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Why Gold Could Still Triple From Here


Strategists expect the yellow metal to move even higher.

Gold broke out to a new high yesterday of $1084, and the yellow metal is glittering again today.

More impressively, strategists note, gold prices moved higher on Tuesday even as the S&P 500 ticked up two points and the DXY index modestly rose to 76.3.

What has triggered this headline-making move in the gold price?

For one, the International Monetary Fund reported that it had sold to India 200 of the 403 tonnes it wants to sell this year. All that remains, market pros note, is the prospect for the other 203 tonnes to be sold, with speculation upon China as the eventual buyer.

But strategists point to another, perhaps equally important reason for gold's surge: fiscal policy in the USA.

Specifically, Peter Orszag, the Administration's Director of the Office of Management and Budget (OMB), delivered a speech yesterday morning at New York University, in which he said that the federal deficit during the current fiscal year will match last year's record high of $1.4 trillion. But he continues to predict the administration will cut that in half by the end of President Barack Obama's first term.

Is there a relationship between the price of gold and the US federal deficit and the amount of US public debt outstanding?

Apparently there is, says Ed Yardeni of Yardeni Research.

In a client note this morning, he notes that the price of gold has tended to lead the US federal deficit since the 1990s. The 12-month deficit peaked during the previous decade at $332.1 billion during April 1992. It then turned into a surplus of $277.8 billion during April 2001, on a 12-month basis.

During the previous decade, the price of gold peaked at $414.80 on February 5, 1996, Yardeni points out. It fell to $255.95 on April 2, 2001.

"It then took off without much downside volatility to yesterday's record high," Yardeni emphasizes. "As gold soared, the federal surplus evaporated and turned into a structural deficit that Orszag's OMB projects at $9 trillion over the next 10 years."

The investment strategist concludes: "So why did gold rally so much yesterday despite Mr. Orszag's assurance that the federal budget deficit will be cut in half? Apparently, the gold bugs don't believe him."

All this red ink bleeding out of Washington is certainly causing a lot understandable hand-wringing.

The American Enterprise Institute for Public Policy Research (AEI) published a paper indicating that "by all relevant debt indicators, the US fiscal scenario will soon approximate the economic scenario for countries on the verge of a sovereign debt default."

Steven Hess, Moody's lead analyst for the US, put it this way on Reuters TV: "The Aaa rating of the US is not guaranteed. So if they don't get the deficit down in the next three to four years to a sustainable level, then the rating will be in jeopardy."
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