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Why Gold Could Still Recover

|Includes:Goldman Sachs Group Inc. (GS)

Gold started the year at a price of $1,202.30 per ounce, rising to highs of $1,379.00 per ounce in March, a price movement that starkly contradicts analyst's estimates, which was that gold would decline in 2014 in view of the prospect of higher interest rates.

Although gold declined mid-May to just under $1,300 per ounce, it is still trading at a significantly high premium relative to Goldman Sachs' (NYSE: GS)end year estimate, which put the 2014 end year price of gold at around $1050 per ounce, 15 percent lower than 2013's close of $1,207.50 per ounce. Some analysts believe that gold could fail to advance sufficiently to offset the March-May retreat, and worse still, that its price could decline further to conform to Goldman Sachs' projection. This is because of increased positive economic data from the U.S., including declining unemployment and fewer jobless claims. The rate of unemployment is currently at 6.3 percent, the lowest in over five years. Similarly, the fewest Americans in seven years filed applications for unemployment benefits in early May. "People don't need to invest in a safe-haven asset like gold when the economy is doing just fine," said Phil Streible, a senior commodity broker at R.J. O'Brien & Associates, as quoted on Bloomberg.

The general idea is that if the U.S continues to churn out positive economic data, interest rates could increase and income investment vehicles could become increasingly attractive, reducing gold's appeal as an investment.

Interest Rates May Not Increase Soon

The idea that interest rates will rise is not misinformed. Not only do historical trends support the argument that interest rates rise when the broader economy is recovering, but declining unemployment in the U.S. has sparked fears that we will start seeing wage inflationary pressures soon, potentially prompting an even swifter upward revision of interest rates.

Despite all the arguments supporting an imminent increase in interest rates, minutes from the Fed's April 30th meeting suggest otherwise. Federal Reserve officials discussed rate hike procedures at the meeting but did not signal that rate hike action would come any time soon. This means that if interest rates don't rise soon, yields from debt securities and to some extent dividends from equities, will largely remain the same in the mid-term. Demand for gold is thereby likely to remain relatively strong going forward.

Geopolitical Drivers

Moving away from the economic discussion, geopolitical drivers, particularly the conflict in Ukraine, are playing an increasingly pertinent role in strengthening gold's appeal as a safe haven investment. It is now emerging more clearly that Europe's and the U.S.'s vision of how Ukraine should develop is fundamentally different from Russia's. This ideological rift means that future developments in Ukraine could prompt an escalation of uncertainty not only in the region, but for U.S., EU and Russian business interests, further increasing gold's appeal as a safe haven.

Stocks: GS