Drop in price makes gold more attractive to long term investors - Nichols

The recent decline in gold prices is more typical of the northern summer hiatus than a sea-change in pattern and price dips remain excellent buying opportunities for the gold investor.

LONDON - 

In a note for precious metals asset firm, Rosland Capital, gold analyst Jeff Nichols comments on the fact that gold prices have fallen sharply in recent weeks from their all-time high over $1,265 on June 21st in New York, but that he feels that this is primarily a consolidation, before the metal moves up to higher levels both later this year and onwards for the foreseeable future.  

"Faint-hearted gold investors need to remember that bull markets never move straight up", says Nichols.  "When they do, it's called a "bubble" ... and bubbles do burst.  Instead, this market is moving up just like we predicted: in a stepwise pattern with volatility and big corrections and big potholes on the road to much, much higher prices in the months and years to come."

Mineweb has also commented on the stepped pattern of advance in the past, and that the northern summer months tend to be a lacklustre time for the gold price anyway, with many traders taking holidays and thin markets.  Perhaps the real surprise was the June high point at a time of the year when we would expect prices normally to be weaker.

Nichols reckons that for the most part, gold-price weakness reflects:

1. The reassessment of U.S. economic prospects by some gold traders and investors.
2. An abatement in perceived European sovereign risk.

But, he also feels that the economic news in recent weeks (particularly indicators of retail sales, consumer demand, business inventories, home prices and residential construction) has prompted rising expectations of an intensified U.S. economic downturn -- the so-called "double dip" -- and with it, rising concern about U.S. consumer price deflation.  This is a bit of a two-edged sword though.  Markets in general have been going through a volatile patch and gold investors obviously have mixed views on what this means, while some gold liquidation may have been necessary to cover other financial commitments.  It is, after all, investment demand which is driving the gold price.

In Europe, meanwhile, a successful (relatively) 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, reversed reckons Nichols, but none of this has, in any way, reduced his long-term bullish view of gold-price prospects.  

Indeed he feels the recent price weakness -- 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.

While price inflation has remained pretty well under control, and many economists seeing deflation as more of a threat than inflation, Nichols still feels the contrary is the principal likely outcome of current policy, even though there is an expectation of another U.S. business cycle downturn followed by perhaps years of sub-par economic growth for the U.S. economy.  This is in direct contrast to spin coming out of the U.S. Fed, but it is in the government's interests to try and talk up confidence in the economy.  As Mineweb has often pointed out before, if confidence in the economy can be maintained, then perhaps the seemingly inevitable can be postponed indefinitely.  But as more and more economic indicators turn negative it is hard to see how this degree of confidence will continue longer term.

"Inflation" says Nichols "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."  

Those who deny the eventual inflation scenario reckon that it will not be a problem because there is 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.  But, this goes against 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.  Again, this is down to confidence.  While Mineweb does not feel hyperinflation is the most likely scenario, the huge increase in money supply would seem likely to start the inflation ball rolling - but when this will start to happen is uncertain.  Perhaps as the realisation takes hold that many U.S. states are facing similar deficit problems to the European PIIGS and that the U.S. is not insulated from problems which have beset the Eurozone, then confidence in the U.S. economy, and the dollar itself, will again start to decline. 

Nichols ends his comments as follows "Today, we are witnessing a loss of confidence in the dollar both at home and even more so abroad, that 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."

One just hopes that such a loss of confidence doesn't turn into a rout, but if it does the long term effects on the gold price could be enormous.  Even with a controlled inflation rise gold could be expected to at least maintain its value vis-a-vis the dollar which is why so many big investors nowadays have a significant gold holding as part of their portfolios.

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Gold commentary One of the best recent articles and commentary on gold. We've shared this on for you to our audience. Thanks and regards, MyCommodity.com by MyCommodity on July 22 2010, 10:57 Find this comment inappropriate? Report it

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