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Short Term Gold Market Outlook

Don't Buy Gold. . . Yet

Written by Luke Burgess
Posted July 31, 2009 at 6:20PM

Long-term trends point to gold prices over $1,000. . . $2,000. . . maybe even over $5,000.

But in the short-term, investors may need continued patience.

Over the past few weeks, the price of gold has been bouncing between $900 and $950 an ounce. And, following a brief visit to the higher end of that range, gold could once again slip below the $900 level. Here's why. . .

The demand for physical gold from the jewelry, industrial, and dental sectors has significantly fallen.

Official figures from GFMS, the world's top authority on gold supply and demand, showed a 24% drop in gold demand from the jewelry sector during the first quarter, compared to the same period of last year. GFMS data also showed a 31% drop in gold demand from the industrial and dental sector for the same period, compared to the previous year. Global gold demand figures for the second quarter of 2009 will be reported around this time next month.

Gold demand from the jewelry, industrial, and dental sectors will likely remain weak in the short-term, considering the relatively high price of gold, a weak global economy, high volatility in the market, and the seasonal lull, which is typically experienced in the summer months.

Meanwhile, there is a fairly large long position on the Comex gold futures market, which may be significantly reduced in size over the next few weeks, as speculators continue to move back into equities. U.S. stocks rallied yesterday, sending the Dow Jones, NASDAQ, and S&P 500 to their highest levels of the year.     

I'm not convinced, however, that there is much hope for a real recovery in the economy. Sure there's plenty of spin in the mainstream financial media, whose job it is to support their advertisers. But the real situation remains pretty dire.

The U.S. government is projecting a $1.84 trillion deficit for this fiscal year that ends September 30. Meanwhile, national public debt just crossed $11.6 trillion — and is growing by almost $4 billion per day.

Where will the government get the money to pay back this enormous debt and balance the budget?

Nobody knows.

The U.S. federal government claims to hold 8,133 tonnes of gold in reserves. At current prices of about $950 an ounce, this gold reserve is worth $272.5 billion. That's only about 2% of the national public debt, which doesn't factor in other finacial obligations like Social Security and government-sponsored healthcare, and is estimated to cost up to an additional $60-$65 trillion in the future.

If the government wanted to pay off the national public debt with the gold reserves that the Fed claims they have, it would have to sell each ounce for $40,580.

Government insiders knows just how dire the situation is, even if their voice is suppressed by the mainstream media. Director of the US Congressional Budget Office Douglas Elmendorf recently wrote in his blog:

Under current law, the federal budget is on an unsustainable path, because federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the population will cause federal spending to increase rapidly under any plausible scenario for current law. Unless revenues increase just as rapidly, the rise in spending will produce growing budget deficits. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress economic growth in the United States. Over time, accumulating debt would cause substantial harm to the economy....

...The current recession and policy responses have little effect on long-term projections of noninterest spending and revenues. But CBO estimates that in fiscal years 2009 and 2010, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of those deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010. This higher debt results in permanently higher spending to pay interest on that debt. Federal interest payments already amount to more than 1 percent of GDP; unless current law changes, that share would rise to 2.5 percent by 2020.

So for now, we'll probably see gold move lower in the short-term. However, it's important not to lose sight of the big picture, which continues to be very bullish for gold.

The gold market is becoming increasingly dependent on investment demand. This is something that we've been expecting for quite some time.

As we've discussed before, the lives of gold bull markets play out in three main stages, which generally overlap:

Stage One: Currency Devaluation
Stage Two: Growing Investment Demand
Stage Three: Speculative Mania Buying

So far in today's gold bull market, we've seen strong evidence of the first two stages.

A dramatic drop in the value of the U.S. dollar against other world currencies has lifted gold prices over the past eight years. This devaluation is evident in the 42% drop of the U.S. Dollar Index, a measure of the dollar's value against six world currencies, between the summer of 2001 and spring 2008. The dollar rallied between the summer of 2008 and spring of this year, as foreign investors bought the greenback as an alternative to their own less stable currencies in the global recession. However, due to macroeconomic issues, such as the massive debt of the United States, the dollar seems destine for continued devaluation, which will continue to be positive for gold prices.

In the second stage of a bull market, gold prices continue to grow, due to increasing investment demand. Attracted by the gains of the first stage, speculators begin to buy gold as an investment. . . which further snowballs the price of gold.

Figures from GFMS show that identifiable investment demand increased 229% between 2003 and 2008.

Continuing this trend, gold investment demand continued to boom in the first quarter of this year, reflecting a desire for a safe haven from the U.S. dollar and other paper assets. Gold investment demand reached a historic high of almost 600 tonnes during the first quarter of 2009 — a whopping 248% increase compared to the same period a year earlier. In dollar terms, this represented a net inflow of $17.4 billion, up from $5.1 billion (or 42%) a year earlier.

GFMS Executive Chairman Philip Klapwijk wrote in a recent report, "Looking at the second half of 2009, investment demand, and especially its western elements, which includes activity in ETFs, futures and the OTC market, is expected to remain the driving force behind gold price movements."

The independent consultancy group predicts identifiable gold investment will exceed 1,500 tonnes by the end of this year. This estimate would represent a 36% increase over identifiable gold investment demand in 2008.

Investment demand will be the driving force that will push gold much higher over the next several months. As I mentioned, global gold demand figures for the second quarter of 2009 will be reported by GFMS around this time next month.

In the meantime, it's important to keep our eye on the prize. Don't get disheartened by another pullback in gold prices. Rather, use any pullbacks to add to or establish new gold positions. If gold does in fact slip below $900, we recommend buying every ounce you can afford.

Good Investing,

luke_signature.gif

Luke Burgess
Managing Editor, Gold World
Investment Director, Hard Money Millionaire

P.S. The most powerful governments, central banks, and investment groups in the world are still holding their gold reserves in anticipation of a significant rally in prices. This puts a virtual lock on Greg McCoach's latest gold investment recommendation. . . which yields two times the profits made by gold. In other words, every time gold goes up 1%, you're paid 2%. . . every time gold goes up 10%, you're paid 20%. To read more on how you can profit from Greg's new investment vehicle, just click here.

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