, on both sides of the Atlantic. In the US, the debate about the debt ceiling will likely intensify ahead of the August deadline. In Europe, policymakers need to show a greater sense of urgency as contagion in the peripheral markets reaches a new dimension, said Barclays Capital analyst Ajay Rajadhyaksha in a note to clients.

And then, the fourth factor that sets the stage for another gold boom is Chinese inflation. Facing down unprecedented inflation, the Chinese are buying gold in truck loads. China kept hiking interest rates since October last year, but inflation is refusing to be tamed. As of June inflation surged to a three-year high of 6.4 percent. Alarmed Chinese are virtually transforming their savings into gold. It is estimated that China will surpass India as the biggest gold buyer this year.

If China decided to devour gold, there is no end in sight as far as the rise in gold prices is concerned. Apart from individual Chinese, the government has also been in a gold investment overdrive.

This is part of the Chinese strategy to diversify its reserve wealth away from a crumbling dollar. China holds trillions of dollars worth of foreign exchange, and most of this is held in dollars. If China decides to convert a big chunk of its reserves into gold, the yellow metal will zoom.

We expect prices to test new highs despite the seasonal weakness in demand, a Barclays analyst said in a research note.

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