Another Gold Boom in Sight: Chinese Inflation, Dollar Sell-off and Sovereign Debt Crisis Set Perfect Stage

The setting is perfect for another gold boom cycle to kick in, perhaps pushing the yellow metal into a super cycle. There are several factors aiding gold's further push into higher price records, greater investment worth and long-term reign as a de facto currency.

There are all sorts of classic factors supporting gold all the way, like the demand from China and India bursting at seams, 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.
Some analysts say if the Democrats and the Republicans reach an agreement on the debt ceiling talks, it may have a negative impact on gold prices. However, it is also pointed out that there will still be strong buy-back interest in the yellow metal as long-term gold investors will not waste an opportunity to consolidate their positions.

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.

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.

Some analysts are a bit skeptical about gold's imminent run into the super cycle. They aver that gold has shown a tendency to pull back following each of its ascents to records. But the truth is that gold has attained the status of a currency now, and in these volatile economic environments, it will remain bullish in the long term. Practically no market observer contradicts this view.

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.

It is worthwhile to check if 'conditions' really improved after two rounds of quantitative easing. How far has the employment scene as well as general economic growth benefitted from two rounds of easing? Negligible. Two rounds of fiscal stimulus have produced neither a sustained rise in growth nor a sustained drop in the unemployment rate. Another round would merely increase deficits and debt levels, says John H. Makin, analyst at the American Enterprise Institute.

So the dominant thinking is that conditions will continue to deteriorate, forcing the Fed to announce further monetary and fiscal easing. That will open a can of worms, but it will be a good tiding for those who are invested heavily in gold.

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.

The intensifying fears over Italian debt roiled markets which were already reeling from the crises in Spain, Portugal and Greece. In Greece, there is panic buying of gold as people are scrambling to steer clear of the seemingly crumbling banking system.

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 are very close to a turning point ... If we can break out above $1,560 an ounce, we will be at $2,000 very quickly, analyst Christian A. DeHaemer wrote in Wealth Daily.