Gold continues to consolidate near recent highs despite profit taking falls. It remains near record highs in British pounds, euro (03-Feb-09 London AM Fix: $902.00, £636.02, €702.93 - ) and many other currencies internationally as fiat currencies come under pressure due to the unprecedented zero percent interest rates, quantitative easing, bailouts and stimulus packages.

Increasing fears of protectionism from the Obama White House may lead to the dollar coming under renewed pressure and see gold prices rise above $1,000/oz early in 2009.

The EU, Canada and others have warned that the Buy American clause in the US economic recovery package could promote protectionism. This will not be liked by the US’ many very large creditors – especially the Chinese. They currently only have 1% of their currency reserves in gold and are on record saying they are going to diversify into gold. It is likely they have been nibbling in the gold market for some months but their buying may become more robust in the coming months as they are understandably concerned about the value of their dollar denominated government debt.

The old market adage as January goes so goes the year bodes ill for stock markets this year. Stock markets in the US had the worst January ever with the Dow Jones and the S&P 500 down by some 8%. Gold, after falling in the first few days of January, rallied from $806/oz to over $900/oz and ended the month up by 2%. Silver surged by over 8.6% in January ($11.38/oz $12.36/oz) – see Performance Table.

The US bond market began to come under serious pressure in January and this does not augur well for US bond markets and the dollar in the coming months. The US 10 year bond fell sharply in price and saw yields rise sharply from 2.087% at the end of December to over 2.84% on January 30th. It could be that the so called bond vigilantes are finally waking up to the fact that government bonds and currencies are being debased as never before. Bonds remain near all time record yields and remain one of the largest bubbles in the world. Especially with Bernanke saying that they will monetize the debt and print money to buy their own bonds. This will not please creditors of the world’s largest debtor nation.

Non Inflation Adjusted Gold Chart 1971-2009

It is important to remember that gold is correlated with US interest rates (see strong correlation since 1971 in charts below) meaning that when interest rates are very low for a period this tends to create inflationary pressures necessitating higher interest rates as was seen in the 1970s. As interest rates move up (and bonds fall in value), gold moves up as well as it takes many months for interest rate changes to have the desired effect and wrong inflation out of the system. Thus in the 1970s, interest rates had to rise to 14% in early 1980 before investors and savers were incentivised to start holding US government bonds and deposits again.

This is likely to happen again and the gold bull market is only concievable to end when deposits and bond markets offer an attractive yield in order to incentivise savers and investors to hold these assets again. Especially in the light of the unprecedented counter party and systemic risk confronting us today.