Short-Term Drop in Gold Prices Overrun by Profit Potential

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Money Morning Contributing Editor Peter Krauth yesterday (Monday) warned readers that a debt-ceiling deal could spark a short-term drop in gold prices, creating a key chance to stock up on the yellow metal.

As you may have noticed, he was dead on – but what he didn't foresee was that gold prices would bounce back as quickly as they did.

Krauth expected a rebound, no doubt. But when investors delved into the details of the feeble agreement conjured up by President Barack Obama and Congressional leaders, gold resumed its upward trajectory at a rate that eclipsed what even Krauth, a noted gold bull, had anticipated.

Gold futures slipped as much as 1.5% yesterday morning as news broke that a deal to raise the debt ceiling by up to $2.4 trillion was taking shape. But gold for December delivery bounced back enough to close the day down just 0.55% at $1,622.30 an ounce.

Gold prices climbed over the past few weeks as investors turned to the metal as a safer investment than stocks and U.S. Treasuries. Gold is up 14% this year, far outpacing the 2.33% gain in the Standard & Poor's 500 Index. The yellow metal hit an all-time high of $1,637.50 on Friday.

The drop in gold prices was short-lived because investors' concerns about the global economy outweigh the limited progress Congress has made reining in U.S. debt. While the weekend's debt compromise may prevent a U.S. debt default, it likely won't be enough to preserve the United States' top-tier AAA credit rating.

"Washington raising the debt ceiling is leading to still more borrowing and spending, and an ever-expanding money supply," said Krauth. "Over the long haul – as we've told you again and again here in Money Morning – this ever-growing debt load will be highly bullish for gold prices."

The growing federal debt will also continue to erode the U.S. dollar's value, pushing investors away from paper currency and into hard assets.

"On Aug. 1, the U.S. dollar officially lost its place as the world's safe currency as a store of value," Tom Winnifrith, a fund manager at t1ps Investment Management, told The Wall Street Journal. "In the absence of an alternative, the only currency whose value is not being systematically destroyed by politicians remains gold, and if you think recent increases in the gold price were startling, you ain't seen nothing yet."

Europe's sovereign debt levels and weak U.S. economic data also support gold's bullish outlook.

U.S. manufacturing in July grew at its slowest pace in two years, according to a report from the Institute of Supply Management. Its index of national factory activity fell to 50.9 from 55.3 in June. A reading below 50 indicates a contraction in manufacturing.

U.S. gross domestic product (GDP) increased by a paltry 1.3% in the second quarter, the U.S. Commerce Department said Friday, representing an economic recovery that has lost momentum and setting up for a weak second half of the year.

All these factors have pushed investor demand for the yellow metal to new highs. Holdings in exchange-traded products backed by gold reached a record $113 billion as of July 29, according to Bloomberg. The increasing interest has stretched supply thin – another catalyst for higher prices.

"It doesn't matter what you do with the gold price, we as an industry can't increase supply as fast as the demand is growing," Gavin Thomas, chief executive of gold miner Kingsgate Consolidated NL, told MarketWatch. "We're in the middle of a 10 year bull-run."

While some skeptics have cried "bubble" at gold's great climb, many say the metal has a ways to go before any danger of a price pop.

"The top of the bubble will be euphoric action, a big accelerated price move, and that's just not the case at the moment," Charles Morris, who oversees $2.5 billion at HSBC Global Asset Management (NYSE: HBC), told Bloomberg. "I would expect it to be a very popular asset at its peak, and I don't think we're anywhere near that. We think it's a bull market and we're on it."

Krauth says an exchange-traded fund (ETF) is a good move for investors to make now.

"The simplest way to gain exposure to gold stocks is by adding the Market Vectors Gold Miners ETF (NYSE: GDX) to your portfolio," said Krauth. "This ETF is composed of the world's largest and most-liquid gold and silver-mining companies, averaging about 10 million shares in daily trading, and a reasonable management expense ratio of 0.53%."

Money Morning Contributing Writer Jack Barnes also recommends Newmont Mining Corp. (NYSE: NEM).

"Newmont is due for its moment in the sun. The stock has put in what appears to be a bottom lately, and is starting a small uptrend," said Barnes. "Newmont has been out of favor this year, but with the rise in gold prices, it should start to get some attention pretty soon."

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  1. Gold Rate | August 7, 2011

    I'm bullish on gold long term, but I expected a sharper pullback short term and the longer we go without a pullback the more dangerous gold becomes. It would be healthy for it to come back down towards $1600 next week. Of course with FOMC coming, that may not happen.

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