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Rising Gold Prices Hinge on 3 Events

By Ed Moy,

With the bull market recording new records and investors discounting Ukraine, will gold prices slowly decline? That is certainly a possibility, but here are three reasons why I would not bet on it.

First, there is considerable risk from unwinding almost $5 trillion of stimulus from the Federal Reserve. Investors have focused on the tapering of quantitative easing, and if everything goes according to plan, the Fed will be buying zero government bonds and mortgage-backed securities by October 2014.

By then, the Fed will be holding almost $5 trillion of bonds and securities. The Fed’s plan is to sell them back to financial institutions and use the proceeds to cancel out the money they created to buy the bonds and securities in the first place. This untested experiment could take a decade or longer. But if they do not, the Fed would have to monetize the money that was not cancelled out. That means the potential for big inflation. Where there is big inflation, there is usually a falling dollar and rising gold.

Second, there is a growing expectation of a major stock market correction. All that money the Fed flooded financial institutions with was supposed to stimulate the economy through cheap loans. Instead, Congress has passed laws significantly limiting risk banks can take, and as a result, fewer companies and individuals qualify for loans. Besides, in a slow economy, it makes little business sense to expand when sales are not coming in.

So financial institutions made big investments in the stock market and global emerging markets. How else could the stocks sustain a five-year bull market and hit record highs in spite of dismal economic growth? Also note that the tapering of quantitative easing has coincided with sinking emerging markets.

Third, there is more geopolitical risk that can impact our economy, and technology has made that impact immediate and wide reaching. When Russia started its annexation of Crimea, gold quickly jumped $100 an ounce. Since then, gold has settled down to $1,300, because it is clear that while the United States and European Union think Russia is wrong, they will not hurt Russia if it hurts their own fragile economic recoveries. So the sanctions have little impact, the U.S. and E.U. economies are not affected and thus no need for a safe-haven asset.

But Ukraine is marching into civil war, which will have a spillover impact on Europe. That is not the only geopolitical situation brewing that could have global economic impact. Like Russia, China is flexing its acquisitive muscles with Vietnam and Japan. Iran is developing nuclear capability unimpeded. Syria is growing increasingly unstable. It will not take much for any of these situations to get out of control.

So while the global economy is in better shape today than it was a year ago, the recovery has been spotty and fragile. There is less risk, but there is still a lot of risk. And that means choppy times ahead, which is good for gold.

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