We Like Gold At The Current Level With 8.95% Target Returns

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 |  Includes: DGL, GLD, IAU
by: Invest Up

TRADE SUMMARY

- Stay long gold (ETF: GLD, IAU, and DGL; Futures: GC).
- The BUY rating was issued at 1289.86 on 4/02/2014.
- Our target return is 8.95% before leverage.

ANALYSIS

We continue to have a preference for exposure to gold.

The dominant driver for our positive outlook on gold is the high government debt level in the US. On the fiscal front, the US has created debt on a scale the country has never done before. The US government has been using its balance sheet to repair the balance sheets of financial entities and the private sector, putting the US itself at risk.

A long-term problem is that the debt accrues interest even if it just sits there, even when it is not expanded with new deficits. This will be the result of the US's failure to reduce its so-called primary deficit, which is the budget deficit minus interest payments. We are extremely skeptical about the official deficit forecasts and we think that, absent some unforeseeable event, it's irrational to assume that the US government's budgetary imbalances will improve as dramatically as indicated by the consensus. Health care, defence, and fiscal stimulus programs are likely to further worsen the budget balance. Consequently, we believe that the government's debt problem will continue to act as a drag on growth and leaving the economy under tremendous pressure.

It is generally understood that as a government expands its deficit, it does so eventually through the process of creating more of its own money to fill the gap between taxes and spending. In other words, higher inflation to dilute the debt is what the government needs and is working to achieve. Therefore, the current level of government debt makes a compelling case for higher inflation, if for no other reason than that it shows clear intent on the part of the central bank to do whatever it takes to offset the reduced demand in the dollar.

Since precious metal prices have a strong link to inflation rates, the direction of the inflation rates plays an important role in the gold market. During periods of high inflation, gold usually outperforms other assets. As there will more printed dollars in the market, each dollar will worth less than what it previously was worth. As the dollar's value falls, it takes more dollars to buy gold, therefore lifting the price of gold. As a result, our tactical views on gold are positive.