After peaking north of the $1,000 per ounce price level last year, gold hit a stumbling block when deflationary fears in the world’s largest economy sucked the air out of commodities prices and sent hoards of investors stampeding into the safe-haven of U.S. Treasuries, and helped spawn a rebound in the U.S. dollar.

Since that time, the global economic outlook – especially beyond U.S. borders – has improved, and gold prices have stabilized.

The next step – many gold bulls say – is for the yellow metal to make a run for new highs.

Whipsaw Trading Patterns

Gold started 2009 at about $870 an ounce – down substantially from early 2008 when prices hit a record-high $1033.90, but significantly higher than the $712.30 an ounce it was trading at in mid-November.

Then, when talk of inflation resurfaced in February, and later in April, prices surged well over $900 an ounce, again testing the $1,000 level. Gold prices hit $983 in early June – a 38% jump from their November low.

Gold prices have since lost some of that momentum, dropping back down to $940 an ounce, but many analysts believe this is where gold will find support before eventually shooting back to $1,000 – and possibly even higher – by the end of the year.

There are many reasons to believe that gold is poised for such a strong showing: Supply of newly mined gold is dwindling, fresh discoveries of deposits are on the wane, and demand has remained strong.

But the biggest reason analysts believe gold will rebound to its 2008 apex is that the medium and long-term outlook for dollar is rapidly darkening.

Government Support for Gold

With the U.S. Federal Reserve pursuing a policy of quantitative easing and a federal budget deficit that’s spiraling out of control, the dollar is extremely vulnerable.

The Federal Reserve has lowered its benchmark Federal Funds rate to a range 0%-0.25% and has said it will remain there for “an extended period.”

The Fed has also injected more than $2 trillion into the financial system, expanding credit through increased loans to banks to provide liquidity. It’s also created the Commercial Paper Funding Facility – which holds $109.2 billion in short-term IOUs issued by corporations – and the Term Asset-Backed Securities Loan Facility (TALF) – which has lent $25 billion to investors to buy securities tied to auto and other consumer and business loans.

And the central bank itself has pledged to buy $1.75 trillion in mortgage-backed securities, Treasury notes, and federal housing agency bonds.

“In the last year alone, the U.S. Federal Reserve has actually doubled the U.S. monetary base,” said Money Morning Contributing Editor Peter Krauth. “That can only lead to serious inflation, perhapseven hyperinflation.  This will cause the value of the U.S. dollar – which has been eroding since 2001 – to decline at an even-more-frenetic pace.”

In addition to the Fed’s action, the United States’ spiraling debt poses a significant threat to the dollar’s value, as well.

Federal debt will reach $12 trillion by this fall and exceed $13 trillion by September 2010, according to theCongressional Budget Office (CBO).

The CBO projects the U.S. budget shortfall will reach at least $1.85 trillion – equivalent to 13% of the nation’s gross domestic product (GDP), a level not seen since World War II – in fiscal 2009. And if the economy doesn’t rebound soon, that number will very likely top $2 trillion by the end of September.

The CBO anticipates the deficit will shrink to about $1.4 trillion in fiscal 2010 and $1 trillion in fiscal 2011, if the economy continues to stagnate, there is a good chance that those budget shortfalls will be even greater than the fiscal 2009 deficit.

Some of U.S. President Barack Obama’s advisors have already acknowledged that the administration underestimated the rapid rise in unemployment and that a second stimulus may be in the cards.

Laura Tyson, former chair of the U.S. President’s Council of Economic Advisers during the Clinton administration and current advisor to President Obama, said July 6 that the $787 billion stimulus passed in February was “a bit too small,” and that more may be required.

But if another stimulus is needed, how exactly does Washington plan on financing it?

While the government has continued to find buyers for its Treasuries, the question being asked by analysts is at what point will investors start to balk at continuing to finance the American expenditures.

China – the largest holder of U.S. debt – is already losing its appetite for U.S. Treasuries. In fact, the world’s fastest growing economy has already admitted to stocking up on gold to hedge against the dwindling value of its dollar holdings.

With the Dollar Diving, China Turns to Gold

China bought less than a sixth of the Treasuries issued by the U.S. government in the 12 months through March.  That stands in stark contrast to the Treasury market of two years ago, when China’s demand for U.S. securities actually exceeded the United States’ own borrowing needs.

Additionally, when China has purchased Treasuries, it has done so by swapping them with other U.S. assets, rather than exchanging foreign currencies or commodities. China has increased purchases of short-term Treasury notes – those that mature in a year or less – while at the same time unwinding its position in Treasuries with longer maturities.

“They are worried about forever-rising deficits, which may devalue Treasuries by pushing interest rates higher,” JPMorgan & Co. (NYSE:JPM) analyst Frank Gong told The Associated Press. “Inside China, there has been a lot of debate about whether they should continue to buy Treasuries.”
As Money Morningreported in June, Treasury Secretary Timothy F. Geithner traveled to Chinato reassure the nation about the value of its holdings. But not everyone was convinced.

“I worry about details,” said Yu Yongding, a former central bank adviser who interviewed Geithner for the China Dailynewspaper. “We will be watching you very carefully.”

Prior to Geithner’s visit, Yu told Bloomberg News that he was hopeful for details on the U.S. plan to support the dollar. He also warned that despite its sizeable commitment to U.S. debt, China has other options.

“I wish to tell the U.S. government: ‘Don’t be complacent and think there isn’t any alternative for China to buy your bills and bonds,’” said Yu. “The euro is an alternative. And there are lots of raw materials we can still buy.”

One such raw material is gold. China recently announced recently that it has increased its holdings of gold by about 450 metric tons in the past six years.

“Gold is shifting back from a sovereign reserve asset central banks were inclined to underplay to one of growing, strategic interest,” said Trevor Keeley, global head of sovereign client services at the Anglo-Swiss bank UBS AG (NYSE: UBS). “This shift is logical; gold remains the world’s primary financial asset that is no one’s liability.”

And China’s not the only one loading up on the yellow metal.

Whether it’s through exchange traded funds (ETFs), or acquiring actual gold bullion, investor demand for gold continues to soar.

Individuals’ bullion purchases almost doubled last year to 862 metric tons, The Wall Street Journal reported. And while gold buying by investors has fallen from its 2008 peak, the volume still remains historically high. The 130 metric tons of gold purchased in the first quarter of 2009 is 50% higher than this decade’s average quarterly volume.

Of course, bullion isn’t the most practical way to get in on gold’s pending surge.

How to Stock Up on Gold

One way to stock up is to buy gold outright, either in bars, or though the gold-linked, exchange-traded fund (ETF) SPDR Gold Shares (NYSE:GLD). Today, SPDR itself holds more than 1,000 ounces of gold, and has a market capitalization of $33 billion.

The fund’s price fluctuates in concert with the price of gold, which adds a small mount of risk. On the other hand, however, buying this ETF is more convenient than buying gold bars directly, because the fund dispenses with the accompanying storage problems that comes with actually owning physical gold.

Buying stakes in gold miners is an excellent way to hedge against the enormous inflationary pressures filtering through the U.S. economy.

In this case, the Market Vectors Gold Miners ETF (NYSE: GDX) – composed chiefly of major gold miners – offers both company and geographic diversification, while including substantial leverage to the price of gold.  Market Vectors is based on the AMEX Gold BUGS Index(HUI), which represents a portfolio of 15 major gold mining companies that do not hedge their gold production beyond a year and a half.

Source: With Inflation on the Horizon, Gold Prices are Ready to Rally

Facts: The open interest in futures contracts on the Comex has fallen to its lowest level since summer 2005, breaking a general uptrend in place since 2001. From a contrarian standpoint, the short-term bottoms in these data tend to favor the buyers over the sellers. However, the statistic went into orbit during the last half of 2007 — it broke away from the upper channel on the charts, creating a bubble in appearance. The current extremity could simply be a symmetrical reaction to that extreme.

Nevertheless, this is a bearish fact, technically speaking, if it represents a lasting new trend.

It is tempting to suggest that the threat of a raid in futures contracts is causing a short squeeze.

It is true that the commercials are liquidating their short positions promptly. But the funds are increasing their short bets, and the liquidation of longs is such that the net short ratio has hardly budged off its mid-September low — which, incidentally, is a level that has coincided with strategic buying points at seven other junctures since the bull cycle began in 2001.

However, the record of this statistic in gold is unique in that during bear markets, the commercials tend to be net long (wrong) most of the time.

So the fact that they are covering their short interests on net does not necessarily presage a rally if a bear market has set in. A bear market would mean that gold prices could fall as far back as US$500.

Fundamentally, the conditions just don’t look ripe for a bear.

I don’t believe the COTs (Commitment of Traders report published by CFTC) have any real predictive value. They tell us only whether the market is too much extended one way or another; they don’t tell us how long those conditions will last. Right now, the structure of the market is healthy. The commercials are covering their shorts, the funds are getting short and the numbers basically favor the bulls. The contraction in open interest worries me a little, but it could be explained in terms of a collapse in spread trades linked to various index products.

In its most recent report on gold demand, the World Gold Council said as much in trying to explain the drop in the gold price in the context of soaring physical demand. In its third-quarter report on gold demand, the WGC noted growth in both jewelry and investment demand across the spectrum relative to both the last quarter and the year-ago quarter. I don’t want to go into a critique of the method here, except to point out that it chronically understates investment demand and overstates jewelry demand.

The inclusion of ETFs all but proves the point.

In just one year, investment demand has grown in importance from under 15% to over 30% of total gold demand, causing the deficit (supply shortfall) to grow nearly tenfold. The WGC interprets this deficit as supply coming from speculative sources, like futures trading or changes in inventories at the various exchanges — like at Comex. Thus, it calls it “inferred investment.” Formerly, it called this the “balance.” But as it grew, the WGC decided it meant something. What is causing it to grow, aside from growing demand in general, is that while the WGC is “identifying” new kinds of demand, it has not kept up with the various sources of supply. Gold bugs have argued for years that the supply of gold is not limited to mine production, officialdom or scrap… that it is not like other consumable commodities.

It is more useful to assume that most of the gold ever produced is held as a reserve, or store, aboveground. And if this is true, then investment demand must be much larger than the WGC calculates, or the price would, frankly, never go up. If the WGC is smart enough to include producer hedging (or dehedging) in the equation, it should also include a measure of demand that expresses itself through all the exchanges and bring itself up to speed on all the sources that supply the market. It assumes that jewelry demand dominates the market, which is incorrect, but even if it were, it still has the wrong idea.

Jewelry demand may be price sensitive in the short term, yet it has grown every year, at successively higher prices, since the bull market began. Despite my objections, however, I am in total agreement with the council’s explanation why gold prices have fallen despite the evidence of soaring gold demand:

“Notably, the selling captured by the [inferred] investment category was mainly by investors with a short-term focus. It largely reflects the fact that gold was caught in the downdraft of other commodities and other assets — it does not reflect a questioning of gold’s value or role as a safe haven. The strong buying in the ETF and bar and coin markets during the quarter, which reflects investors with largely a longer-term focus, suggests that investor belief in gold’s role as a safe haven and store of value is stronger than ever.”

Morgan & Citigroup Gold Analysts Bullish on Gold Regardless of Dollar

No wonder the commercials are covering. The establishment is getting hot for gold.

PMorgan’s gold analysts “urged” investors to stock up on gold this month, citing counterparty risk and tight supplies. See the article here.

Citigroup’s foreign exchange group also put out a bullish tout.

Well, that’s an understatement, actually. “[Gold] continues to look like a bull market to us. We continue to believe that a move of similar percentage to that seen in the 1976-1980 bull market can be seen, which would suggest a price north of $2,000,” Citigroup’s FX group said last week.

What I found particularly intriguing, besides the timing of these calls, was that they both discounted the dollar. That is, they noted, as I have in the past, that the foreign exchange value of the dollar may not be important at this stage. Morgan said, “It is not an absolute given that a rally in gold means a falling U.S. dollar,” while Citigroup (NYSE:C) pointed out, as I also have, examples of just such a situation during the 1970s.

Anyway, it’s not a sure thing yet, and it all makes great fodder for the bull market in gold.

Source: Bulls Rev up for Comex Raid, Commercials Exit Stage Left

Platinum did much better, pushing higher through the NYMEX session and trading sideways during the afternoon, to end just off its intraday high at $1960/oz., up $33. Overnight, platinum is sharply lower.

Silver ran all the way to $17 at mid-morning, before determined afternoon selling took it back to a close at $16.84, up 15 cents. Overnight, silver is trending lower.
(Click here for charts)

A pretty lackluster day for gold, although its sister metals performed well, as buyers are trying hard to put the ‘correction,’ if that’s what it was, behind them.

It didn’t hurt that it was a very supportive day on the part of the usual suspects, surging energy prices and a dollar that continues to tank, although gold bulls had to be disappointed that the metals market didn’t react more dramatically.

Clearly, traders are not throwing their arms entirely around the factors that are breaking so much in their favor. It is also likely that some see the bounce of recent days as an opportunity to take some cash off the table. And others may be watching as the first quarter reports from the gold miners flood in.

Most influential, though, is probably the dollar. Many are wary after it had such a run-up against the euro, and are biding their time until they become convinced that the buck has truly turned down again.

Jim Sinclair, of jsmineset.com, isn’t mincing his words on the subject. “Keep in mind,” he writes, “that the fundamental reason for gold’s normal violent reaction was the euro coming off the $1.60 level, seen by some as a top. It is NOT!”

He goes on to say that “it is unlikely that the ECB will join the Fed in the race to 0%. Considering inflation even at the manufactured rate the PPI and CPI show, the Fed is giving away money in exchange for garbage paper at ZERO percent.”

Sinclair concludes: “I dare to say the bottom in gold has occurred this week. Gold will take out $1024 on the third try. Now the magnet is at $980 to $985.”