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GOLD: RECOVERY INSIGHT

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Despite increasingly strong supply/demand fundamentals, gold prices continue to tread water – more or less within a narrow $100 range – having hit overhead resistance a few weeks ago near $1175 and now testing support near $1075 an ounce.

For the past year or two, financial-market expectations of U.S. Federal Reserve interest-rate policies – driven by the day-to-day flow of economic news and pronouncements by various Federal Reserve officials – have been the single-most important determinant of day-to-day fluctuations in the price of gold and the longer multi-year correction in the metal’s price.

The persistent widespread belief, so far wrong, that the Fed would soon start weaning the markets off near-zero interest rates, has weighed heavily on gold prices and fueled bubble-like conditions in many other asset markets – notably equities, long-term bonds, the U.S. dollar, New York City apartment prices, fine art, and collectibles of all sorts.

The recent improvement in the flow of U.S. economic indicators, and hints of things to come from Fed Chair Janet Yellen and a number of other Fed officials, has raised expectations that the central bank will boost its short-term Fed funds interest rate a quarter-percentage point at the next Federal Reserve policy-setting meeting in mid-December.

And, as financial-market expectations shifted in recent weeks, the price of gold has fallen to the lower end of its recent trading range.

Many investors and financial-market pundits believe that rising interest rates will weigh down the price of gold. But, if history is a guide, we should expect both rising gold prices and rising interest rates over the next few years, much like the 1970s which saw the price of gold rise from $35 an ounce early in the decade to over $850 an ounce by January 1980.

Here's a more recent example: The last time the Fed raised interest rates was in 2004 to 2006. While the Fed funds rate rose over the period from 1.00 % to 5.25%, gold prices soared from under $400 an ounce to over $700 an ounce!

This time around, higher interest rates will likely undermine the much over-valued stock and bond markets – touching off a rush into gold.

We agree that an increase in the Fed funds rate may be in the cards, if not for this coming December than within the next few months. But we do not agree – apart from the possibility of a brief knee-jerk sell-off by institutional traders and speculators – that this will be bearish for the price of gold over the next few years.

Indeed, looking out a few years we see gold scoring new all-time highs regardless of Federal Reserve monetary and interest-rate policies.

Gold may be out of favor on Wall Street . . . but not on Main Street, nor across Asia where, led by China and India, gold buying continues apace, nor among the central bankers of a number of countries that want to reduce their dependence on the U.S. dollar by acquiring more of the monetary metal.

In fact, just yesterday, the World Gold Council reported that worldwide demand for physical gold rose in the third quarter to 1,121 tons – an eight-percent year-over-year increase and its highest level since the second-quarter of 2013. Importantly, we think global gold demand is actually much greater as some of the buying, particularly in the developing economies, remains unrecorded and hidden from government bean-counters. Even some central banks, especially the Chinese, the single-largest official buyer in recent years, have a history of underreporting their gold purchases.

While many hedge-find managers, institutional speculators, and the financial press have disparaged the yellow metal, retail investors and savers around the world have recognized a bargain and bought physical gold.

Some of this year’s growth in demand has been prompted by the lower prevailing price of gold itself. But, in addition to this bargain-hunting, increased interest in gold also reflects the rise in geopolitical anxieties, and a desire by some to insure against the growing possibility of a correction – or worse – on Wall Street and other major world stock markets.

Looking at the components of demand so far this year, demand for small bars and bullion coins rose by more than 30 percent over a year ago and jewelry demand is up by at least six percent. Importantly, we are now entering a seasonally strong time for gold buying in many of the key gold markets around the world so we should expect a further pick-up in demand in the weeks ahead.