Gold Bolstered by Both Global and Domestic Worries

by Peter A. Grant

February 24, a.m.
(from USAGOLD.com) --

Gold remains generally well bid above the $1400 level, underpinned by ongoing events in North Africa and the Middle East, skyrocketing oil prices, a softer dollar and slumping stocks. The yellow metal moved within $13 of its all-time high from late last year at 1430.88 in earlier trading, before retreating into the range. Silver is comparatively weak amid ongoing market chatter of huge commercial shorts under pressure and a supply shortage of deliverable silver ahead of Monday's first-notice for Mar COMEX futures contracts.

Fundamental events here in America seem to have been pushed to the back-burner in recent weeks due to geopolitical events on the other side of the world. Let's take a moment today to get caught up on some important issues a little closer to home.

Despite periodic glimmers of an improving economy in the data, the recovery remains sluggish. Nonetheless, the data has provided just enough impetus to spark debate over whether Fed accommodations should continue or not. St. Louis Fed President Bullard suggested that an improved outlook has sparked a "natural debate" about whether to complete or "taper-off" the Fed's $600 bln QE2 operation. Bullard expects further discussion of that topic at the March FOMC meeting.

Speaking at a different event, Kansas City Fed President Thomas Hoenig warned that the Fed's zero interest rate policy "invites speculation." Hoenig said that too-big-to-fail financial institutions pose the greatest risk to the US economy and that in his view, the situation is now "even worse than before the crisis." As for efforts to reform the financial system, Hoenig added, "As well-intentioned as the Dodd-Frank Act may be, it will not improve outcomes."

The AP reported yesterday that the number of troubled banks at risk of failure rose to nearly 12% of all federally insured banks in Q4-10, the highest level in 18-years. There were 157 US bank failures in 2010, compared with 140 in 2009, 25 in 2008 and just 3 in 2007. While FDIC chairwoman Sheila Bair recently said, "We believe that the number of [bank] failures peaked in 2010," there have already been 22 bank failures this year. That's two more failures than the same period from last year.

The US housing market remains under pressure, with talk of a double dip mounting. The December S&P/Case-Shiller home price index for 20-cities showed that prices fell 2.4% y/y. While US existing home sales rose 2.4% in January, up 4.92% from a year ago, prices are down 2.7% from January 2010. The HousingPulse Distressed Property Index suggests that nearly half of all home sales in January were bank owned or short-sales. New home sales plummeted 12.6% in January, well below market expectations, due to substantial inventory overhang and upward pressure on mortgage rates. This poses a real problem for the Fed, as tighter monetary policy is likely to put housing under further pressure, undoing the wealth effect they've created by underpinning the stock market.[chart]

Unemployment remains extremely high. While you could argue that 91% of people are working based on the BLS headline number, most people realize that the 'real unemployment rate' is quite a bit higher than 9%. Nonetheless, whether you're inclined to use the BLS jobless rate, the broader U6 number, or Shadow Stats alternative unemployment rate, there remains a considerable drag on economic recovery. Most economists -- along with Fed chairman Bernanke himself -- have acknowledged that unemployment is likely to remain stubbornly high for some time to come. This too presents a conundrum for the Fed regarding future policy moves, as a rise in interest rates could further slow the recovery, negatively impacting employment.

Finally, and put simply, the United States is broke and massively in debt. As our representatives in Washington grapple with this reality, a shut down of the government looms. Additionally, our national debt is butted up against the current $14.294 trillion debt ceiling. Congress will have to raise the debt ceiling in order for the Treasury Department to continue issuing debt. While Tim Geithner and company have been successful -- through some accounting tricks -- in forestalling the inevitable, it is widely believed that either the debt ceiling will have to be hiked by May, or the federal government won't be able to meet its obligations. With the US dollar's standing as the global reserve currency already under assault, the latter would certainly hasten the demise of the greenback. Yet, I think there is a growing consensus that the current pace of borrowing and spending is simply unsustainable.

Combine all this domestic uncertainty with all the geopolitical turmoil and you have a pretty compelling case for gold ownership. The markets seem to agree, with gold trading within striking distance of its record high.

Peter Grant is USAGOLD's resident economist and a well-known analyst globally in the forex and precious metals markets.

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